Sinking Funds: What They Are, & Why You Should Include Them In Your Budget ASAP

how to use a sinking fund

About eight months ago, I was introduced to a financial concept that has already changed my life: the sinking fund. 

Right around November, people start saving rapidly for Christmas, Hanukkah, etc. But what if you had been putting $15 or $20 a month away, for a no-sweat holiday season? This, in essence, is the value of sinking funds. Minimize the stress you feel about large, predictable expenses through small, long-term savings goals. 

What is the purpose of a sinking fund?

The purpose of sinking funds vary per individual and can be personalized to you, so whether you’d like to save for a $300 vacuum or a $3,000 car, you can do so. It is important to keep in mind that a sinking fund is different from an emergency fund. Emergency funds are meant, as you might guess, solely for emergencies. However, a sinking fund is used to save up for nonemergency expenses.

For example, if you would like to have $500 to spend by Christmas day of 2019, you should start putting away $83.33 this July. If you would like $100 by New Year’s Eve, you should start putting away $16.67 this July. Saving large amounts for the year becomes easier the sooner you begin. I would like to have $300 to spend on holidays in December, so I have been putting $25 into a designated savings account each month, which I started this past January.

How does a sinking fund work?

A sinking fund is often created through an envelope system. If you were saving as I did for Christmas, you would pull out $25 from your bank account each month starting in January and store it inside your envelope in a safe location. This is a tried and true method for many, but I tend to prefer an online method for safety purposes. [Editor’s note: using a high-interest savings account means you can also put your money to work and earn a little on top of what you’d already be saving.]

To set up my sinking funds, I went to my credit union and set up six additional savings accounts: 

  • Pets – $70
  • Salon – $120
  • Vacation – $50
  • Car – $325
  • Holidays – $25
  • Clothing – $20

While I already budget in $50 a month for my dog’s needs, I have also set up a sinking fund of $70 a month for his medical expenses. I can’t always know when an issue might arise and he will need veterinary care, so this sinking fund gives me peace of mind. I get my hair dyed once every two months and cut once every three months, so my salon sinking fund allows me to make those purchases with no sweat. Previously, I struggled to properly allocate these funds in my regular monthly budget, because I did not like storing them in my typical checking account. For me, it is easy for my checking account funds to just walk away!

While vacation is not a category I am aggressively saving towards, I still like to put $50 a month towards it for when opportunities for travel arise. My car fund is by far the largest sinking fund I have at $325 a month. This monthly savings account is designed to include my yearly car insurance costs, registration fees, and any unexpected repairs. My car fund does not include regular monthly expenses like gas — that comes out of my regular, everyday spending. My holiday sinking fund is used to save up for my major holiday spends: Christmas and New Year’s Eve. Lastly, my clothing sinking fund is a low-priority fund that I use to put away for big purchases. I have been eyeing a pair of athletic leggings to use for my boxing classes for a few weeks now, and if I decide to purchase them, I will be using the money from my sinking funds. 

What can be these funds include?

A sinking fund perhaps most important for expenses that are likely to come, but difficult to predict the timing of. For example, a veterinary bill, high medical copay, or car repair can easily force you to swipe a credit card. By preparing for these expenses throughout the year, you can prevent yourself from the last-minute money scrambling that so often leads to debt. 

Sinking funds are especially useful on very tight budgets. If you are on a strict budget or limited income, you likely do not have a whole lot of wiggle room for unexpected expenses, making you vulnerable to debt. Packing even just a few dollars away for each of your major sinking fund categories will provide the necessary safety net that may be harder to build up as one large, lump sum. Start with $10 a month towards the area that you think may be most likely to come up in future. Are your car’s tires starting to go? Are you expecting any medical procedures in the next year? Is a holiday with expenses coming up soon? These are the questions to ask yourself now.

While having an emergency fund in place is smart, it is not wise to constantly have to dip into it for predictable, not-actual-emergency expenses and then have to build your emergency fund back up. This not only relies on your ability to quickly replenish your funds, but also leaves you vulnerable during the moments after you have depleted your emergency fund. If building sinking funds for every major need seems overwhelming, start with just one and build out from there. The two sinking funds that I suggest everyone have are for a car (if you own a vehicle) and for taxes (if you expect to owe at the end of the year). You can save yourself a lot of hassle!

When I was living in New York on a pre-tax salary of $40,000 a year and budgeting for the first time, I failed to address Black Friday and Thanksgiving in my November budget. That threw me off by $173 — an amount that can be extremely hard to make up on a tight income. Now that I have sinking funds in place, I feel confident in my ability to address the financial obstacles that might come up on the road ahead. The practice of creating these accounts has decreased my financial stress and increased my confidence — and in just a matter of months.

Anna Craven is a publicist and writer from Boston, MA. She loves finance, organization, and most of all, storytelling. You can follow her adventures with her rescue pup, Mickey, here

Image via Unsplash

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