What Is a Sinking Fund? How to Stay Prepared for All Expenses

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A sinking fund is money you set aside for a specific goal, like a down payment on a car or a house. That money might also be used to cover other big-ticket items like self-employment tax or a wedding.

But why is it called a sinking fund? Simply put, it’s because you’re gradually saving money over time — or “sinking” money — until you have enough for what you need. With a sinking fund, you don’t have to come up with a huge chunk of cash all at once because you’ve already spent months or even years saving up.

Examples of Expenses You Can Use Your Sinking Fund For 

Sinking funds are usually geared toward one specific goal. That can be a short-term, medium-term or long-term goal. It all depends on what you’re prioritizing.

Here are some examples of expenses you can use a sinking fund for:

• Anticipated car repairs or maintenance
• Holiday or birthday gifts
• Wedding reception or other expenses
• Cruise
• Family trip or other vacation
• Home renovations
• Anticipated veterinary bills or pet care
• New home appliances
• Down payment for a car
• Down payment for a house

The main point behind a sinking fund is to have extra money saved for these financial goals so you don’t have to take on more debt or dip into your emergency savings.

You can also start a sinking fund for a specific goal and change it later based on your future priorities or needs. Say you’ve started a sinking fund on a house. If you decide not to buy, you could reallocate that money for something else.

But what if you have multiple things you want to save up for? You can set up a sinking fund for each one. For example:

• $20,000 for a down payment on a house
• $5,000 for a down payment on a car
• $4,000 on new furniture or appliances (for that new house)
• $7,000 for a family trip

Note: This is what a sinking fund is in personal finance. You might also hear about sinking funds in corporate finance or investing — particularly when it comes to repaying debt or buying back issued bonds prior to their maturity date.

How Is a Sinking Fund Different from Other Ways to Save? 

On the surface, a sinking account might seem like just another way to save — and in some ways, it is. But it’s more than that. Here’s how sinking funds differ from other savings options:

Savings Account

A savings account is a catch-all term for where you save money. You can keep your savings in an envelope under your bed, for example. Or you can stash it in a high-yield savings account where it can grow.

You might not have a specific purpose for saving money, but it’s nice to have.

Emergency Fund

An emergency fund is money set aside specifically for, well, emergencies. This includes any unexpected expense that falls beyond your usual budget. It might be a flat tire or a trip to the doctor that wasn’t covered by your insurance.

Experts recommend having three to six months of living expenses set aside in case something comes up that impacts your income — like layoffs at work.

Splurge Fund

You might want to have a separate savings account for splurging. These aren’t specific or planned expenses, so they might not fit into your regular budget or savings.

They can be big or small, but they’re most likely spontaneous — like a romantic getaway or when your favorite band comes into town.

An Additional Money Bucket

Your sinking fund is extra money you have in addition to regular savings, emergencies and the like. It’s for specific goals that might not fit into your regular monthly budget. However, you could have a separate category in your budget for your sinking fund.

Say you want to buy a new car in a year. The average new car costs nearly $50,000, but cheaper options exist.

Say you find one for $25,000 and want to put 10% down. You’ll need $2,500. If you have 12 months, you’ll need to set aside about $208 from your budget each month in a sinking fund for that car.

Pros and Cons of a Sinking Fund

Setting up a sinking fund does have quite a few benefits. For example, they can:

• Help you avoid taking on debt (like high-interest credit cards)
• Earn interest if you keep the funds in a HYSA or other interest-bearing account
• Keep you motivated and on track with your goals
• Be created for several different savings goals or only one — whichever you need

A few drawbacks to consider include:

• You’ll have less money available for other things
• You might have to pull from the sinking fund if an emergency arises or your budget falls short
• You’ll need to be disciplined so you don’t dip into the sinking fund before it’s time to use it

Where Should You Keep Your Sinking Funds?

Your sinking funds should be somewhat accessible, so you probably don’t want them to go into a regular investment account. But you also shouldn’t keep them where you’ll accidentally use them. That means no checking accounts either.

Here are some of the best places to keep your sinking funds (depending on your goals):

• High-yield savings account: A high-yield savings account, or HYSA, is similar to a traditional savings account. The main difference is the yields are higher, meaning your money could theoretically grow faster. APYs on these accounts can be 4.00% or higher.
• Money market account: A money market account takes features from checking and savings accounts and combines them into one. These accounts usually offer higher interest rates than checking accounts. They may have higher fees or minimum opening or account balance requirements.
• Certificate of deposit: Certificates of deposit (CDs) are a type of interest-bearing account where you keep your money for a specific amount of time — usually six months or longer. During this time, the account funds will earn interest. If you have medium- or long-term goals, you could put your sinking fund in a CD.

Are Sinking Funds Right for You? 

Sinking funds could be a good idea if you have room in your budget to set aside extra cash for specific goals. You’ll generally want to have a separate emergency fund to cover any unexpected expenses, too. That way, you won’t end up drawing from your sinking fund — and taking away from other priorities.

If you’ve never created a sinking fund before, try starting with just one to see if it works with your budget. If it doesn’t, there may be other strategies or savings methods that work better for you.

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