When it comes to personal finance, sinking funds are a game-changer. They help you set aside money for specific expenses, so you’re not caught off guard when those bills or special occasions roll around. Whether you’re saving for a vacation, car repairs, or holiday gifts, sinking funds offer a stress-free way to manage your finances without relying on debt or scrambling for cash.
In this blog post, we’ll break down exactly what sinking funds are, how they work, and the simple steps you can take to create your own. Let’s dive in!
What is a Sinking Fund?
A sinking fund is a dedicated pool of money saved for a specific purpose or expense. Instead of facing surprise costs or piling on debt, you gradually save small amounts of money each month. By the time the expense arises, you’ll have the funds ready to go.
Sinking funds can be used for both large and small goals, including:
- Vacations
- Car maintenance, insurance, registration
- Home repairs
- Summer camp
- Holiday shopping
- Birthdays & Gifts
- Insurance premiums
- Weddings or special events
- Annual memberships
- Tax filing fees
Unlike an emergency fund, which is reserved for unforeseen expenses, sinking funds are for planned, non-monthly expenses that you know are coming.
Benefits of Sinking Funds
Sinking funds offer a host of benefits that can help you maintain financial stability and peace of mind:
- Avoid Debt: By saving in advance, you avoid the need to rely on credit cards or loans when big expenses come up.
- Better Budgeting: With sinking funds, your budget becomes more predictable since you’re setting aside small amounts over time rather than dealing with large, irregular payments.
- Reduced Stress: You’ll feel more in control knowing that when expenses arise, you’ve already planned for them. No more last-minute panic!
- Flexibility: Sinking funds allow you to plan for a variety of goals, from fun vacations to necessary repairs, making it easier to achieve both short-term and long-term financial objectives.
Pro-tip: If you have kids, at any age, sinking funds are a life-saver, too. They truly were my saving grace when it came to paying for unplanned school expenses, summer camps, school pictures and more.
How to Create Sinking Funds in 5 Simple Steps
1. Identify Your Goals
The first step is to decide what you’re saving for. Think about all the expenses that you anticipate in the future but don’t come up every month. These can be both fun and practical.
Here are some examples:
- Vacation: You want to take a $2,000 vacation in a year.
- Car Repairs: You expect $600 in maintenance costs over the next 6 months.
- Christmas Gifts: You plan to spend $500 on holiday shopping in 5 months.
List out each goal and estimate how much money you’ll need for each one. A good point of reference is to gather last-year’s financial spending records from your bank and/or card statements. Of course, which money is actually available for your sinking funds categories versus what you would like them to be can be two different things. But this will give you a good starting point.
2. Set a Target Date
Next, determine when you’ll need the money. This will help you figure out how much you need to save each month. If you’re saving for Christmas gifts, for example, you’d set the target date for December. For vacation, your target date might be next summer.
The target date should align with when the expense will occur or when you’ll make the purchase. I also tend to set my target dates back a little. Like my target goal for Christmas is set for November so I have time to shop.
3. Break It Down
Now, take your total savings goal and divide it by the number of months you have until the target date. This will give you the amount you need to save each month.
Example:
- Vacation: $2,000 ÷ 12 months = $167 per month
- Car Repairs: $600 ÷ 6 months = $100 per month
- Holiday Shopping: $500 ÷ 5 months = $100 per month
By breaking it down into manageable monthly amounts, sinking funds make large expenses more affordable over time. The first year is usually a little off because if you are just starting your sinking funds, things like this coming Christmas or tax time are only a few months away.
4. Set Up Separate Accounts or Track Separately
To keep your sinking funds organized, consider setting up separate savings accounts for each goal. Many banks allow you to create sub-accounts, or you can use budgeting apps to track different funds. The key is to keep the money earmarked for its specific purpose so you’re not tempted to spend it elsewhere.
Note: I get questions on how to handle monies for Sinking Fund categories. Be it opening a separate account for each category or one single savings account. I do a single savings account specifically for my sinking funds and track the individual categories on paper or on my personal tracking spreadsheet. Ally Bank allows you to do buckets on your one account for up to 10 categories.
Note 2: I recommend sinking funds to go into a regular savings account. Due to their short term nature, interest earned is not significant over the course of saving and using the sinking funds.
Here are some simple trackers you can download for personal use. Just make sure you know exactly how much is allocated to each goal.
5. Automate Your Savings
The easiest way to stay consistent with your sinking funds is to automate the process. Set up automatic transfers from your checking account to your sinking fund accounts each month or payday. This way, you’ll never forget to save, and your goals will be funded without you having to think about it.
Automation also helps you prioritize saving, ensuring that you meet your goals without being tempted to spend the money on something else.
How Many Sinking Funds Should You Have?
The number of sinking funds you create depends on your personal goals and needs. Some people prefer to keep things simple with just a few categories (like vacation, car, and holiday), while others create separate funds for each specific expense (like annual insurance, back-to-school supplies, and home repairs).
There’s no right or wrong answer—just make sure that the sinking funds you create align with your financial goals and budget.
Personally I have 13 categories where I breakdown the holidays and annual membership separately (e.g., Christmas, Halloween, Costco, etc…). I am happy not having the car categories anymore now that I live in the city with great transit!
Tips for Managing Your Sinking Funds
- Review Regularly: Check in on your sinking funds every few months to make sure you’re on track to meet your goals. You can always adjust your contributions if your income or expenses change.
- Keep an Emergency Fund Separate: Don’t confuse sinking funds with an emergency fund. While sinking funds are for planned expenses, an emergency fund should be reserved for unexpected financial setbacks.
- Prioritize Your Funds: If you can’t save for all your sinking fund goals at once, prioritize the most important ones. Start with the expenses that are necessities, like car repairs or insurance, and then focus on fun goals like vacations. It’s totally normal if all your sinking funds are not covered. My “new car” category is not getting anything because I really don’t need a new car at this time and I don’t have the money to allot in there right now. I would love to see my travel fund be increased from $150 to infinite. But the money available tells me otherwise. 😂
In Closing
Sinking funds are a smart way to plan for future expenses without the stress of scrambling for money or relying on debt. By identifying your goals, breaking them down into manageable amounts, and automating your savings, you’ll be well on your way to a financially smoother, less stressful life.
On one hand it can be a bummer to not be able to fund everything desirable. On the other hand, seeing funds grow for things that usually equate to accruing debt is a better feeling overall. It’s empowering to be in a stronger, financial state of things.
Start small if you need to, and watch your savings grow over time. With sinking funds, you’re taking control of your financial future—one small step at a time. Happy saving!
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