Last Updated June 24, 2020
Want to find a way to save more money? You probably have heard of the term “sinking funds” from some of your friends, or money gurus like Dave Ramsey, but never understood what they were. Find out what is a sinking fund, and why you probably need it.
What Is A Sinking Fund?
A sinking fund is when you set aside money specifically for a major purchase or a bill. In other words, you are basically saving up a little bit of money over time so you can prepare for the expense and it doesn’t catch you off guard.
What Is The Purpose Of A Sinking Fund?
A sinking fund can serve two purposes:
- Help you save for a major purchase over a period of time.
- Help you plan and prepare for your irregular expenses — meaning expenses you know will occur but they don’t occur every month.
By putting aside money every month for these irregular bills, you’re making sure your budget doesn’t get thrown off when the bill is due. A sinking fund also helps you stay on track if you have a large savings goal.
Types Of Sinking Fund
You can literally save for anything with a sinking fund. Usually, you’re saving for a major purchase (like buying a car or a house) and/or for irregular expenses (such as Christmas gifts, Thanksgiving dinner, birthdays, or an annual vacation you like to take).
So I like to break up my sinking funds for my short-term goals (will take me less than 3 years to achieve) and my long-term goals (will take me 3 years or more to achieve). Let’s go over some sinking fund examples so you get a better idea of what I mean.
Sinking Fund Examples
Long-Term Sinking Fund Examples
- Buy A House
- Buy A Car
- Emergency Fund
- College Savings
- Dream Vacation
Short-Term Sinking Fund Examples
- Property Taxes
- Birthday Gifts
- Anniversary Gifts
- Christmas, Easter, Thanksgiving, Mother’s Day, Father’s Day (or any other holiday that requires you to spend money)
- Home/Car Insurance (if you don’t pay monthly)
- Wedding Fund
- Annual Vacation
- Annual Membership Fees
- Licenses (professional, driver’s, etc.)
- Doctor Visits
- School Tuition
How Is A Sinking Fund Different From My Emergency Fund?
Now that you know what is a sinking fund, you’re probably wondering how it’s different from an emergency fund. A sinking fund is different from your emergency fund because your emergency fund is for unexpected expenses.
Your sinking fund is for expenses you know will come up. For example, Christmas gifts, Thanksgiving dinner, or an annual vacation you like to take.
Why Do You Need A Sinking Fund?
A sinking fund is great because it specifies what you’re saving for. This keeps you more organized when you’re saving for multiple expenses at the same time. You know exactly how much you have saved for each expense separately. Let me give you an example to illustrate this.
Let’s say you would like to save for a vacation and Christmas gifts at the same time. For example, assume you’re saving $150 every month in a general savings account ($100 for your vacation and $50 for Christmas gifts). This savings rate will give you a total of $1,800 for the year.
Assume at the end of 12 months you take a vacation that costs you $1,500. You’re now left with $300. The problem comes when you’re ready to start Christmas shopping. You calculated you needed $600 for your Christmas gifts, but now you’re short.
The reason why you’re short is because all of your money is saved in a general savings account, and you didn’t specify how much money is for your vacation and how much money is for your Christmas gifts. All you saw was that you had $1,800 in your account, and that was more than enough to pay for your vacation. But you didn’t realize you were taking money away that you needed for Christmas gifts.
In other words, by not keeping your savings goals separate, you may overestimate how much you actually have available to spend on one expense.
Here’s what the same situation would look like if you used a sinking fund:
- $50 for Christmas gifts
- $100 for vacation
At the end of the year your sinking fund totals would be:
- $600 for Christmas gifts
- $1,200 for vacation
When it’s time for you to take your vacation, you have two choices:
- You can take a cheaper vacation for $1,200.
- Or continue to save until your vacation sinking fund reaches $1,500.
By having a sinking fund, you can choose to take your vacation and still be prepared for Christmas.
How Much Should I Put In A Sinking Fund?
How much you put in your sinking fund really depends on what you’re saving for. Here’s how you determine how much you should put in your sinking fund:
- First, you need to make a list of all the things you want to save for.
- Next, determine how much money you need for each upcoming expense.
- Then take that amount and divide it by the number of months or weeks you have until you need to spend that money.
The figure you come up with will let you know how much you need to save every month or week towards that upcoming expense.
So your sinking fund formula is:
Total expense ➗months or weeks you have to save = how much you need to save every month or week in your sinking fund
For example, say you want to save $1,800 for a vacation you want to take 6 months from now. Your sinking fund formula would look like this:
$1,800 ➗6 months = $300 per month
You would need to save $300 per month for your vacation sinking fund.
Or say you want to save $420 for Christmas, which is 7 weeks from now. Your sinking fund formula would look like this:
$420 ➗7 weeks = $60 per week
You would need to save $60 every week for your Christmas sinking fund.
You can use the Sinking Fund Worksheet in my FREE Resource Library to help you with this.
Now, if you can’t afford the number you come up with for your sinking fund (because you’re trying to save for a ton of things all at once), you can do a few things:
- Give yourself more time to save for your long-term sinking funds.
- See if you can reduce the cost of some of the bills on your list.
- Prioritize your most important savings goals. Cross out the things on your list that doesn’t mean as much to you or save for it at a later date.
How Do I Include A Sinking Fund Into My Budget?
Now that you know what a sinking fund is, and how much you should put in your sinking fund, let’s determine how you include your sinking fund into your budget. If you don’t have a budget set up yet, you can download this FREE Printable Monthly Budget Worksheet.
In this worksheet, I provide a “Savings Plan” section where you can track your sinking fund.
You can enter your starting balance, the amount you plan to save each month, and what your monthly ending balance is. I would put in parenthesis what my long-term savings goal is.
For example, assume you’re saving $1,200 for your vacation sinking fund from the example I gave you earlier. You would write $0 in the “Starting Balance” box. Then write $100 in the “Monthly Savings Goal” box.
Next, write $100 in the “Ending Balance” box after you put aside your $100 for the month. Finally, next to the $100 you wrote in the “Ending Balance” box, you should write ($1,200) to remind yourself what your long-term savings goal is.
Every month as you get closer to my goal, you should continue to keep your long-term savings goal in parenthesis. Look at the picture below to see an example of what I mean.
If you have more than one savings plan you want to track, I recommend getting my excel Monthly Budget template. This budget template is more detailed than the worksheet and allows you to add additional rows for multiple savings goals.
These templates are what I’m currently using for my budget, and it has helped me save over 50% of my income every month. You can read my detailed article “How To Use A Monthly and Yearly Household Budget Spreadsheet” to learn more about how to set up a budget that actually works.
Where To Keep Your Sinking Fund?
Savings Account
I like to keep my sinking funds separate from my savings because I know exactly how much money I have set aside for what expense.
For example, I like to travel; therefore I have a separate savings account only for my vacations. Since I know I want to take a vacation at least every year, I know how much I can afford to spend on my vacations based on what’s in my vacation account.
If you open a separate savings account for your sinking fund, like me, make sure that account has a low (or no) minimum required balance.
I recommend Radius Bank because it offers competitive interest rates, has no monthly maintenance fees, and no minimum balance requirement after $100 to open.
This is super important because you don’t want to be penalized for withdrawing your money once you are ready to pay for the expense you’ve been saving for. Also, their checking account has free ATMs worldwide.
If you don’t like the idea of having too many separate savings accounts, you can keep your total sinking fund savings in one account. However, this will only work if you keep track of how much money is allocated to each savings goal.
Cash Envelope
You can also save for your sinking fund by just setting aside money in separate cash envelopes. You don’t necessarily have to open up another savings account for this purpose if you don’t want to.
By the way, if you are looking for a fun way to save money for your sinking fund, join my 31 Day Savings Challenge. If you start today, you will have almost $500 ($496 to be exact) within 31 days.
The rules of the challenge are easy. Each day of the challenge deposit the corresponding amount into your sinking fund account or cash envelope. If you decide to go the cash envelope route, you can download these FREE cash envelopes.
Summary
Now that you know what is a sinking fund, you should consider using one. You need a sinking fund to keep you more organized when you’re saving for multiple expenses at the same time.
It keeps all your savings goals separate so you know exactly how much you have saved for each expense. Using this method makes sure that your reoccurring planned expenses don’t catch you off guard. So start incorporating a sinking fund (or a few) into your budget today!
Related Articles:
- 101 Easy Ways To Save More Money
- How to Save 50 Percent Of Your Income
- Paying Debt Vs. Saving: Which Is Best
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