Imagine a world where you had money for upcoming expenses. Where you had the cash to spend on vacations without going into debt. A life where you had the money to pay for Christmas gifts and special occasions without racking up credit card debt. A world where you had the money to replace your car without a loan that would take longer to pay off than earning a medical degree.
Is this a pipe dream only for the super-affluent? Absolutely not! It’s a dream you can achieve when you start creating a solid financial plan. A plan that includes establishing sinking funds.
What are sinking funds?
The official accounting definition of a sinking fund is the periodic setting aside of money for the repayment of a debt or replacement of an asset. When you routinely set a particular amount of money aside for the purchase of something, you create a sinking fund.
How to use sinking funds
Sinking funds are a great way to encourage you to pay for large purchases by helping you save up money over time. Instead of financing a large purchase, set aside the “monthly payment” amount each month and pay cash for the purchase instead.
By earmarking your savings for particular items, you create intentionality in your budget.
Sinking Funds vs. Savings Account
If you’re wondering “What’s the difference between a sinking fund and a savings account?” The answer is, not a whole lot. Sinking funds are still a way to save money in an account. They are just targeted, specific ways to save.
Benefits of a Sinking Fund
Sinking funds can be created for absolutely anything
- A cool new toy, fancy shoes, or a weekend away at a luxury hotel. Sinking funds are a great way to budget for fun!
Reduce the guilt of spending your money on something fun or totally frivolous
- Being an adult means paying bills and generally being responsible with money. Often when we are budgeting or trying to get out of debt, we can feel guilty about spending money on things that aren’t “essential”.
- Sinking funds reduce that guilt because instead of feeling impulsive for spending cash on something you desire, you save up over time to earn the thing you want. Then, you can spend that money guilt-free, knowing you planned for it and accomplished your savings goal!
Save up for big projects, big purchases, or unexpected expenses
- We created a sinking fund when we wanted to gut and remodel the first floor of our home. Another huge benefit of sinking funds is that it gives you a ceiling for your budget. If you want to pay cash, you have to get creative to ensure the money you have saved can cover the cost.
Sinking funds help you stay on budget
- When you know how much you plan on spending on an item, and you have saved routinely for it, you will be likely to keep to that budget because you have saved up the cash and been intentional about its purpose.
Types of sinking funds
You can create a sinking fund any purchase. Literally, anything you can think of!
Often, sinking funds fall into a few categories:
- Large purchases, like a vehicle, furniture, or a family vacation
- (Not so) unexpected expenses such as new clothes for your teenager that hit a massive growth spurt or replacing a damaged cell phone
- Routine expenses, such as annual insurance or medical bills
Consider a few of these popular sinking fund ideas to get started:
- New car purchase
- Annual or semi-annual payments, such as car or home insurance, or property taxes
- Home remodeling project
- Special event spendingReunion
- Baby shower
- Wardrobe upgrades
- Child extracurricular expenses
- Special purchaseAn educational course
- Computer or other technology
- Cell phone
How is a sinking fund different from an emergency fund?
While both types of funds cover expenses that arise in your financial life, their purpose is different. Emergency funds should be saved for just that- true emergencies. Job loss, unexpected medical issues, or unforeseen home repairs can all be occasions one might need to dip into an emergency fund.
On the contrary, sinking funds are generally used for covering expenses that are more routine or intentional. They cover large purchases as well as expected replacements. While you might not know when your car will need to be replaced, it’s no mystery that vehicles wear out and won’t last forever. You can use a sinking fund to plan for that cost.
Sinking fund calculator-do the math
To set up a sinking fund, determine how much money will need to be saved toward the fund goal. Then, divide that number by the number of months, weeks, or paychecks you have left until you need to make the purchase. Set aside that amount for each installment.
Cost of item ÷ # of intervals before purchase = deposit amount for each interval
If that sounds confusing, check out the following example.
Sinking fund example
Say you want to save money for Christmas gifts. You decide you want to have $750 saved by the time shopping season arrives, which is 10 months away.
Monthly sinking fund deposit:
$750 ÷ 10 months = $75 per deposit
Bi-weekly sinking fund deposits:
$750 ÷ 20 weeks = $37.50 per deposit
Weekly sinking fund deposits
$750 ÷ 40 weeks = $18.75 per deposit
The amount you are saving for can be adjusted for any purchase, as can the time before purchasing.
If you want to buy something cash, but can’t afford the amount of the sinking fund deposit each time, that’s a sign something needs to be adjusted.
Either you will need to put off the purchase for a later date so that more money can be saved, or you’ll need to adjust your expectations for the purchase, such as planning an epic road trip versus that bucket list international adventure.
Need to squeeze more from your travel budget? Check out our 6 part series on Traveling on a Budget!
How to organize sinking funds
To organize sinking funds, you’ll need to first determine the categories you want to save for. Then, research the cost of each event, as well as the time table for purchase.
Once you know the cost & savings duration, you can calculate the amount of each sinking fund and budget accordingly.
We like to use sinking funds for cars, vacations, and large purchases. Here’s an example from our budget:
You can track sinking funds in a variety of ways- online tools, a bullet journal, worksheet or spreadsheet, or with our free sinking fund printable!
Best accounts for sinking funds
The best accounts for sinking funds are those which let you earmark funds for each category. My favorite account for this is the Capital One 360 Savings Account. This account is fee-free and earns 1% APY- plus, no balance minimums are required!
Your money is FDIC insured and they have a great mobile app so you can view your account and transfer money easily. To top it all off, there’s also no charge to transfer funds between your current bank and your Capital One account.
With the Capital One 360 Savings Account, you can set up savings goals and track your progress daily. Plus, you can create as many as 25 separate savings categories under one account number so that you can track individual sinking funds. This is such a huge benefit! I love seeing the progress of each individual goal instead of one number for all sinking funds!
You can also set up automatic savings plans within your account. Capital One will automatically transfer the desired amount on whatever date(s) you specify. Set it and forget it…and watch your savings grow!
Sinking funds template
Research shows that people are more likely to stick with a goal if they write it down and refer to it regularly. If you want to give sinking funds a try, here’s a great way to start tracking your savings!
Score this sinking funds free printable template and get started tracking your sinking funds today!