Chances are you have big expenses coming up in six months, a year or even five years. How will you save toward those expenses without cutting into your emergency savings or taking on more debt? A sinking fund might be the answer.
What Is a Sinking Fund?
A sinking fund is money you save for a particular goal. That goal might be a future purchase, such as a car, or a predictable expense you pay on an infrequent schedule, such as self-employment tax.
How Does a Sinking Fund Compare to a Savings Account?
A savings account is usually considered a catchall account. It’s where you stash money to let it grow or to serve as an emergency reserve for unexpected expenses. Experts recommend that you have three to six months of living expenses set aside in case of job loss and other unexpected life changes that might impact your income.
Why Sinking Funds Should Be In Your Budget
You’ve saved for emergencies, but you also have a long list of things you want. They don’t warrant chipping away at your traditional savings account or emergency fund, but they don’t fit in your monthly budget.
That’s where a sinking fund comes in. It’s like a savings account but with a very specific purpose and goal. That wish list of ideas you’re juggling in your head? Set up a sinking fund for each one. Examples can include:
|Braces for your child
|Down payment on a new car
|Wedding shower for your husband’s sister
How Do You Prioritize?
When you look at a list of expenses this long, your goals can seem unattainable. You may even feel like giving up and taking out a loan or waiting to see if things just work out somehow.
The money probably isn’t just going to land in your lap anytime soon. By creating a sinking fund for each of your specific goals, you can determine exactly how much you need to save each month.
If your sister-in-law’s wedding shower is three months away, it might take precedence over the new car you hope to purchase three years from now. You can scale back on the car fund while you sock away $167 per month for the next three months to cover the gift. Then after you’ve purchased the gift, that $167 can go toward the new car.
How Do You Establish Your Sinking Fund?
- Set your goals. Be specific about what the account is for.
- Open accounts. As an alternative to opening a separate savings account for each goal, look for a savings account that lets you create a number of goals within a single account. Make sure the account doesn’t charge maintenance fees.
- Write down a timeline. Know when you want to achieve each goal.
- Calculate your savings deposits. Divide the cost of each goal by the amount of time you have to reach it.
- Add it to the budget. Make sure your sinking fund is explicitly outlined in your budget.
How Can You Incorporate Sinking Funds Into Your Budget?
You should assess your budget every month and adjust for changes in your expenses. Maybe last month you had to renew the registration for your car, but this month you have a niece’s birthday to attend.
1. Create a Line Item
Add your sinking fund as a specific line item to your budget. Prioritize it along with bills, emergency savings and paying down debt. Spending money is fun, but it can also be stressful when it doesn’t fit into your budget.
2. Stay Committed to Your Goals
The trick to making a sinking fund work is to not dip into it for other expenses. That defeats the purpose of saving toward a specific goal. If you break the rules once, it will be too easy to do it again in the future.
3. Automate Transfers
Most banks allow you to set up automatic transfers on designated days. If you know when your paycheck deposits, schedule an automatic transfer to your sinking fund for the same day. You won’t even have a chance to miss the money.
Pros and Cons of a Sinking Fund
As with anything in life, there are good things and bad things about a sinking fund. Before committing to a sinking fund, it’s important to decide if it’s the right choice for you.
A Sinking Fund Benefits You in Many Ways
- Avoid credit card interest: By saving for goals in advance, you avoid having to rely on credit cards for large purchases.
- Earn money on your balance: With the right savings account, you can earn interest on your balance.
- Control your money: By opening a sinking fund and committing to saving toward large purchases, you stay in control of how you spend and save.
- Avoid impulse purchases: When you get into the habit of saving for large purchases, you curb impulse spending.
A Sinking Fund Also Has Its Pitfalls
- Less money is available for more immediate uses: Once you begin contributing toward a purchase, you have to follow through and fulfill your commitment. This means you’ll have less cash to put toward other uses, such as paying down debt or investing.
- It requires discipline: Since there are no restrictions on access to your sinking fund, it’s easy to break the rules. You may think that just this once, it’s okay to dip into your sinking fund for something you want.
Start with one sinking fund to test the waters. If it works for you, consider setting up additional sinking funds for other purchases you have coming up. If it doesn’t work for you, think of another strategy to save for large purchases.
A sinking fund is a great idea in theory, but what if you don’t have room in your budget to save for a large purchase? It’s definitely possible to cut back in places, but all budgets have a limit.
If that’s the case, consider how you can pick up extra income. After all, no matter how much you put them off, the anticipated expenses aren’t going anywhere. You’ll have to address them whether you’re financially prepared or not.
Daria Uhlig contributed to the reporting for this article.
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- Dave Ramsey. 2022. "What Is a Sinking Fund and How Do You Create One?"
- Forbes. 2020. "6 Reasons To Start A Sinking Fund Now."
- CNBC. 2019. "How a 'Sinking Fund' Can Keep You From Blowing Your Budget "