What are Sinking Funds and are They Smart to Have?
(This page may contain affiliate links and we may earn fees from qualifying purchases at no additional cost to you. See our Disclosure for more info.)
It can be overwhelming to learn how to manage your money and build a financially secure future.
Paying down debt, budgeting, tracking expenses, saving an emergency fund, and opening investment accounts take patience and focus.
You’ve made good progress some months, but sticking to a budget and saving money has been hard. Bills and expenses always seem to come up and throw you off track.
It seems like you have to dip into your emergency fund for things that aren’t emergencies too.
You don’t have a budget line for maintaining or repairing your car, a weekend getaway for your anniversary, an overnight summer camp for the kids, and gifts for the holidays.
Yet you know you’ll spend money on things like this each year.
This is why it’s a smart idea to add sinking funds to both your vocabulary and your budget.
Sinking funds help prevent you from busting your monthly budget. Or taking on more debt for expected – but not regular monthly expenses.
And if you think sinking funds are just for people who are starting to build their financial house, think again.
Unless money is no concern at all, making the shift from frantic spender to prepared saver can improve your financial health and reduce your stress.
What is a Sinking Fund?
You may have set up a monthly budget after tracking your expenses for a few months. While that's a great first step in taking control of your finances, it isn’t surprising you’d come up short some months.
We tend to keep monthly budgets consistent, even though spending can vary greatly. The use of sinking funds can help preserve stable monthly budgets.
A sinking fund is used for short-term savings goals for expenses you expect to have but are not a part of your regular monthly spending.
You plan and save money in small amounts over some time for a specific purpose.
Sinking funds are a useful strategy to help keep you out of debt. You’ll use these funds, rather than putting expenses on a credit card or using money from your emergency fund.
Let’s take holiday spending as an example. If you plan to spend $600 on gifts this holiday season, you’ll put $50 a month into your holiday gift fund.
When it’s time to shop, you can withdraw this money and use the cash to make purchases, or you can pay your credit card bill with this fund.
Your parents or grandparents might call this a “Christmas Club” account.
While it’s easier to customize savings accounts and set up several at one bank now, these accounts are still popular with some people – especially those who use credit unions.
If you get a “save the date” card for your cousin’s out-of-state wedding, create a sinking fund.
Determine how much you think you’ll spend and divide the amount by the number of months or weeks left before the wedding.
If you think it will cost around $1000 and their big day is five months away, direct $200 per month into a “wedding trip” sinking fund.
How Are Sinking Funds Different Than Emergency Funds?
Sinking funds will help prevent you from using money in your emergency fund for expenses you should have been able to anticipate.
At some point, your house will need repairs and so will your car. You’ll visit the dentist, get new glasses, and you’ll take your pet to the vet for shots.
Yet, you might not have a budget line for these expenses because they aren’t a part of your regular monthly spending.
Rather than using money from your emergency fund to cover bills you know you’ll have at some point in the year, set up a sinking fund to pay them.
Try to keep your emergency fund for emergencies – severe illness or injury, the loss of a job, or a flooded home. These are unexpected expenses.
While it might be tempting to use money in your emergency fund for other things you consider essential, don’t risk going into serious debt for things you could have planned for.
You plan to spend sinking funds. You hope you’ll never have to spend emergency funds.
Categories of Sinking Funds
Renting a beach house for a week in the summer? Saving a downpayment for a home?
Paying insurance or tax payments annually or semi-annually, rather than by the month?
You can create sinking funds for all of those expenses and more.
Sinking funds are another excellent example of why it’s called “personal” finance. The funds are aligned to meet your needs and lifestyle.
Here are some examples of sinking funds:
- Preparing for a new baby
- Maintenance or Repairs (car, home)
- Car replacement
- Pets
- Gifts (birthday, anniversary)
- Holidays
- Home upgrades/remodeling
- Medical bills – dental or vision care
- Clothing
- Charitable giving
- House downpayment
- Insurance premiums
- Travel/Vacation
- Kids sports and activities
- Taxes
- Utilities (quarterly, annual)
- Membership renewal
- Fees, licenses, subscriptions, dues
Where To Keep Sinking Funds
Once you decide which sinking funds you need, how much to save each month, and adjust your budget – you’ll need to choose where to keep the money.
Using cash envelopes, multiple jars or piggy banks are an option for smaller funds.
But if you think you might be tempted to spend cash (or if you’re afraid it could get lost or stolen) – it’s a better idea to use savings accounts.
Your neighborhood bank or credit union may allow you to set up multiple accounts and name each one separately. Just be sure you won’t have to pay fees to maintain the accounts.
Using high-interest online savings accounts such as those offered by Capital One or CIT bank is a way to make money on your money – even if you only save for a few months.
It may be a little extra work, in the beginning, to set up your sinking fund accounts. But if you automate deposits – you’re well on your way to reducing stress!
You can easily track these funds using a sheet of paper, spreadsheet, or with financial apps like Mint, Tiller, and Personal Capital.
You’ll be prepared for those expenses you know are coming but you failed to budget for adequately in the past.
Safeguard Your Budget With Sinking Funds
While compound interest, net worth, and target-date retirement funds are important financial terms to learn about and understand, sinking funds will help you manage your money so you can invest in your future.
And that goes for those of you just starting to get your finances in order, to those looking to improve upon how you currently budget your money.
Shifting from reactive spender to proactive saver will improve your financial house and lessen your financial stress.
Written by Women Who Money Cofounders Vicki Cook and Amy Blacklock.
Amy and Vicki are the coauthors of Estate Planning 101, From Avoiding Probate and Assessing Assets to Establishing Directives and Understanding Taxes, Your Essential Primer to Estate Planning, from Adams Media.
