What Is A Sinking Fund, And How To Use It?

5/24/2022

A Sinking Fund is a financial strategy that allows you to not just dream about a large purchase or sunny vacation, but to save the cash to make it happen. Sinking funds become a part of your monthly budget and can even be automated to make saving easy.

What Is a Sinking Fund?
A Sinking Fund is a line item in your budget to save money for a specific purpose by saving a small portion of your income each month.

How does it work?
Here's the plan; decide what you want (or need) to save for and how much. This can be something fun like a vacation, or something much more mundane like your annual car insurance bill. Divide the amount needed by the number of months you have before you'll need that money. That's the amount that you'll need to save each month to make this a reality.

Read more: Beginner's Guide To Financial Literacy

Where to keep your Sinking Fund
Now you need somewhere to put it! By designating a specific savings account for these funds, you'll not be tempted to use them for something else. Set up an automatic transfer each month from your paycheck to be transferred to your sinking fund. Now, let time work in your favor as the money slowly accumulates into that account and is ready when you need it.

If you don't have a specific time frame for when you need those funds, say you're saving for a home deposit but aren't sure when you want to buy a house, just start the fund and let a small amount of money, consistently deposited over time, accumulate. The key is having these funds in a separate account that is specifically for that purpose so that you won't use it for a different reason. Here are some accounts to consider:

High-yield savings account: These savings accounts carry a higher interest rate than traditional savings accounts and are just as easy to pull cash out of when you need the money. These accounts may need to maintain a minimum balance to avoid fees.

Money market account: Money market accounts typically offer higher interest rates than traditional savings accounts, but will require a higher minimum starting balance than other types of savings accounts.

By creating and automating your savings for a specific purpose, you'll feel the joy of being able to pay for an expensive item when the time arises with cash, and experience little financial stress. Saving a small amount regularly for a planned and expected expense will eliminate you needing to come up with a large sum of money on the fly.

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This is a very intentional way to manage financial planning for large ticket items. Have as many Sinking Fund accounts as you see fit. Separating our your financial goals is a great way to keep track of where you are with each target. Several Sinking Funds can be tracked in a budgeting app like Mint. Remember to review your budget at least every 6 months to ensure you are staying on track.

How is a Sinking fund Different from an Emergency Fund?
Sinking funds have a specific purpose and usually a defined target amount that you are saving.

An emergency fund is a separate saving account that will cover unforeseen issues and should contain 3 to 6 months' living expenses. For example, you'll need to use your emergency fund to repair your car, pay a large unexpected medical bill or purchase a new washing machine should yours suddenly die. The only thing that is certain about financial emergencies is that you will experience them from time to time. Emergency funds cover these unexpected items so that they a mere inconveniences rather than financial emergencies.

Creating Sinking Funds that cover your foreseeable financial needs and wants by turning them into small, manageable budget line items, removes the stress around paying for even fun things. Want to save up for a family vacation? Planning ahead with a Sinking Fund so that the money is there when it's time to pay for the flights and hotel rooms will make that vacation much more enjoyable. If you put all of those expenses on your credit card and had to pay them off after you returned from your trip, it would play on your mind the entire time you were away.

Ideally, before you create Sinking Funds for vacations or a new car, you'll have your other debts under control and your emergency fund in place. If you need help gaining control over your unsecured credit card debts, consider a credit counseling session with a Certified Credit Counselor.

 

 

 

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