Sinking funds are a way to save money over time. If you are hoping to save up money for a specific goal, the best way to do so is to use sinking funds!
What are sinking funds?
Sinking funds are savings goals where the money that you put away on a regular cadence is to save for a specific expense. Generally, a sinking funds are meant for an expense that is irregular or out of the ordinary, and requires a larger up-front payment.
For example, say you’re saving up for a beach vacation that you plan to take in 10 months and it’s going to cost you $1,500/. How do you pay for it? Do you use your emergency fund, or do you front the money and pay it off by credit card? Or maybe you trim off areas of your budget.
Sinking funds eliminate the need to do any of these things. With sinking funds, you set aside money each month as part of your overarching spending plan that is specifically intended for this expense. In this case, you’d set aside $150 per month to save for it. Doesn’t seem so expensive and feels a lot more achievable, huh?
As a result, you’re able to slowly save up for it, without dipping into your emergency fund or needing to put it all on your card. And in 10 months, you’re hitting the beach without a worry in the world.
What are they used for?
Sinking funds can be used for literally any type of savings goal or planned expense. I’m currently using one to save up for a down-payment on a house. You can create a sinking fund for a vacation, a wedding or any type of similar/related event, a car, a surgery or medical procedure, a gift, a piece of furniture, an expensive handbag… the list goes on and on.
You can also use one for a category of expenses, rather than a specific identified expense. For example, say you recently bought a used car. It would be a great idea to set aside a car sinking fund for $1,000 that is specifically meant for any expenses related to your car. That way if you need to get your breaks replaced or your windshield cracks, you have money set aside to use without draining your emergency savings.
How are they different from an emergency fund?
Now you may be thinking, what’s the point of an emergency fund? How is it different than a sinking fund?
An emergency fund is meant for emergencies. This is often confused with “unexpected expenses.” An emergency is when something happens to you that is completely out of your control, unexpected, and the amount of money required for you to pay is largely indisputable. An emergency would also be classified as losing your job for an extended period of time, or needing to care for a family member with little to no notice.
A sinking fund is meant for anticipated expenses. Going back to the car example; when you buy a car, you know there will be maintenance involved. Sure you don’t know when, but you know it’s going to happen. Therefore, you can be proactive and plan ahead for it. You can’t always anticipate getting hit by a car or losing your job. Those are emergencies 🙂
How does a sinking fund fit into your framework?
A sinking fund is a short-term savings goal, so it should be in a savings account. You have two options: a traditional savings account, or a high-yield savings account.
In my opinion, a high-yield savings account is always a better option because you earn more money per dollar compared to a regular savings account. However, if you have the option to open multiple savings accounts within your bank, it could be easier to organize.
How to Calculate How Much You Need
You can calculate the right amount for your sinking fund by setting SMART financial goals. Two important elements of SMART goals are that they are:
First, you need to think about what the expense will look like, and how much it’s going to cost. Once you’ve identified a measurable dollar amount, you need to decide how long you’d like to save for it and give yourself a timeline.
With those 2 pieces of information, you can do some simple math. Take the total amount you plan to save and divide it by the number of months you plan to save for it. The result is how much you need to save each month to reach the goal. You can adjust this number by either reducing or increasing the timeframe in which you save for.
(Ex: You want to save foo travel to your friends wedding in 1 year. It’s going to cost $1,000 for the flight, hotel, and gift. This means you need to save $84 per month ($1,000/ 12 months). Each month, transfer that amount of money into your savings account for the fund.
It really is that simple.
Sinking funds are a great way to save for a planned expense. You can use them to be proactive about your finances and anticipate upcoming expenses. As a result, you can buy the things you want and you can live the life of your dreams while also sticking to a budget and being fiscally responsible! You just need to put in a little work!