If you want to start saving up for large purchases and future expenses, you may want to set up a sinking fund.
But what exactly is this sinking fund concept?
A sinking fund is simply money that you put into a savings account over a number of months with the intent of paying for a future expense. This can include larger purchases, one-time expenses, or to pay off debt. Ultimately, you’ll set up a savings account for each specific goal that you are saving for. The purpose of a sinking fund is to ensure that you have enough money saved to cover large expenses.
Sinking funds can virtually be used for anything—from funding new cars, home repairs, Christmas gifts, to vacations. The concept is very simple: save a little bit over time.
In this post, I’ll share exactly how to get started with sinking funds. We’ll discuss:
- Sinking fund vs savings account
- Where to put your sinking fund?
- How many sinking funds should you have?
- How to set up a sinking fund
- How much should you put in your sinking fund?
So if you’re ready to start hitting your savings goals, keep reading.
Sinking fund vs savings account
A sinking fund shouldn’t be confused with a savings account, because the two are different. The main difference between them is that a sinking fund has the sole purpose of being spent.
When you put money into savings, the purpose is to save just in case you have unexpected expenses.
You want to have money set aside in case of an emergency; however, the plan (and hope) is that you never have to spend it.
Ultimately, when this money goes unspent, it contributes to your overall wealth building. Because of this, the goal is to maximize your potential for growth in your savings account. That’s why I recommend putting your emergency fund into a high-yield account.
By doing so, you can take advantage of a higher interest rate and allow your emergency savings money to work for you.
This is different from a regular savings account that you would find at a traditional brick-and-mortar bank. Instead, you will find higher-yield savings accounts with an online bank. It’s a good idea to check out our article on savings accounts to find out more information about these savings accounts
Where to put your sinking fund?
Where you put your sinking fund will all depend on your specific savings goal.
For instance, if you have a specific expense that will only take a few months to save up for, then a traditional checking account will work. In this case, you won’t reap the benefits of the annual interest rate that you would get with a savings account. Nonetheless, the money will be easily accessible for this short-term goal.
Contrarily, if you’re saving up for a long-term goal like buying a new car, the ideal location may be a money market account or a high-yield savings account. In this case, you will reap the benefits of higher interest rates and be able to earn a few dollars on your money while it’s in the account. This is extra funds that can be used toward your overall saving goal.
Though you would need to likely transfer the money from a savings account to actually pay for your expense, a money market account comes with the option of using a debit card or check.
I recommend opening a separate account for each fund that you’re creating. However, banks like Ally allow you to create buckets that you can assign sinking fund categories to. Doing this allows you to organize each fund so you know exactly how much you have put aside for that expense.
How many sinking funds should you have?
There is no rule of thumb when it comes to how many sinking funds you need. It’s completely based on your own personal goals and expenses.
Generally, I would steer away from excessive funds that would make saving difficult. For instance, if you only have $1,000 in extra cash to put toward your funds, you don’t want to have that spread across twenty accounts. That’d make it hard to save efficiently.
Nonetheless, there are a few funds that I think every adult should have at some point in their financial journey.
If you already own a home, then you’ll understand the importance of having money set aside for repairs, renovations, and even decor.
We typically set aside money per pay period to cover these expenses and other little things, like mulching our yard or having our home pressure washed. This means that we don’t have to make additional concessions in our monthly budget to pay for these yearly, random house expenses.
This fund is also practical if you’re saving up for a home. Maybe you’re paying off other debt but still want to put some money aside. Having a sinking fund for your home is ideal for this situation. In this case, you’d put your money away in a high-yield savings account, as it is a longer-term goal and you’d benefit from interest.
Here are some house expenses to save for:
- Down payment for a new home
- Deep cleaning services
Ultimately, anything that is not a regular expense for your home can be put into a sinking fund.
Having a sinking fund for car expenses is a great idea. Not only at some point, you’ll need to replace your car, but you’ll have expenses along the way. Knowing this, you should save ahead of time.
You don’t have to use this fund exclusively for a new car. It could be for an unexpected car repair, registration, or even taxes. Simply setting aside a few dollars a month for things related to your vehicle can make a huge difference.
Your car sinking fund can cover some of the followings expenses:
- Car repairs
- Car maintenance
- New tires
- Annual taxes, fees, registrations
- Annual insurance premium
- Down payment
- New car
Essentially, put money aside for upcoming expenses related to maintaining or purchasing a new car.
Traveling becomes much less of a financial stress when you save for it over time. For instance, if you know that you’ll be taking a yearly family vacation, why not put a little away each month to save for it?
Some things to save for include:
- Hotel/rental accommodations
- Travel expenses & insurance
- Vacation clothes & necessities
I suggest checking out our video on how you can plan and budget for a vacation.
Birthdays, Christmas, and anniversaries all come every year. So instead of having to squeeze gifts into the budget or go into credit card debt, just set up a sinking fund exclusively for these things.
Holiday gifts are much less of a burden when you already have a set amount of money put away to pay for things. This also helps you put a limit on your spending, as you can only spend what’s in the account.
Don’t forget that the holidays aren’t just about gifts, so be sure to save for:
- Holiday decorations
- Holiday party hosting/attendance
- The additional cost of meals
There are all types of expenses around the holidays, so be sure to plan for them. You can also check out our holiday planner to start budgeting for these expenses.
It should go without saying, but children are expensive. Studies show that the cost of raising two kids to age 17 is over a whopping $310,000! The good news is that you can be prepared.
You can set up a sinking fund that will cover expenses as your child grows. This includes saving for expenses related to childbirth to covering school supplies and extracurricular activities.
Here are some expenses to consider:
- Summer camps
- Extracurricular activities
- New clothes for the school year
The options are infinite on what this fund can be used for.
How to set up a sinking fund
Setting up a sinking fund is quite simple. You’ll just need to determine what funds you’ll be setting up and where you want to put them. The most challenging part is determining how much to put aside. Here are four easy steps to get started.
- Determine what funds you want to have. Write a list of goals and expenses that you are saving for.
- Open a corresponding bank account for each fund or one account with buckets. Create an account or bucket for each type of fund you’re saving for.
- Determine how much you’ll put in each account. Create a specific target amount for each sinking fund.
- Automatically transfer this money into each account each month. Start putting money away in your sinking funds based on your monthly budget.
How much should you put in your sinking fund?
The amount that you put into each fund will largely depend on how much free cash flow you have after expenses are paid. For instance, you may have $1,000 left at the end of each month after all of your bills are paid.
From that $1,000 you’ll decide how much should be allocated toward each account. This number will depend on which expense needs to be funded first and which one needs the most money.
Divide that $1,000 among your sinking funds:
- $300 for House Fund
- $175 for Car Fund
- $150 for Travel Fund
- $150 for Christmas Fund
- $225 for Kid’s Fund
These numbers are completely arbitrary, but give you an example of how you can divide out your extra money to put toward your sinking fund.
If you consistently save this amount each month for each fund, you’ll have a total of $12,000 saved for the year with money for each fund put aside.
- $3, 600 for House Fund
- $2,100 for Car Fund
- $1,800 for Travel Fund
- $1,800 for Christmas Fund
- $2,700 for Kid’s Fund
The other way to decide how much to put aside each month is to have an actual target amount for each fund for the year.
For instance, you may only want to save and spend $750 dollars for Christmas. In this case, you’d just divide your target by 12 months to determine how much you should save each month. In that scenario, you only put aside $62.50 per month instead of $150 per month.
If you know how much your expense will require, I suggest using this reverse method. This ensures that you hit your target and are able to cover the expense.
If you’re ready to start your own sinking fund, you can grab my budget spreadsheet which includes a savings tracker. It’s a fun way to track how much you’ve saved and how much you have left to reach your goal.
You can also check out our post on savings challenges to learn other savings strategies to reach your goals.
Set up your sinking funds!
Overall, having sinking funds is great for reaching your financial goals and should be a part of your overall how you manage your personal finances. It is an easy way to make sure your important goals and expenses get taken care of in a strategic way. Each fund has a specific purpose that will help you reach your overall goals.
I’ve given a few examples of sinking funds that you can set up, but you can also consider one for medical expenses and even large debt where you may want to pay the total amount instead of monthly payments.
Are you ready to set up your sinking funds?