Rachel Cruze: What Is a Sinking Fund and How Does It Work?

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Sinking funds are a fantastic financial tool to save up for substantial expenses. Whether you’re dreaming about a family vacation to Disney World or in need of a new car, sinking funds are your go-to solution to avoid debt and regret. Rachel Cruze discusses the mechanics of sinking funds and how to create one to kickstart your savings journey.

Understanding Sinking Funds

A sinking fund is a disciplined saving method where a specific amount of money is set aside each month toward a particular goal. This way, you accumulate small amounts over time, eliminating the need to cough up a large sum all at once.

“It’s the perfect way to save up for any large expense,” said Cruze in her column. “Sinking funds help you pay cash for all of it and avoid the post-purchase regret.”

Sinking funds are ideal for expenses that aren’t covered in a single month’s budget, such as vacations, home renovations, or Christmas gifts. Essentially, you’re preparing for future costs by saving incrementally.

Sinking Fund vs. Savings Account

Though they complement each other, a sinking fund and a savings account serve different purposes. A savings account determines where to save your money, while a sinking fund determines how. When saving for multiple goals like a car, vacation, or Christmas presents, having them all in one savings account can get confusing. By creating different sinking funds for various purposes, you know exactly when you’ve hit your savings targets and how much you’ve allocated for each.

Make Your Money Work for You

Sinking Fund vs. Emergency Fund

A sinking fund and an emergency fund are distinct. A sinking fund is for expected expenses, like your child’s soccer season or a friend’s wedding. In contrast, an emergency fund is for unforeseen expenses like a sudden car repair. While sinking funds cover anticipated costs, an emergency fund is your financial safety net for the unexpected.

Benefits of Sinking Funds

No matter your spending habits, sinking funds cater to everyone. It’s an easy way to get started with a big savings goal. Putting away small amounts will help you stay motivated.

“Sinking funds work great for things you can’t or don’t want to pay for in a single month’s budget,” added Cruze. “Every month, you’ll save a certain amount of money for a specific purpose to use at a later date. That way, you’re saving up small amounts over time instead of having to come up with a big chunk of money all at once.”

Sinking funds enable you to:

  • Save for anything. You can be as specific as you want to ensure you cover all your financial bases.
  • Plan for exciting ventures. Whether upgrading your kitchen or planning a dream vacation, sinking funds make these aspirations attainable.
  • Avoid large-purchase guilt. By deciding beforehand what you’re saving for, you can spend without worry or regret when the time comes.
  • Prepare for inevitable expenses. Start saving for foreseeable expenses, turning potential emergencies into mere inconveniences.

How to Create a Sinking Fund

Creating a sinking fund is a straightforward four-step process:

  1. Identify your goal.  Be it a cruise or a down payment on a house, know what you’re saving for.
  2. Choose a storage place. Open a separate savings account or use budgeting tools like EveryDollar to track your sinking fund.
  3. Decide the amount to save. Determine the total amount you need and divide it by the months or weeks left until the purchase.
  4. Include your sinking fund in the budget. Ensure it’s part of your monthly budget, making adjustments as necessary to reach your goal.
Make Your Money Work for You

Balancing Multiple Sinking Funds

While sinking funds are beneficial, spreading your savings thinly over numerous funds can hinder progress. It’s essential to prioritize based on your financial goals and circumstances, ensuring you make meaningful progress toward what matters most.

The Bottom Line

Sinking funds are a proactive approach to managing substantial future expenses. They not only keep stress at bay but also prevent debt, promoting a healthier financial life. By planning and saving incrementally, you can enjoy your purchases without any financial hangover. So, take the leap, set up your sinking funds, and embrace the peace of mind that comes with being financially prepared.

Editor's note: This article was produced via automated technology and then fine-tuned and verified for accuracy by a member of GOBankingRates' editorial team.

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