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Sinking Funds 101: What Is It And How To Save It

Jun 21, 2024

Are you tired of being caught off guard by large, irregular expenses like annual insurance premiums, holiday shopping, or car repairs?

Do you find yourself scrambling to come up with the money or resorting to credit cards when these bills come due?

person holding iPad - Sinking Funds 101
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If so, it’s time to learn about the power of sinking funds.

A sinking fund definition in personal finance is a savings account set aside for a known future expense to prevent budgetary strain.

What Are Sinking Funds?

A sinking fund is a specific way to save money for a specific future expense by setting aside small amounts on a regular basis.

Unlike an emergency fund, which covers unexpected expenses, a sinking fund is for costs that you can anticipate and plan for.

The concept is simple: instead of being hit with a large bill all at once, you break it down into manageable monthly or weekly contributions.

By the time the expense comes due, you’ll have saved up the full amount needed.

For example, let’s say your car insurance is $1,200 per year. Rather than scrambling to come up with $1,200 when the bill arrives, you could set aside $100 per month in a sinking fund. After 12 months, you’ll have the full amount saved and can pay the bill stress-free.

Sinking Funds vs. Emergency Funds

While both sinking funds and emergency funds involve setting aside money for future use, they serve different purposes.

money bag inside a glass jar with a lock - Sinking Funds 101

An emergency fund is for unexpected, urgent expenses like a job loss, medical emergency, or major car repair. 

Experts recommend saving 3-6 months’ worth of living expenses in your emergency fund.

In contrast, sinking funds are for expected, planned expenses that you know are coming up. The savings timeline and amount needed will vary depending on the specific expense.

Ideally, you should have both an emergency fund and various sinking funds as part of your overall financial plan. This ensures you’re prepared for both the unexpected and the anticipated.

Here are the differences between sinking funds and emergency funds:

  1. Purpose
  • Sinking funds are used to save for specific, anticipated expenses like vacations, home renovations, car repairs, annual bills, etc.
  • Emergency funds are for unexpected, urgent expenses like job loss, medical emergencies, unexpected home or car repairs, etc.
  1. Specificity of goal
  • Sinking funds are tied to a specific savings goal, and the target amount is based on the anticipated cost of that expense
  • Emergency funds are general safety nets without a singular purpose, meant to cover 3-6 months of living expenses
  1. Timeframe
  • Sinking funds are built over a defined period of time to meet a known future expense
  • Emergency funds are ongoing savings to provide a buffer against unexpected financial crises that could occur anytime
  1. Accessibility of funds
  • Sinking funds can be kept in a general savings account since the need is anticipated
  • Emergency funds should be easily accessible and often kept in savings or money market accounts
  1. Savings approach
  • Sinking funds involves saving smaller amounts consistently to meet a defined future goal
  • Emergency funds are built up to a target amount (e.g. 3-6 months of expenses) and then maintained

Sinking funds are strategic savings for anticipated, specific expenses, while emergency funds are broad safety nets for unexpected financial emergencies. 

Both are important financial tools but serve different purposes in one’s overall savings plan. 

Sinking funds allow for planned spending, while emergency funds provide a critical buffer against financial shocks.

Why You Need Sinking Funds in Your Budget

Sinking funds offer numerous benefits for your finances and peace of mind:

  1. Avoid debt: By saving up in advance, you can pay for large expenses with cash instead of relying on credit cards or loans.
  2. Reduce financial stress: Knowing you have money set aside for upcoming bills can alleviate anxiety and help you feel more in control of your finances.
  3. Maintain a balanced budget: Sinking funds allows you to spread out the cost of large expenses over time, making them easier to incorporate into your monthly budget. They also help in managing and tracking your monthly expenses, ensuring that you stay on top of your financial planning.
  4. Save money: Some expenses, like insurance premiums or vacations, may offer discounts for paying in full upfront. Sinking funds enables you to take advantage of these savings.
  5. Reach financial goals: Whether it’s a dream vacation, a wedding, or a home renovation, sinking funds provide a structured way to save for your specific goals.

Examples of Common Sinking Fund Categories

scramble letters near glasses in glass case - sinking funds 101

You can create a sinking fund for virtually any anticipated expense. Some popular categories include:

  • Car maintenance and repairs
  • Home repairs and appliance replacements
  • Annual insurance premium
  • Property taxes
  • Holiday and birthday gifts
  • Vacations and travel
  • Weddings and special events
  • School tuition and supplies
  • Medical and dental expenses
  • Pet care and vet bills
  • Clothing and wardrobe updates
  • Technology upgrades
  • Charitable giving

Creating sinking funds for these categories helps in planning for upcoming expenses and ensures that sufficient funds are set aside.

Creating a Sinking Fund

screenshot of a sinking fund spreadsheet - Sinking Fund 101

How to Set Up and Manage Sinking Funds

  1. Identify your specific savings goals: Make a list of the irregular expenses you want to save for and estimate the total amount needed for each.
  2. Determine your timeline: Decide when you’ll need the money for each expense and calculate how many months or weeks you have to save.
  3. Calculate your contribution amounts: Divide the total amount needed by the number of saving periods to determine how much to set aside each month or week.
  4. Choose a place to keep your sinking funds: You can use a separate new savings account, a budgeting app with virtual envelopes, or even physical cash envelopes. The key is to keep the money separate from your everyday spending.
  5. Automate your savings: Set up automatic transfers from your checking account to your sinking fund accounts each month or payday. This ensures you consistently save without having to remember or be tempted to skip.
  6. Track your progress: Regularly review your sinking fund balances and adjust your contributions if needed. Celebrate milestones along the way to stay motivated.
  7. Use the money for its intended purpose: When the anticipated expense arrives, use the money from your sinking fund to pay for it in full. Resist the temptation to dip into the funds for other purposes.

Creative ways to fund your sinking fund

The key is to get creative, make funding your sinking funds a priority, and automate your savings as much as possible.

woman holding clothing - sinking funds 101

Every little bit you can set aside will add up over time and help you reach your savings goals.

Here are some creative ways to fund your sinking fund.

  1. Sell unused items – Go through your home and sell items you no longer need or use, like old electronics, clothes, furniture, etc. Put the proceeds directly into your sinking funds.
  2. Save your spare change – Empty your pockets each day and put the change in a jar. Once it fills up, deposit the money into your sinking fund accounts. Some banks also offer programs that round up your purchases and transfer the change to savings.
  3. Cut an expense and redirect the money – Look for subscriptions, memberships, or services you can cancel or downgrade. Allocate the money you save each month to your sinking funds instead.
  4. Use cash-back rewards – If you have a cash-back credit card, redeem the rewards and deposit the money into your sinking funds. Just make sure to pay off the card balance in full each month.
  5. Save your tax refund – When you receive your annual tax refund, resist the urge to spend it. Instead, give your sinking funds a big boost by depositing some or all of the refund.
  6. Allocate extra/unexpected income – If you get a raise, bonus, gift money, or other unexpected cash, consider putting at least a portion of it towards your sinking fund goals.
  7. Do a savings challenge – Make funding your sinking funds into a game with a savings challenge. For example, save all $5 bills you receive or do a no-spend month and allocate the money you didn’t spend.
  8. Use an app that saves for you – Some apps, like Qapital analyze your spending and automatically transfer small amounts to savings on your behalf. You could dedicate this to your sinking funds.

Choosing the Right High-Yield Savings Account for Your Sinking Fund

While a traditional savings account can be used for a sinking fund, it may not offer good interest rates compared to other options like high-yield savings accounts.

The key is to choose an account that maximizes your savings potential while providing the necessary accessibility and organizational tools to keep your sinking fund on track.

notepad clipped with binder clip near glasses on a table - Best High Yield Savings account - Sinking Fund 101

Consider a high-yield savings account

  • High-yield savings accounts offer higher interest rates than traditional savings accounts, helping your sinking fund grow faster. Comparing annual percentage yield (APY) rates can help you earn more interest and reach your financial goals sooner.
  • Online banks often provide the best high-yield savings account rates due to lower overhead costs.
  • Look for FDIC-insured high-yield savings accounts to ensure your money is safe.

Check out Bankrate for a comparison of high-yield savings account rates.

Evaluate your timeline and goals

  • If you need regular access to your sinking fund, a general savings account is more suitable than a certificate of deposit (CD).
  • For longer-term goals, a high-yield savings account or a CD with a higher interest rate may be a good option if you don’t need to make frequent contributions.
  • Money market accounts offer higher interest rates and liquidity, making them a good choice for sinking funds.

Look for accounts with low or no fees

  • Avoid accounts with high maintenance fees that could eat into your sinking fund savings.
  • Some banks offer specialized accounts for sinking funds, like vacation or holiday clubs, that may have favorable terms.

Choose an account that fits your budget and regular contribution schedule

  • Determine how much you can realistically contribute to your sinking fund each month or pay period.
  • Make sure the account you choose aligns with your budget and allows for your preferred contribution frequency.

Consider automating your savings

  • Look for accounts that allow you to set up automatic transfers from your checking account to your sinking fund.
  • Automating your savings helps ensure consistent contributions and reduces the temptation to skip transfers.

Keep your sinking fund separate from your other accounts

  • Separating your sinking fund from your everyday spending accounts helps avoid accidental withdrawals and makes it easier to track your progress.
  • Some banks allow you to create “sub-accounts” or “buckets” within a savings account for different sinking fund goals.
  • Check out Ally and SoFi for the ability to create a sinking fund with sub-accounts.
Image of SoFi Vaults and Ally Savings Bucket on a phone
Courtesy of SoFi and Ally

By considering these factors and comparing your options, you can find a sinking fund account that meets your specific needs, offers competitive interest rates, and aligns with your overall financial goals and budget.

Benefits of Sinking Funds

Pink piggy bank on water - Sinking Fund 101

Sinking funds are powerful budgeting tools that reduce financial stress by allowing you to proactively plan and save for large, anticipated expenses in smaller increments. 

This eliminates the strain of major costs on your monthly budget, enables guilt-free spending on planned purchases, and helps you avoid debt and late payments. 

Sinking funds lead to more consistent, predictable budgeting and greater control over your finances.

Here are some of the key benefits of using sinking funds to reduce financial stress and improve budgeting and planning:

  1. Improved budgeting and planning by reducing the surprise and stress of large purchases
  • By setting aside money each month in a sinking fund, you can avoid the shock and financial strain of large, infrequent expenses when they arise.
  • Sinking funds help you feel in control of your finances by proactively planning and saving for future needs.
  1. Reduced financial stress with a dedicated fund eliminating scrambling for money when big expenses come up
  • Sinking funds allow you to spread the cost of large purchases over time, making them more manageable in your monthly budget.
  • With money already saved, you won’t have to scramble to find extra cash or adjust your budget last minute for major costs.
  1. Enables guilt-free spending on planned purchases
  • Saving up gradually for specific goals in sinking funds lets you make those purchases without guilt or stress since the money is already allocated.
  • You can enjoy planned splurges or vacations more knowing you saved responsibly for them in advance.
  1. Helps you pay bills on time and avoid debt
  • With sinking funds, you’ll have the money ready to go when large, infrequent bills arrive, avoiding late payments.
  • By saving proactively, sinking funds prevents you from having to go into debt to cover major expenses you didn’t prepare for.
  1. Allows for more consistent and predictable budgeting
  • Sinking funds help smooth out budgeting by accounting for infrequent expenses every month.
  • This leads to a more stable cash flow and makes it easier to see where your money is going each month.

Managing Your Sinking Funds

The number of sinking funds and how much you contribute to them will depend on your unique financial situation. 

person placing money in a money jar - sinking fund 101

Start small, prioritize your savings goals, and adjust your budget to make room for consistent sinking fund contributions. 

As you get more comfortable with the process, you can expand and refine your sinking fund’s strategy.

Here are some key insights on managing your sinking funds, how many to have, and reworking your budget to accommodate them:

How many sinking funds should you have?

  • The number of sinking funds you have depends on your personal financial situation and goals. There’s no fixed number, but having too many can become overwhelming to manage.
  • Start with a few key categories (3-5) to get used to the process. You can always add more later as you get more comfortable with budgeting and saving.
  • If you have too many sinking fund goals, consider combining some into broader categories or prioritizing the most important ones.
  • Focus on your debt payoff and emergency fund first before adding too many sinking funds.

Reworking Your Budget for Sinking Funds and Unexpected Expenses:

  • Look at your annual expenses and identify which ones could be turned into sinking funds. Common categories include car maintenance, home repairs, holidays, and vacations.
  • Divide the total amount needed by the number of months until the expense is due. This gives you the monthly amount to budget for each sinking fund.
  • Adjust your monthly budget to accommodate these sinking fund contributions. You may need to cut back on other areas to make room.
  • If you can’t fully fund all sinking funds, prioritize them based on urgency and importance. Focus on the most pressing expenses first.
  • Make sinking fund contributions part of your monthly budget. Treat them like any other bill or expense.
  • Consider setting up automatic transfers to your sinking fund accounts so you save consistently.

Integrating Sinking Funds into Your Financial Plan

Sinking funds can be an effective tool for saving toward long-term goals by breaking them down into manageable, regular contributions. 

napkin pen and coffee mug - sinking funds 101

By choosing the right savings vehicle, consistently saving over an extended period, and adjusting contributions as needed, you can successfully use sinking funds to achieve your long-term financial objectives. 

However, it’s important to remember that sinking funds should be used alongside, not in place of, other long-term investment strategies.

Here are some key insights on using sinking funds for long-term goals:

Sinking Funds Can Be Used for Various Long-Term Goals

  • While sinking funds are often associated with short-term expenses, they can also be leveraged for longer-term goals like saving for a down payment on a home.
  • Other long-term goals suitable for sinking funds include saving for a wedding, a dream vacation, or a major home renovation project.

Saving Consistently Over an Extended Period

  • For long-term sinking funds, you can gradually accumulate the necessary money over an extended period, such as several years.
  • By breaking down a large savings goal into smaller, regular contributions, sinking funds make long-term goals more manageable and achievable.

Choosing the Right Savings Vehicle

  • For longer-term sinking fund goals, consider using a savings account with a higher interest rate, like a high-yield savings account or a certificate of deposit (CD).
  • CDs may offer higher interest rates than savings accounts, but they typically require you to lock in your money for a set term. This can be suitable for long-term goals with a fixed timeline.
  • Money market accounts also offer higher interest rates and liquidity, making them another option for long-term sinking funds.

Adjusting Contributions as Needed

  • As your long-term goal approaches, you may need to adjust your sinking fund contributions based on your progress and any changes in your financial situation.
  • Regularly review your sinking fund balance and timeline, and make adjustments to your contributions as needed to stay on track.

Sinking Funds vs. Long-Term Investments

  • While sinking funds can be used for long-term goals, they are not a replacement for retirement savings or other long-term investments.
  • Retirement savings and long-term investments should be handled separately in appropriate investment vehicles like 401(k)s, IRAs, and brokerage accounts.

Should you invest your sinking fund?

For most sinking fund goals, it’s recommended to keep the money in a liquid, low-risk account like a high-yield savings account. 

person's hand holding a small piggy bank - sinking funds 101

For longer-term goals, some low-risk investment options may be appropriate, but investing in the stock market is generally not advised for sinking funds. 

The primary purpose is to have the money available for the planned expense, not to maximize returns.

Here are the key insights on whether you should invest your sinking fund:

Short-term sinking funds (less than 1-3 years):

  • Keep the money in a liquid account that you can easily access when needed, such as a high-yield savings account or money market account.
  • Avoid investing short-term sinking funds in the stock market or other investments where there is a risk of loss.
  • The priority for short-term sinking funds is to have the money readily available when the planned expense arises, rather than maximizing returns.

Longer-term sinking funds (3-5+ years):

  • For sinking fund goals that are several years away, you may consider investing the money in a low-risk vehicle with higher yields than a savings account, such as certificates of deposit (CDs) or bonds.
  • If your sinking fund is for a goal that is 5 years or more in the future, it might make sense to open a brokerage account and invest the money, depending on your risk tolerance.
  • However, most experts still do not recommend investing sinking funds in the stock market, as the primary purpose is to have the money available for a planned expense, not to maximize returns.

Other considerations:

  • If you choose to invest in a longer-term sinking fund, be aware that the money will be less liquid and may be subject to market fluctuations.
  • Your risk tolerance and the importance of the planned expense should guide your decision. If you absolutely need the money by a specific date, it’s best to keep it in a safer, more accessible account.
  • Sinking funds are just one part of a comprehensive financial plan and should not replace other forms of saving and investing, such as emergency funds and retirement accounts.

Common Questions and Concerns

Can sinking funds be withdrawn?

A sinking fund serves a purpose for your budget. Most people keep sinking funds in a checking or savings account, making them accessible anytime.

Is a sinking fund risky?

A sinking fund is a very low-risk way of saving money, and you can access your funds whenever needed.

Final Thoughts

Sinking funds are a powerful tool for managing your money and reducing financial stress. 

By anticipating and saving for large, irregular expenses in advance, you can avoid debt, maintain a balanced budget, and make steady progress toward your financial goals.

Whether you’re saving for a vacation, a new car, or your children’s education, sinking funds provide a clear roadmap to get there. 

So take a few minutes to identify your specific savings goals and start setting aside those small, regular contributions.

Your future self will thank you!

The Budget Academy
Fab Kellum author of the Girl, Get Out of Debt! blog

Hey you! Welcome to The Budget Academy. I am Fab, a mom, and an entrepreneur at heart. Like many, I have overcome financial struggles, and now I get to share with you how I became debt-free and what I learned on my own personal journey.  I have a Finance and Real Estate background and am passionate about helping others succeed and achieve financial freedom.  So, please don’t be shy, let’s connect and start this journey together! Learn more about me here.