In any given year, you probably have expenses you know are coming – holiday gifts, the family vacation you take every summer, annual homeowners association fees, or perhaps home renewals. membership. But just because these costs are predictable doesn’t mean you’re always prepared.
If you’re dipping into your emergency fund or using a credit card to cover foreseeable costs, you might consider using one or more “sinking funds.” A sinking fund is a savings account dedicated to a particular expense that you fund gradually through regular payments. Sinking funds often have a maturity date, but not always.
You can add sinking funds to your budget for expenses that come up at the same time every year or to plan for a big purchase you want but don’t necessarily need – like a new couch for your living room or that amenity. exercise you’ve been eyeing for months.
Either way, sitting down with your calendar and writing down upcoming expenses is a good way to anticipate foreseeable costs and avoid unwanted debt or dip into your emergency fund.
How do sinking funds compare to other savings accounts?
A sinking fund is different from other types of savings accounts — like an emergency fund or a traditional savings account — in several ways. An “emergency fund is for real emergencies, and then your sinking fund is for a planned, planned purchase in the future that we know is coming,” says Miko Love, credentialed financial advisor and creator of The Budget Mom, a website with resources to help people create and stick to a budget.
Because they have different purposes, it is wise to separate sinking and emergency funds.
“I think it’s a good idea to separate your emergency fund from a sinking fund just because otherwise it’s a little tempting to dip into your emergency fund for things that aren’t really emergencies,” says Madison Block, a marketing communications and programs associate at the nonprofit American Consumer Credit Counseling.
Sinking funds also differ from traditional savings accounts because they have a specific purpose and maturity. It helps you track progress on multiple goals while putting all your savings into one big jar can get confusing and cause you to lose sight of your goals.
The sinking fund strategy
Most sinking funds have a target date, and with that deadline “comes a strategic way to plan this purchase responsibly,” says Love, who currently has 13 sinking funds. For example, if homeowners association fees are due in May of each year, you can start planning ahead to have the money on hand.
Take the example of HOA: if annual dues are $500 and you have six months to save, you need to put about $83 per month into your sinking fund. Or about $42 per paycheck if paid bi-weekly. Or $21 per week. As you can see, it is highly customizable.
You can also use windfalls such as tax refunds or cash donations to boost these accounts and reach your goals faster. Remember: Put money into sinking funds based on priority and need. Required fees or memberships should come before wants, such as a new couch or exercise bike.
If you have money left over in a sinking fund, keep it there to get ahead of the game next year, reallocate it to the next priority, or boost your emergency fund, if necessary.
Can we have too much sinking funds?
The trick with sinking funds is to find the right balance. “You can absolutely complicate your finances too much by having too many of these sinking funds,” Block says. You might find having multiple buckets of savings to fund with each paycheck seem overwhelming. Setting up autopay could be a way to streamline things. Some banks offer their customers the option of customizing savings tranches in their accounts.
Determining your top priorities and setting up sinking funds is a good start. “(Y)ou probably don’t really need a separate sinking fund for every little expense you plan,” Block says. You can always add more sinking funds if you find this strategy works for you.
Are sinking funds right for you?
This is a low risk savings strategy for expected future costs. “I believe sinking funds can be for anyone, no matter where they are with their finances,” Love says.
Managing sinking funds also “trains us to create healthy habits in our lives to prepare us for the things that put us in debt,” Love says.