Advanced Budgeting: Part 1: Sinking Funds
Updated: Apr 21, 2022
One of the issues that my clients face is the month-to-month fluctuations in their expenses. It appears to them that there are months when their expenses surpass their income, and then there are months when they have a surplus with money left over. Most clients don’t know how to smooth them out. The secret is to use "sinking funds," a better planning method for non-monthly costs.
Consider the following scenario and the typical flow of non-monthly spending: In the example, I consolidate the constant expenses and focus on a few "examples" of non-monthly expenses.
As you can see, the monthly expenses range from $700 to $1,300. So, if you're trying to live month to month on a fixed income, imagine the stress that some of these months cause. This is especially true if these peaks exceed your fixed income.
Coaching clients to smooth this out is one of my specialties. My favorite method is to figure out the annual budget versus the monthly budget. In this example, you can see where I totaled up the annual spending for these non-monthly expense categories on the right-hand side of the table. Then I divide the annual sums by 12 to get the monthly totals, shown in the far-right column. In this example of expenses, the goal is to keep your monthly budget stable at $877 every month.
Peek at what this would look like.
Now, if you want additional money for Valentine's Day or Christmas, you just change your annual amount, divide it by 12, and add it to your budget. Now, keep in mind that these are some non-monthly examples. Hobbies, sports fees, school supplies, seasonal school clothes, and summer camps are even more items to consider. You most likely have even more.
Now, Coach Ryan, this looks perfect, but it's unrealistic. If we are in May and my car registration is due in June, how do I budget $10 and then be able to pay it? Well, great question. This is where a coach is powerful, as we can help you build your transition plan. In most cases, the way this works is that you will still have some ups and downs, but as you go forward, each month it will get smoother and smoother until you reach the consistent month-over-month level you desire. Let us dive into your worries. You are in May, and a car registration of $125 is due in June. Thus, you take that bill and divide it by the number of months until it's due. In this case, the number is two (2). So, you would budget $62.50 in May and June, and then in August you would start to budget $10.42 for next year’s car registration.
Now let’s take a more critical one: Christmas. It’s May in our example, and Christmas is December, and you haven’t started budgeting for it yet. We wish to spend $600 this year, and we want to start buying things in November, so let's use 7 as the number of months we must save until we shop. So, your Christmas budget from May through November would be $86. Then in December and into the next year, you can drop that back down to $50 a month. The other cool thing about budgeting and creating cash flow is that if something really cool goes on sale in August and you want to buy it for Christmas, because you have been budgeting, you have the cash flow built up to buy it while it is on sale in August versus the price increase around the holiday.
Are you starting to see how this works? You go from where you are today, highs and lows, to smoothing out your budget so it becomes more consistent each month.
When you reach this advanced level of budgeting, you will start to feel so much more in control of your financial situation.
The next blog post will be a continuation of this topic and will show you how to ensure you maintain a positive cash flow all year long.