We got an exciting piece of mail the other week! My husband’s dear friend from high school is getting married in Hawaii next fall. When we opened the save the date and got past the excitement of a destination wedding in Hawaii we decided this was a can’t miss opportunity for us to travel Hawaii. We had already been in talks to take a vacation this fall but this exciting piece of news helped up pick our fall vacation spot. This will be our first destination wedding and we couldn’t be more excited to celebrate with this incredible couple in Maui!
With the fun and excitement of picking a vacation spot behind us, it was time to create a budget for the trip and start the savings process.
I won’t get into too much detail on our personal vacation budget but I will share with you all that we aim to keep our annual vacation spending to 5% of our after-tax income.
Where does this number come from? For those of you who read my post on budgeting, I talk about the 50/30/20 rule for budgeting:
- 50% of net income towards essentials expenses
- 30% of net income towards discretionary expenses
- 20% of net income towards savings or debt repayment
The 5% is the amount we’ve personally chosen to carve out of the discretionary expense bucket for vacations. Other items that fall into the discretionary category for us include dining out, clothing (of course!), entertainment, hobbies and miscellaneous items. Because of the other demands within this category, we personally only allocate 5% to travel as its not as high of a priority for us as going to concerts and our hobbies of golf and snowboarding.
What it comes down to is prioritizing the sub discretionary categories and allocating the 30% budget between those items. For some folks, vacation is at the top of the list. There is no wrong answer and everyone’s travel budget will look and feel different depending on what they place the highest value on.
With our annual vacation budget set, it’s time to start saving to meet our goal. While there are many methods to save for a financial goal, my husband and I are adopting the “sinking fund” strategy to ensure we are able to cover all the expenses that will come with the our trip to Hawaii. The term sinking fund comes from the idea that this is a sunk expense as we have already committed to making this purchase at some point in the future.
The first step to designing a sinking fund is to identify the cost of the trip which was discussed above. Next step is to determine how long you have to save for the trip and do the math to figure out how much should be set-aside each paycheck or month.
Let’s look at an example:
- Expected Cost of Trip = $6,000
- Number of Months until Trip = 12 months
- Monthly Savings Required = $7,000/12 = $500/mo.
In this scenario the trip taker would need to save $500 each month to ensure their total trip expenses are covered by savings. In reality, a big ticket trip is paid in installments so be sure there are enough funds in the account to cover plane-tickets and hotel/lodging at the appropriate intervals. To implement the sinking fund, the user would set-up a separate account and then set-up a recurring deposit to match the monthly savings amount identified. From there you set it and forget it until it’s time to start covering trip expenses like air fare and lodging reservations.
Having a separate pool of assets already identified for an upcoming expenses alleviates the stress that often comes with making big purchases. It also prevents the trip taker from putting trip expenses on a credit card with no re-payment plan. The funds will be there waiting to cover those lumpier credit card statements with car rentals, scuba excursions, helicopter rides and meals out for a week straight.
Sinking funds can be used for for short term, mid term and long term financial goals. Think an holiday gifting, an upcoming car purchase or a down payment on a future home. The real difference is the amount of time you have to save and where those savings are held. For short and mid-term goals, its best to keep those savings in a savings account, preferably high yield earning in excess of 1.5% interest. For those financial goals with a timeline of three years or greater, it may make sense to invest those funds in a taxable brokerage account.
Now that my husband and I have an automated savings plan in place for our trip to Hawaii we can now focus our attention to planning the trip. Would love to hear from you if you’ve been to Maui. Where did you go and what excursions do you recommend?