Sinking funds: What they are and how they might help you achieve your savings goals
Saving money can be hard, but it’s an important part of reaching your financial goals.
One saving strategy is to establish sinking funds. A sinking fund is a place to save money for a specific goal. Each month, you set money aside in your sinking fund so you can make progress toward your goal. When you have enough money saved, you take the money from your sinking fund and use it.
“The most significant benefit of sinking funds is that they allow you to plan for expenses you know will pop up,” says Tana Williams, a personal finance blogger at Debt Free Forties. “By thinking ahead, you’re saving yourself money as well as avoiding stress.”
Examples of a sinking fund
You can use a sinking fund for all sorts of different goals; including:
- Travel. If you want to take a vacation, you can establish a sinking fund to help you save for the trip.
- Lifestyle upgrades. You could also use a sinking fund to save for something like buying a new car or remodeling your kitchen.
- Pet expenses. If you bring your dog to the vet for a checkup once a year, you can use a sinking fund to set money aside for that visit.
- Really anything. One of the things that makes sinking funds useful is their versatility. You can set up a sinking fund for almost any financial goal. All you have to do is choose a goal and set money aside each month.
What are the benefits of a sinking fund?
There are several benefits to setting up a sinking fund.
Sinking funds break savings goals down into smaller points, making them seem more achievable. Saving $1,000 for a vacation might sound like a lot, but saving $20 a week or $85 each month into your sinking fund might sound more manageable.
Sinking funds can also help reduce the guilt associated with spending large sums of money. If you want to treat yourself to something expensive, like a new TV or a trip, you might feel guilty about spending hundreds of dollars on a non-necessity. With a sinking fund, you’ve earmarked the money in the fund for that purpose, so you don’t have to feel guilty about spending your hard-earned cash on something that isn’t strictly necessary.
It also helps you reduce financial stress. You can know exactly how you’ll pay for those important, predictable expenses, and save money in the long run.
“It’s easy to ignore irregular expenses like car maintenance and plop it on a credit card when it finally does show up,” Williams says. “With sinking funds, you’re choosing to think ahead and plan for that expense that you know is eventually coming. When it finally does appear, you’re able to pay with cash, so there’s no stress — and no interest paid on a credit card.”
What’s the difference between a sinking fund and emergency fund?
The primary difference between a sinking fund and an emergency fund is predictability.
When you set up a sinking fund, you’re creating the fund for a predictable expense. This expense can be anything from buying a car to helping a niece or nephew pay for college textbooks. Whatever the purpose of the sinking fund is, you know what it is when you open the account and start saving.
That also means you know how much you need to save, as well as your weekly or monthly saving plan and how long it will take to reach your goal. When you reach your goal, you can withdraw your money and close the sinking fund.
An emergency fund is designed to help you save for the unpredictable. You can’t know when you’ll get into a car accident or have your computer break. Your emergency fund can help you pay for unexpected expenses. You shouldn’t use the money in the emergency fund for things like going on a trip or paying for predictable maintenance on your home or your car. It should stay there for emergencies.
Common advice for an emergency fund is to have between three and six months’ expenses in the fund. With a sinking fund, you only save up to whatever goal you set, which will depend on how much money you need to accomplish your goal.
How many sinking funds should I have?
There isn’t a single answer to the question of how many sinking funds you should have. It all depends on you and your goals.
If you are not saving for anything in particular at the moment, you don’t really need to have any sinking funds. However, most people have some things they should be saving for or that they want to be saving for and you can set up as many sinking funds as you’d like.
You could have one fund for your vacation money, another to save for your pet’s next checkup, a third to buy a new set of tires for your car, and a fourth to help your child buy textbooks for the next semester of college.
While you can create as many sinking funds as you wish, make sure you meet the account’s requirements to avoid paying fees.
What should I watch out for?
Sinking funds are a great financial tool, but there are things you should watch out for.
“A common pitfall to be aware of when using sinking funds is to not have too many,” says Kelly Anne Smith, founder of the blog Freedom in a Budget. “It is very easy to get excited about them and then the next thing you know, you have 20 sinking funds and you are putting less and less money towards your current goals of saving, investing, or paying off debt. …Take a step back and see if that $20 a month to your haircuts sinking funds is really helping or if the $20 is better spent towards your debt payoff and then cash flow the haircuts when needed.”
Another common pitfall, according to Williams, is not separating your sinking funds.
“When I’ve lumped them together into one savings account, it’s been painfully easy to mix up each category’s saved amounts,” Williams says. “This makes it easier to dip into other categories and short one of them accidentally.
“I recommend opening a savings account with a bank that allows sub-accounts. I’ve opened one … and I have several accounts for my different sinking funds, including Christmas, taxes, vacation funds and more.”
Bottom line
Saving for your financial goals and for predictable, long-term expenses can seem daunting. Sinking funds are a great way to break down large savings goals into more manageable pieces.
To make things even easier, look for a savings account that pays a competitive rate of interest, as every extra dollar will get you closer to your goal. Here are the high-yield savings accounts paying the highest rates right now. Also consider using a savings app to serve as the home for your sinking funds. Here are some of our favorite apps.
