What You Need to Know About Sinking Funds

Money seems to disappear quickly. One week, your savings account looks great, and the next, you’re staring at your phone wondering where your money went. Since there’s always something new to spend on or save for, it’s crucial to plan ahead. Keep reading to learn what a sinking fund is, how it’s different from other savings methods, and how to start one today. 

What is a sinking fund?

A sinking fund is money you intentionally set aside for a specific goal or expense. Instead of paying for large costs all at once, you save a little each month so that the expense is manageable when it arrives. It’s perfect for occasional costs or large purchases that you don’t want eating up your entire monthly budget, like vacations, home repairs, vet bills, or annual insurance costs.

For example, if you’re planning to spend around $600 on holiday gifts for your family and friends next season, you could break up the expense over the course of the year. Saving roughly $50 each month feels less intimidating than footing the entire bill for presents in December. Other savings goals could include new tires for your car, replacing your smartphone, or seeing your favorite artist in concert. You can create a sinking fund for just about any financial goal that you want to plan ahead for.

What's the difference between sinking funds vs. savings accounts?

Sinking funds and savings accounts are closely related, but they aren’t the same thing. A savings account is where you save your money, whereas a sinking fund is how you organize and use that money for specific goals. If you’re trying to save for several things at once, such as a birthday gift, new video game console, and post-grad certification, it may be overwhelming. Keeping all of the funds in the same savings account can make it easy to lose track of your progress with each individual goal.

Instead, you can create a sinking fund for each specific purpose. That way, you’ll know exactly when you hit your savings goals and how much you have to spend in each category. Some online bank accounts allow you to create and label sub-accounts for different purposes. If your bank doesn’t offer that feature, you can create a simple spreadsheet to keep track of your money. Tracking your progress digitally gives you a clear visual of where your money’s going, helps you make quick updates, and can keep you motivated on your financial journey. 

What's the difference between sinking funds vs. emergency funds?

A sinking fund is also different from an emergency fund. The sinking fund should be used for future expenses that you expect, like annual insurance premiums, property taxes, or vacations. You can dip into it whenever you need, as long as it’s for its intended purpose. The main goal of a sinking fund is preparation.

An emergency fund, on the other hand, is for life’s surprises. Urgent and unexpected expenses, like job loss, medical emergencies, or a broken furnace in winter, are examples of when it’s okay to use your emergency fund. It’s your safety net for true emergencies, and not for impulse buys or “limited-time” sales. The goal of the fund is protection against unexpected expenses. 

Both funds help you avoid debt, but they solve different problems. A sinking fund keeps you organized for predictable costs, while an emergency fund keeps you safe from financial shocks. If you can’t build both at the same time, start with your emergency fund. Once both are in place, you’ll be better protected for both expected and unexpected circumstances.

How to create a sinking fund

Setting up a sinking fund is simple once you know the steps. A little planning upfront can save you a lot of stress later, and once it’s set up, it mostly runs on autopilot. Here’s how to get started:

1. Decide what you’re saving for

You can start by identifying your goals. Are you saving for a used car, next semester’s textbooks, a new patio furniture set, or even all three? You can have one goal or several, as long as each sinking fund is dedicated to a specific purpose.

2. Choose where you will keep the fund

If you’re good at resisting the urge to spend, you can keep your sinking fund in your regular savings account. Opening separate accounts is also an option.

3. Estimate how much you need to save

Next, you’ll write down how much your goal will cost. It might be $300 to have a personal color analysis done or $600 for concert tickets and accommodations after the show. Knowing the total amount helps you plan how much to save incrementally.

4. Divide by your timeline

After you have the total, you can divide the cost by the number of months you have to save. For example, an annual bill of $1,200 would allow you twelve months to divvy out the cost ($100 per month). If you estimate $3,650 for study abroad costs in six months, you’ll have less time to spread out the expenses and will have to save more (roughly $610) per month. 

5. Set up automatic transfers

Once you have your figures and timelines, you can make saving effortless. Set up an automatic transfer from your checking account to each sinking fund every month. If you get paid bi-weekly, you can dedicate half the required monthly amount of money from each paycheck. 

6. Adjust as necessary

Finally, review your accounts and make changes as necessary. Costs or fees could potentially change, so you may need to update your targets to stay on track. Small adjustments allow you to have control of your money in the short-term for long-term peace of mind.

What are the benefits of a sinking fund?

Sinking funds can help you plan ahead and save for the future in a manageable way. Instead of scrambling when big costs pop up, you’ll already have the money set aside. Here are a few benefits:

Organization

Sinking funds keep your finances neat and intentional. Separating your money for specific goals helps you know what each dollar is meant for. This makes it easier to budget, track your progress, and avoid accidentally spending money meant for another purchase. 

Flexibility

You can save for anything and everything with sinking funds, including both practical adulting needs or exciting wants. Whether it’s a new phone or a new roof, sinking funds let you balance your responsibilities without feeling rushed to save or guilty for indulging in a nice-to-have purchase or two. 

Preparedness

With a lot on your plate, it’s easy to forget predictable expenses. A sinking fund helps you stay prepared for inevitable purchases and expenses. Staying ahead of the game helps you avoid large budget surprises. Plus, if you end up saving more than necessary, you’re able to transfer the extra funds to another active goal.

Debt avoidance

Perhaps the biggest benefit is that sinking funds keep you out of unnecessary debt. When you’ve already saved for an expense, you won’t need to rely on credit cards or loans to cover it. You’ll be able to pay with cash, avoid interest, and feel more in control of your money.

How many sinking funds should I have?

There’s actually no limit to how many sinking funds you can have open at one time. However, there’s only so much money you can save in a month. Due to this constraint, you’ll have to decide if you would rather save small amounts across several funds or make larger contributions to just a few. 

Managing multiple sinking funds can get tricky, but don’t let it stress you out. What matters is finding the right balance between your income, priorities, and timeline. Start with two or three key goals, and expand as your budget allows.

The bottom line is that you shouldn’t allow big costs to sink you. When you take the time to plan ahead for large expenses, they become much less worrisome. Getting into the habit of setting aside money before you need it can be a catalyst for increasing your financial literacy and monetary health. If you already have an idea in mind for a sinking fund, don’t wait. Starting today will help your confidence (and savings) grow!