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Sunday, April 21, 2024

Saving for something big? Try a sinking fund

What a sinking fund is & how to create one

03.03.2023

When it comes to savings, there’s no denying that the emergency fund gets all the glory. But there’s a lesser-known fund that’s also important: a sinking fund.

In fact, if you have an emergency fund but still find yourself struggling with your finances, it could be because you haven’t set up a sinking fund.

Let’s explore exactly what a sinking fund does, why you might want to add one to your budget, and how to create one.

What is a sinking fund?

A sinking fund is a fund of money that you intend to spend on a particular need or want at some point in the future. These expenses happen only occasionally or sometimes just once.

Think of that vacation that you’ve just started daydreaming about or the weddings and birthdays coming up. These aren’t monthly expenses that you’re used to budgeting for and they aren’t emergencies (no matter how badly your mind is telling you that you need to be beachside for some emergency Vitamin D). They’re occasional expenses, which is why a sinking fund might be a good fit.

Why might I want a sinking fund?

Sinking funds can allow us to live and enjoy life without throwing a wrench into our finances.

To help you see exactly why you might consider a sinking fund, imagine this scenario: It’s been a whirlwind of a year, including a big switch in jobs. Though the holiday season is still many months away, you know that you’ll eventually want to kick your shopping into high gear.

So what do you do?

If you’re like many Americans, you may potentially go into credit card debt.1 You might also try to cover the cost with December’s budget but that could be a squeeze. Or maybe you pull from your emergency fund even though poor planning definitely is not an emergency.

There has to be a better way, right?

Enter the sinking fund. By creating one or more sinking funds, you can prepare your finances for different expenses you will encounter throughout the year. By making small deposits on a schedule that works for you, you can grow your short-term savings to cover the cost without debt.

Examples of sinking funds

Life is expensive and unpredictable. That can be a recipe for disaster when it comes to budgeting. Luckily, setting up sinking funds for irregular or unexpected expenses can help certain spending sting a bit less.

That’s why sinking funds categories might also include:

  • Car maintenance
  • Medical and dental co-pays
  • Property taxes
  • Pet care

In the case of both humans and animals in your household, there are bound to be medical expenses. You just don’t know when they will strike.

By setting up a sinking fund, you can stress less about money when you’re sitting in the waiting room of the urgent care or vet office. To determine what other sinking funds might help with irregular expenses, look at housing and transportation costs, as well as other essential expenses.

Just like people shouldn’t be all work and no play, your money should have some fun, too.

That’s why sinking funds might also include:

  • Vacations
  • Home renovations
  • Concert tickets
  • Birthdays and holidays
  • Charitable giving

By creating one or more of these sinking funds, you can start saving now. That way, when an awesome opportunity to have some fun and give back shows up, you can say yes wholeheartedly.

How to create a sinking fund

Now that you understand what a sinking fund is and why they can be useful, let’s talk about how to create a sinking fund.

1) Decide where you are going to keep your money

Some people choose to open savings accounts with higher interest rates that feature sub-accounts, sometimes called envelopes or buckets, that you can name.

Other people prefer to open several separate savings accounts.

And some people work best with a traditional spreadsheet. In that case, you keep all of your money stashed in a single savings account and simply earmark portions of it into sinking funds using Google Sheets or Excel.

2) Ballpark the expense

After you know where you want to stash your cash, it’s time to figure out how to fill up that account. For this example, let’s choose new tires for your car.

After your last oil change and tire rotation, you and your mechanic both agreed that your tires are starting to show a lot of wear. A bit of research online reveals that $600 is a reasonable estimate for what these tires will set you back.

3) Crunch the numbers

You can do an online search for sinking fund calculators or you can do the math yourself.

If you estimate that new tires will cost $600 and you expect to replace them in the next 6 months, you can divide the expense by the number of months to see what you need to set aside each month. In this case, you should add $100 a month (or $50 from your biweekly paychecks!) to your sinking fund.

4) Spend without worry

Once your sinking fund is full, you can spend the money without worrying about busting your budget or derailing your financial plans. Just make sure that once the money is spent, consider rebuilding your sinking fund or create a new one for your next short-term savings goal.

Are sinking funds a good idea?

When it comes to finances, people often think of emergency funds as the one account that can really rescue their money. Emergency funds are crucial, but if you have one and still struggle with your finances, it could be because you haven’t created any sinking funds.

Sinking funds cover occasional essential expenses, such as car maintenance or vet visits. They can also help you say yes to more optional exciting expenses that come your way, including concerts and vacations.

 

1 LendingTree, “Average Holiday Debt Nears $1,550, Highest in LendingTree Survey’s 8-Year History,” December 2022.

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Andy Hill, AFC®

Contributor

Andy Hill, AFC®, is the award-winning family finance coach behind Marriage, Kids, and Money, a platform dedicated to helping young families build wealth and happiness.

Author is not a client of Empower Advisory Group, LLC, and is compensated as a freelance writer.

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