What is a Sinking Fund and How Do You Get Started?

Planning ahead is a great way to stay in control of your finances, and a sinking fund may help you do just that. A sinking fund is a way to save for specific expenses, like back-to-school shopping or a future vacation, without going outside your budget.

Let’s dive into what a sinking fund is, how it differs from other types of savings and how you can create one to make smarter money decisions.

What is a sinking fund?

A sinking fund is money you "sink” into a specific, planned purchase. Unlike other savings methods, a sinking fund is targeted.¹ Think of your sinking fund as a financial bucket dedicated to one particular goal. When the time comes to make that planned purchase, you can look to your sinking fund, right when you need it. You can create a sinking fund for several different types of planned expenses, including:

• Holiday/birthday gifts
• Wedding expenses
• Family vacation
• School supplies
• Appliances
• Furniture
• Home improvements

Sinking fund vs. emergency fund

It’s easy to confuse a sinking fund with an emergency fund, but the two serve different purposes. An emergency fund is a safety net to help pay for unexpected expenses, like car repairs or fixing a broken pipe in your home.² The goal of an emergency fund is to help you handle financial surprises without going into debt.

On the other hand, a sinking fund is for predictable expenses you know are coming. For example, you could start a sinking fund for a new laptop you know you’ll want to replace in a year.

Sinking fund vs. savings account

A savings account is where you stash away the money you want to save for any purpose. A sinking fund isn’t a type of account, though you may keep the money you set aside for it in a savings account. Instead, your sinking fund is the reason why you’re saving. You could even stay organized by creating separate savings accounts for different sinking funds, like one for birthday gifts and another for back-to-school shopping.

Benefits of a sinking fund

Having a sinking fund offers several benefits, including the following:

• Reduces financial stress: You may not have to worry about where the money will come from for your targeted expenses.

• Helps avoid debt: You may be less likely to rely on credit cards or loans when you save for expenses in advance.

• Encourages smart spending: A sinking fund could help you to think ahead and prioritize your financial goals more efficiently.

• Limits strain on emergency funds: You may be less likely to dip into your emergency savings for non-emergencies.

How to create a sinking fund

Setting aside money over time for your financial goals doesn’t take much leg work. Here are some simple steps to help you set up a sinking fund to take control of your future expenses.

Figure out what you want to save up for

The first step is to identify your savings goals no matter how far in the future they are. Consider whether you’d save for holiday gifts, a home renovation or a plane ticket for your next trip.

Set a timeline and calculate savings

Determine when you’ll need the money and how much you’ll need to reach your goal. Let’s say you want to purchase a brand new couch in a year that costs $1,200. Divide the total amount ($1,200) by the amount of time until your deadline (12 months) to decide how much you should save. You’ll need to plan to save $100 per month for 12 months to pay for the couch in full.

Choose where you want to save the money in your sinking fund

The next step is to decide where you’ll keep your sinking fund. A high-yield savings account is a good option since you’ll earn interest, which may help you save a bit faster. Another option is to use the “envelope system,” where you set aside cash in an envelope to save toward your money goals. This option may be ideal for smaller amounts of money. Be sure to keep your funds in a safe place if you decide not to put your sinking fund in a bank or credit union.

Budget for your contributions

It’s a good idea to incorporate your sinking fund contributions into your monthly budget. Treat it as a non-negotiable expense, like your rent or utilities, to ensure your sinking fund grows without neglecting other financial obligations.

Take charge of your savings goals

A sinking fund is more than just a way to save—it’s a way to stay prepared and intentional with your money. Whether you’re saving for a new appliance or a family vacation, it’s never too late to get started.

Source

1. https://www.bankrate.com/banking/what-is-a-sinking-fund/
   
2. https://www.experian.com/blogs/ask-experian/how-to-use-sinking-funds-to-meet-goals/#s2