Why You Should Be Using Sinking Funds
I’ve been using sinking funds long before I knew what they were. I always referred to them as my “spending savings.” My “spending savings” is where I would budget and save for things, I knew I’d be spending money on soon.
The purpose of a sinking fund is to start saving now for expenses you know you are going to have soon. Adding them to your budget means you dedicate money for them so you have it when you know you’re going to need it.
Examples would be knowing you need money in November for Christmas gifts. Estimating how much you will need and starting to save now will ensure you have money when you plan to spend it.
Another example is as specific as getting your hair cut. You know you’ll need $40 in 6-8 weeks when you get it cut again. So, setting aside $10 from each paycheck so you’ll have the $40 in cash ready to go when your next hair appointment comes.
I always felt that if I didn’t save for things (big and small) that I knew I’d be spending on, that I’d risk spending all my money on something and forget about an upcoming expense.
Yes, I’m sure I could come up with $40 to get my haircut without having a line item in the budget for it. But since I work with a zero-based budget each month, using sinking funds to save money for things I knew I’d be spending on soon made sense to me.
Plus, most of us need to get our savings act together. According to a Northwestern Mutual Survey, in 2018 the average personal debt of an American outside of a mortgage was $38,000. Paying attention to sinking funds could help you avoid more debt!
What is the purpose of a sinking fund account?
A sinking fund is a spending savings account. That’s how I’ve always thought of them. It’s money you intend to spend soon but are budgeting and saving for now.
It’s money that is saved for an intentional, specific reason. Not a generic savings account. You know specifically what you plan to spend it on, and therefore know exactly how much you need to save to get there.
Why do you need a sinking fund?
For many things, you know you are going to spend money. How will you make sure the money is there when you plan to spend it? It truly doesn’t matter how much you make.
Planning for sinking funds benefits anyone regardless of earnings. And you can incorporate categories into your sinking funds that are both big and small. A forgotten or unbudgeted expense is painful regardless of if it is $100 or $1,000.
Reasons why you need a sinking fund:
- You’re ready with cash when the time comes to buy. You’ve planned to spend money. When the time comes to spend said money, you have it and can pay in cash.
- No guilt associated with the purchase since you planned for it. Vacations are a great example. Want to go on a trip next year? Start planning to pay for it now, so when the time comes you can withdraw cash and pay for it without guilt. You’ll probably enjoy the trip a lot more, too, knowing it’s not putting you in debt.
- Make dreams a reality. Sinking funds are a great way to chip away at down payments for cars or home renovations. If you plan to save, even if it takes a while, you’ll accomplish your goals. Make your dreams a reality by planning for all known expenses you’d like to make in the future. Whether next month, next year, or 5 years from now.
What’s the difference between a sinking fund and a savings account?
There isn’t much difference between a savings account and a sinking fund. You’re saving money with both.
The main difference is how specific sinking funds are. We all know we should be “saving money.” And if you have a savings account with money in it, that’s awesome! But what is that money for? What happens if there is an emergency today and you drain the entire savings account?
Then tomorrow you need money for your child’s fall soccer registration. A savings account is great, but when you don’t know what the money is intended for when a situation arises where you could spend it, you may without thinking about expenses coming up soon where you will also need that money.
How do sinking funds work?
Each month, you set aside money that you intend to spend in various categories that you decide. It’s much more specific than simply saving $500 per month. You determine where each of those 500 dollars is going to go toward a specific purchase in the future.
Without a sinking fund:
Save $500/month = $6,000 total at the end of a year. With all that money, why not go on a vacation? Oh, wait… right after you booked the vacation you forgot we owed taxes and now you’re scrambling with how to pay for them.
With a sinking fund:
Save $500/month = $6,000 total at the end of a year
You know the $6,000 will go toward:
- $3,000 – needs to go to property taxes
- $600 – car insurance bills are coming for both vehicles.
- $500 – baseball clinic for my son
- $1900 – annual summer vacation
- $6,000 – Total
Related: Use a spending journal to help identify possible sinking fund categories
How much should be in a sinking fund?
That depends on what categories you are saving to spend and how much you intend to put in each month. For each category, you decide you need a sinking fund for, estimate how much money you will spend in that category annually.
Then divide the number by 12 months. That will tell you how much money you should set aside each month for that fund. IF you prefer 2x per month or for each paycheck if you get paid bi-weekly, then divide by 26.
For example, you want to have $2500 in a vacation fund to go on a trip next summer. You get paid every-other-week or 26 times per year. So, $2500/26 = $96 per paycheck. Let’s round it up to $100.
So, you’ll set aside $100 from each paycheck for the next year or 26 paychecks and will have $2600 in a year to go on that vacation.
How to set up a sinking fund
- Determine the sinking fund categories. For what, specifically are you going to be saving for, knowing you will spend soon? Categories can be as specific as you want, and as many as you want.
- Know when you need the money. Do you need the money next month? Or next year?
- Divide when by how many weeks/months. Take the total you need for each category and divide by the number of months you must save before you need it.
- Create a line item in your budget for each item. Make sure you are accounting for each expense in your budget.
- Identify where you are going to keep the money. Do you plan to take all the money out in cash and keep in envelopes? Perhaps your bank allows you to easily set up extra accounts where you can keep the money in an institution, but access it quickly as needed.
- Set up automatic transfers/physically withdraw the money. Make sure you have a plan to put that money aside each month. Ideally, it’s kept somewhere safe, but easy to access as you do plan to spend it soon. That could mean a cash envelope in a drawer somewhere. Or high-yield savings account that you can access quickly, and transfer funds as needed.
Many credit unions and other banking institutions make it quick and easy to set up as many accounts as you want. This is popular around the Christmas holidays getting people financially ready for spending a lot of money in November and December.
How to fund your sinking fund
First, you need to know how much you plan to save.
Then create a budget and determine where the money is going to come from. If you already have a savings account line in your budget that is not for an emergency fund, that would be a good place to start breaking it down.
If you’re looking for ways to come up with the money to fund your sinking fund, check out these easy money-saving challenges that can help you jump start your sinking fund.
How many sinking funds should I have?
Sinking funds are very personal and you can make as many or as few as you want. My personal experience has waffled between many and a few. I have gotten specific and made a ton of different ones.
But then I found myself “stealing” money from one account to pay for another. So, then I combined a few accounts into broader categories. Play around with them and find the categories that work well for you and adjust as needed.
Example Sinking Fund Categories:
- Vacation (at the top because a high priority for me! If you like rest & relaxation via vacations, build it in!)
- House maintenance (repairs, if the washer/dryer need replacement, etc.)
- Yard maintenance (do you outsource mowing annually?)
- Kid-related (school tuition, school supplies, sports, etc.)
- Car fund (Repairs, auto insurance, and registration annually)
- Pet-related (Vaccinations, boarding, food, etc.)
- Clothing (Work, casual, workout, shoes, etc.)
- Date nights (yep, you need to have fun, too! Build it into the budget!)
- Giving/donation (this is an important one to remember!)
- Beauty (Haircut, mani/pedi, your expensive shampoo, etc.)
- Gifts – Christmas (since this holiday is a large expense usually, I keep it separate from other gifts)
- Gifts – Other (birthdays, anniversaries, wedding, etc.)
- Annual subscriptions (Costco, Amazon, etc.)
- Memberships (gym, grocery delivery, etc.)
- Homeowners association dues
How to track sinking funds
I’ve always just used a plain old spreadsheet. All my sinking funds’ savings go into the same account and I use a spreadsheet to track the total, how much is for this category and how much is for that category.
Check with your bank, many offer the ability to create as many savings accounts as you want, and you can do it right online. So, if you prefer each sinking fund as their own account you can find a way to do that.
What is not a sinking fund
Your retirement – This is an investment in your long-term future, not technically a sinking fund. You should be putting money away for retirement each month. But, unlike a sinking fund where you know you’ll be spending the money soon, a retirement account is for the long haul.
Emergency fund – Emergencies happen. You will at some point probably need money to cover something you were not expecting. But an emergency fund should be kept separate.
Keep your sinking funds simple (don’t over-complicate to start)
Sinking funds are meant to be for specific items or categories. But you may find yourself getting too specific and end up with 30 categories you can’t possibly manage. Sinking funds are unique to everyone and yours will be different from mine. Use trial and error over a few months to see how many categories make sense for you.
Final thought on sinking funds
Sinking funds, or as I like to call them, “spending savings” will keep you out of debt. When you know expenses are coming regularly, use a sinking fund as a way to account for these dollars in your budget. If you set money aside for a known purpose, when you need money for that purpose, the funds should be there. Magic!
If you need more information on how to set up a budget so you can include sinking funds, check out how and why you need a zero-based budget.
Do you use sinking funds? What is your favorite sinking fund you save for monthly?
Related sinking fund articles:
The Purpose of a Sinking Fund: what you need to know