When you hear the term sinking fund, the first image that comes to mind may be of a sinking pirate ship with treasure on board. That’s not what we’re talking about here.
In fact, sinking funds are a great addition to your financial strategy. A sinking fund works like a savings account, but with its own purpose and approach.
A sinking fund is money you set aside for a specific upcoming expense. Unlike a general savings account or emergency fund, a sinking fund has a clear purpose, whether it’s saving for a vacation, a down payment on a house, or a big splurge. Financial educator Haley Sacks has a leaking account just for astrologers.
If you have a big expense coming up, you might consider setting up a sinking fund to take the stress out of saving.
Let’s talk about what a sinking fund is, how it works, and what makes it worthy of being a line item in your budget.
What is a sinking fund?
A sinking fund is a safe, secure, and liquid savings account that is earmarked for a specific future expense. You can use a sinking fund for almost anything, but it helps to have an approximate amount and a timeline in mind. This will help you plan your budget until you reach your goal.
“[Sinking funds] allow you to take small, manageable steps towards your ultimate goal,” says Sophia White, CEO and Founder of The balanced budget.
Sinking Fund Examples
Some common known upcoming expenses include:
- Vehicle purchases or financing
- Car repair or maintenance
- Home repair or renovation
- Insurance premiums
- Buy new furniture
- Saving for the holidays
- Holiday and Travel Gifts
- Paying self-employment taxes
- A big event, like attending a wedding or having a baby shower
- Living expenses during parental leave
These are just a few to get you started. Really, you can use a sinking fund for many other types of expenses.
Sinking funds serve their best purpose when you have a known upcoming expense, assign a timeline, and work it into your budget. They are completely separate from your emergency fund and other savings accounts.
Sinking Fund Vs. Savings Account
When it comes to a sinking fund or a savings account, it’s all about intention and the desired outcome.
A savings account is a place where you can safely put your money for your needs and long-term goals.
When you have an expense that you know about, you don’t want to mix funds inside accounts for larger purposes that don’t have a specific timeline.
For example, you don’t want to pay your insurance premiums from the same account you use to save extra student loan payments, because the lines can quickly fade.
It is best to separate your financial goals from each other so that you are not tempted to use the money you have saved for purposes other than those for which it is intended.
Sinking Fund Vs. Emergency Fund
An emergency fund is money set aside for the worst-case scenario, such as a sudden loss of income or a large, unforeseen expense. “You have no control over when this will happen. An emergency fund is your safety net for covering these types of emergency expenses,” says White.
A sinking fund is for purchases with a set schedule, and emergency funds are for unknown expenses that occur without warning.
You never want to keep these accounts together, just in case you use your sinking funds for a purpose and experience an emergency right after. If this were to happen, your funds could be totally depleted, depending on how much you keep in your emergency fund, and end up derailing your progress.
How to Start a Sinking Fund
To get started, review your past spending to get an idea of what will show up again in the future. For example, if you pay for your car insurance every six months, you will have an idea of when your premium will be due again.
Make a list of everything you want to save for, so that when it comes time to pay those expenses again, you can dip into your sinking fund and deal with it right away. Peasy easy.
Next, decide how many months or pay periods you need to reach your goal. For example, if you need $1,000 for a vacation, you would need to save $83 per month. If you decide your budget allows more, you can save $167 per month over six months instead. Adjust the schedule until the amounts are meaningful and manageable.
Commit to your goal by transferring the amount to your sinking fund account each month or each pay period. Reach the goal by paying your expenses when they are due. Take a moment to appreciate your accomplishment. Repeat as often as needed.
Where should you keep your sinking fund?
Whatever you do, don’t mix your sinking funds with your other accounts. This method works best when you have a completely separate account.
If you are disciplined and not prone to temptation, you can open a separate savings account with your main bank and label it accordingly. This way you will see all of your sinking funds clearly listed in your main account dashboard.
But if you know you’re going to give in and dip into the funds for other expenses, be honest with yourself and open an account elsewhere – an online-only savings account is perfect as it takes a few days to complete a transfer out of account. , so you’ll be more likely to leave it alone.
“You can choose to keep it in a separate checking account if you plan to use those funds quickly,” says White. If your goal is several months to over a year away, you can even opt for a high-yield savings account to earn some interest.
You can have as much sinking fund as you need for various expenses. As long as there’s room in your budget and you’re making regular contributions, you can use sinking funds and distribute them as you pay off expenses and plan new ones.
Other Types of Savings Accounts You Need
Ideally, before you start your sinking funds, you’ll have your other accounts in order — that means a fully funded emergency fund and no high-interest consumer debt, like credit cards.
If you don’t already have an emergency fund, it’s a great idea to have at least 6-9 months of expenses set aside in case something happens. Many experts recommend more, but the amount you need depends on various factors regarding your personal finances.
Once you have an emergency fund, you can tackle debts such as credit cards, personal loans, and medical bills. Once these are covered, you can focus on sinking funds.
Remember to review your budget from time to time and adjust it as you progress or as needed.