What is a Sinking Fund?
Perhaps the first thing that springs to mind when you hear the phrase "sinking fund" is a pirate ship going down with a load of gold on board. That’s not what we’re talking about here! A sinking fund is money set aside for a specific future expense. Unlike a general savings account or an emergency fund, a sinking fund has a clear goal, like saving for a trip, a down payment on a house, or even a big purchase. If you have a big expense coming up, you might want to start a sinking fund to make saving for it less stressful.
Let's talk about what a sinking fund is, how it works, and why it should be a line item in your budget!
What is a Sinking Fund?
A sinking fund is a safe, secure, and easily accessible savings account for a specific upcoming expense. You can use a sinking fund for almost anything, but it helps to have an idea of how much you want to save and when. This will help you figure out how to spend your money until you reach your goal.
Examples of Sinking Funds:
Some common costs that people know are coming up are:
- Buying or financing a vehicle
- Car repairs or maintenance
- Fixing or remodeling a house
- Insurance premiums
- Buying new furniture
- Saving up for a trip
- Gifts for the holidays and trips
- Paying taxes for self-employment
- Attending a wedding or throwing a baby shower
- Living expenses during parental leave
- Coldplay concert tickets!
These are just a few ideas to get you started. In fact, you can use a sinking fund for a lot of different kinds of costs.
Sinking funds work best when you know you need to pay for something in the near future, give it a due date, and include it in your budget. They are not connected to your emergency fund or other savings accounts in any way.
Savings Accounts vs. Sinking Funds
When deciding between a sinking fund and a savings account, it comes down to your goals and how you want to use your money.
A savings account is a safe place to put money for long-term goals and needs. When you have a known expense, you don't want to put the money for it in a savings account for bigger goals that don't have a set date.
For example, you don't want to pay your insurance premiums from the same account you use to save extra money for your student loans, because it's easy for the lines to get blurry. It's best to keep your financial goals separate so you won't be tempted to use the money you saved for something other than what it was meant for.
Sinking Funds Vs. Emergency Funds
An emergency fund is money set aside for the worst-case scenario, such as a sudden loss of income or a big, unexpected expense. You don't have any say over when it will happen. An emergency fund is your safety net for paying for these kinds of unexpected costs.
A sinking fund is for purchases with a set date, and an emergency fund is for expenses you don't know about that come up out of the blue. You should never keep these accounts together, in case you use your sinking funds for a goal and then have an emergency right after. Depending on how much you keep in your emergency fund, if that happened, you might not have any money left. This could stop your progress.
How to Get a Sinking Fund Started
Start by looking at your past bills to see what might come up again in the future. For instance, if you pay your car insurance premium every six months, you'll know when your next payment is due. Write down everything you want to save for so that when you need to pay for these things again, you can use your sinking fund to pay for them right away. Easy peasy. Then, figure out how many months or pay periods it will take to reach your goal. For example, if you need $1,000 for a trip, you'll need to save $83 per month. If you think your budget can handle it, you can instead save $167 per month for six months. Change the schedule until the amounts seem fair and doable.
Commit to your goal by putting the money in your sinking fund every month or every time you get paid. Pay for your expenses when they are due to reach the goal. Take a moment to be proud of what you've done. Repeat as many times as you need to.
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Is There an Ideal Place to Keep a Sinking Fund?
Don't put your sinking funds in the same account as your other money. This method works best if you have a completely separate account!
If you're disciplined and not easily tempted, you could open a separate savings account with your main bank and label it as such. So, you'll be able to see a list of all your sinking funds in your main account dashboard. But if you know you'll give in and use the money for other things, be fair with yourself and open an account somewhere else. An online-only savings account is perfect because it takes a few days to transfer money out of it, so you'll be more likely to leave it alone.
You could keep it in a separate checking account if you think you'll need to use the money quickly. If your goal is several months or more than a year away, you might even choose a high-yield savings account to earn a little interest. You can set up as many sinking funds as you need to pay for different things. As long as there is room in your budget and you make regular contributions, you can use sinking funds and switch them out as you pay off expenses and plan for new ones.
You can start a sinking fund in a lot of different ways. You can start saving in just a few minutes, which is great!
1. Open an Interest-Paying Savings Account
The first step is to open a separate bank account for each sinking fund. This fund should earn interest on the whole amount you put in and not charge any monthly fees. One thing you could do is open a new account at the bank you already use. Opening a high-yield account at an online bank, which is more likely to be free of fees and earn more interest, may be a better choice. Since your money might not be being used for a few years, you might want to think about making more passive income. Alternative investment ideas can have higher returns, but they can also be riskier than a high-yield savings account or a CD ladder. Pay attention to the minimum investment period to make sure you can get your cash when you need it.
Watch out: Don't use sinking funds to protect against overdrafts!
Your bank may let you link your new account to your checking account in case you go overdrawn on your checking account. Don't choose this option because any overdraft on your checking account can use up your sinking fund.
2. Set Up Regular Transfers
Just like your employer can take money out of each paycheck to put into your 401(k), you should schedule a monthly transfer. The easiest way to get into the habit of making regular contributions is to set up your finances so that they do it for you. If you don't have much money left over, this recurring contribution may be small. Then, at the end of each month, you can use your extra cash to make one-time transfers.
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Other Savings Accounts You Need:
Before you start your sinking fund, you should have your other accounts in order. This means you have a fully-funded emergency fund and no high-interest consumer debt like credit cards. If you don't already have one, it's a good idea to save up at least 6–9 months' worth of expenses in case something unfortunate/unexpected happens.
Once you have an emergency fund, you can pay off credit card debt, personal loans, and medical bills. Once you've taken care of those, you can move on to sinking funds. Don't forget to look at your budget every now and then and make changes as you go or if you need to.
Check these out! (A lot of useful information here)
It can be difficult to save up for big purchases! One of the easiest ways to thrive financially is to plan ahead for future expenses. Even if you usually have no trouble paying your bills, a "expensive" month can be tough to make up for if you don't have any savings. To make ends meet, you might have to dip into your savings, put off investments, or take out a loan. None of these three options are ideal when you want to master your finances. A sinking fund can be a helpful savings tool to reduce financial strain. Sinking funds are a great way to save money for the future even if you're still making payments on other debts. Starting a sinking fund today can be a low-effort way to save for future expenses. *Future YOU* will thank you for it!
I hope this information was helpful. If you have any questions, feel free to reach out. I’d be happy to chat with you.
About the Author
Renee helps clients make sound financial decisions in her role as a Financial Planner at Vincere Wealth. Having a trusted advisor steer you toward wise choices now can have a major impact on your financial future. Renee is especially proud of her work educating and empowering women in the areas of personal finance, budgeting, and debt management.
If you're interested in an investment advisory or financial planning relationship, please consider Vincere Wealth Management.
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