What is a sinking fund?
What is a sinking fund? AND WHY I THINK MOST EVERYONE SHOULD USE THEM.
A lot of times we’re doing so many things right in our personal finances, but we’re still not seeing the progress we want. I have experienced this first hand, and I hear about it from my community all the time. You’ve taken the time to set up a weekly or monthly budget (you may even be using a great budgeting spreadsheet). Everything runs smoothly for a little while, until a larger irregular expense comes up.
This might be an expense that happens every year, like the holidays; a one-time purchase like a flight to your best friend’s bachelorette party; or even your quarterly haircut. Regardless of what the expense is, it can make cash feel really tight, force you to dip into your savings, or run up your credit card balance.
The good news is that you can do something about these less-frequent expenses that end up throwing your budget into disarray. And the sooner you start, the less pain you’ll feel in your everyday spending and saving.
I’ve found that sinking funds are an easy and straightforward solution to getting rid of the ups and downs and money stress that come with these types of expenses.
So what is a sinking fund? I’m glad you asked! Here is everything you need to know about sinking funds so you can set them up to work for you and your spending.
WHAT IS A SINKING FUND?
A sinking fund is money you set aside each week, paycheck, or month with the intent of spending it on something in particular. In the above examples, the holidays, your bestie’s bachelorette, and your quarterly haircut would all get their own sinking fund account.
That’s why it gets the name “sinking.” The fund will eventually sink - or get spent. By putting money aside over time, the money is there waiting for you by the time you’re ready to spend it.
SET UP YOUR SINKING FUND ACCOUNTS.
Getting clear on the logistics of your sinking fund is the key to its success. The first thing to think about is which expenses you’ll want a sinking fund for. Think through the next twelve months or even the next couple of years. Do you have any larger expenses coming up that you’d want to start planning for?
Some ideas to jog your memory:
Celebrations like holidays, birthdays, weddings, and bachelorettes
Travel including longer trips and shorter weekend trips
Moving homes or apartments Tuition payments and summer camp
Medical or vet bills (this might be your deductible)
Shopping (if you prefer to do larger seasonal shops or are saving for something special)
Car or home repairs
Taxes and tax preparation
A spontaneous fund to be able to say “yes!” to the fun, spontaneous things that come up
This list is by no means exhaustive. I recommend starting simple and adding as you get the hang of it or notice it would be valuable to have sinking funds for more things.
If it feels overwhelming to have a sinking fund for each trip (it does for me!), a single sinking fund to cover all travel for the year might work best for you. If you want to be held more closely accountable for staying on budget for each trip, a separate account for each trip might make more sense.
Then you’ll want to set up your sinking fund accounts. A great place to keep your sinking funds is in an online savings account. Online savings accounts are ideal because they are out of sight, out of mind (so you can’t steal from your sinking funds for other things), they are free, and they earn some interest.
You can create multiple savings accounts and name them based on what each sinking fund is for. For example, “holiday fund” or “travel fund.”
HOW MUCH WILL GO TOWARDS EACH SINKING FUND (AND HOW OFTEN)?
Next, you decide how often and how much money to set aside to each sinking fund. If you have an idea of what something will cost, you can work backwards. If you’re not sure what something will cost, make an educated guess. I recommend checking in on your sinking funds at least once per quarter so you can reassess and adjust if you have more information.
Let’s say you know you want to buy a flight for a vacation in four months and estimate the flight will cost $400. You’d want to set aside $100 per month toward your vacation sinking fund.
Some might prefer to transfer money over each week or each paycheck which will make each transfer a smaller amount. Others prefer to do it monthly and schedule the transfer during the time of the month when they don’t have larger bills like rent or mortgage.
MAKE TRANSFERS TO YOUR SINKING FUND AUTOMATIC.
You want to make sure all transfers to your sinking fund are happening automatically so you don’t have to remember to make them yourself and can rest assured that they are going to happen. Automatic transfers makes it so your sinking funds are a financial priority.
USING THE FUNDS FROM YOUR SINKING FUND.
When it’s time to make a purchase that you planned for, there are a couple of ways to do it. You can transfer the money out of your sinking fund in advance so it’s available in your bank account by the time you make the purchase. This is great if you’d like to pay in cash or with your debit card, or if you’d like to pay off your credit card immediately.
If you use sinking funds for a lot of things, it might feel overwhelming or tedious to be transferring money over all the time. You can look at the week ahead and transfer money over proactively, or you can look back at the past week to determine how much to transfer over from your sinking funds.
If you want to charge your credit card and get points for sinking fund expenses, I highly recommend transferring the money over and paying that part of the balance off right away.
It can be tempting if you have enough cash in your bank account not to transfer money over from the sinking fund. That can end up causing more money stress because you won’t have the typical amount of cash available for your everyday expenses. If you end up having extra funds all the time, that might be a sign you can transfer more money over to build your rainy day fund or to put towards other money goals.
SINKING FUND VS. SAVINGS - WHAT’S THE DIFFERENCE?
Sinking funds are savings accounts for very specific things. Your vacation fund is your short-term savings account to pay for your vacations each year. You’re saving up for specific things in the short term.
SINKING FUND VS RAINY DAY FUND - WHAT’S THE DIFFERENCE?
Your sinking funds are not the same as your rainy day fund. Your rainy day (aka emergency fund) is money set aside for an emergency, and ideally is also in an online savings account. It’s not a sinking fund because you don’t spend it unless it’s necessary. You don’t know what it will be used for.
If you were to lose your job, for example, and need to use the money in your rainy day fund, you’d work to rebuild it again as soon as you have the opportunity. It’s a fund that doesn’t sink, it stays.
WHY A SINKING FUND WORKS.
Having sinking funds for your less frequent, large expenses will make your life so much easier and less stressful. Putting aside $35 per paycheck feels a whole lot different than having to spend $910 in one paycheck.
It’s a completely different experience to have the money set aside and waiting when you are ready to make a purchase. It reduces the chance of over drafting (and getting the fees that come with), having to pull from savings, or having to put things on our credit cards and accumulating credit card debt.
It also makes you take a step back to plan so that you are spending money you have. When you don’t have a plan, your non-essential spending can make you feel guilty - and that ironically takes a lot of the joy out of it. By using sinking funds, you can spend money on the things that matter to you without the shame and guilt.
REASSESS YOUR SINKING FUNDS EACH QUARTER.
It’s helpful to reassess your sinking funds every few months since you aren’t always sure of the cost of things when you plan in advance. As you get closer to the time you need to book a flight, you probably have a better idea of prices. Once you decide on which Airbnb, for example, you know exactly how much it will cost.
By checking in on your sinking funds, you can reassess prices and adjust your automatic transfers as needed.
TO SUM IT UP - WHAT IS A SINKING FUND?
Using sinking funds is a great strategy to smooth out larger irregular expenses so they don’t cause financial stress. You can set up a sinking fund for various expense categories and have money transfer over automatically every week, each paycheck, or every month. When it’s time for you to make the purchase, the money will be there waiting for you in your sinking fund account.