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Sinking Funds: What They Are and How They Could Help You
A sinking fund may help saving for a major purchase easier.
Whether you need a down payment for a house or want to pay off a credit card, it may feel overwhelming to build up the savings. And your goals may require you to save up for several months (or years) to cover the costs.
Sure, you could dip into your general savings account or even tap into your emergency fund, but there may be a better option – a sinking fund. Setting up a sinking fund may help you save for one goal without impacting other financial goals.
Key Takeaways
Sinking funds help you save for a specific purchase or event.
You should establish a clear savings goal and timeline when using a sinking fund.
Keeping your sinking fund in a dedicated savings account may make it easier to track your progress.
What Is a Sinking Fund?
A sinking fund is a savings method that helps fund a specific purchase or expense by a certain date. The term “sinking fund” was first used in 18th century England to refer to funding public debts,¹ but the meaning has changed over the years. Today, in corporate environments the concept is related to payments toward bonds. For individuals, the term simply refers to an account and process used in saving toward a goal.
Individuals may use sinking funds to save toward a purchase like a new car, a wedding, or buying a home, as well as toward a future, planned expense. These funds differ from general savings since you’re building them with a specific goal in mind.²
Purpose of a Sinking Fund
For individuals, a sinking fund is distinct from other saving categories you may have, like an emergency fund or a rainy day fund. A sinking fund is usually a bigger purchase or expense, and some people may choose to name their sinking fund after the goal they’re saving for, such as a wedding fund.
Before we dive into more details about a sinking fund, here are the definitions of other fund types, so that you can better understand how they are different.
Emergency Fund: An emergency fund covers major unexpected financial situations, such as losing your job or a medical emergency.
Rainy Day Fund: A rainy day fund covers smaller unexpected financial situations, such as a surprise vet bill or the water heater breaking.
Splurge Fund: A splurge fund helps you cover spontaneous purchases, like concert tickets or a shopping spree, without impacting other financial goals.
Vacation Fund: A vacation fund helps you cover expenses related to travel, from hotels to airlines to meals. (Some people may choose to use a sinking fund to save for a vacation. It’s up to you!)
It’s important to create funds that align with your financial goals. Not everyone needs to have every type of savings fund.
Benefits of a Sinking Fund
A sinking fund offers a few pros that may make saving toward your goal easier and more rewarding. Here are a few ways starting a sinking fund may help.³
Stay Motivated: Since most people create a timeline for reaching their goal when using a sinking fund, you may find it easier to stay motivated because you know exactly where the finish line is.
Reduces Guilt:
Nearly 50% of shoppers report feeling guilt or buyer’s remorse after making a large purchase without saving for it in advance.⁴ By saving ahead of time, you may be able to enjoy the purchase without battling guilt.
Plan for Annual Costs: If you have annual or semi-annual expenses like buying holiday gifts or insurance premiums for a house or car, a sinking fund may help you prepare for these costs ahead of time and reduce stress when those purchases roll around.
Accommodate Multiple Goals: If you’re saving toward multiple goals at the same time, sinking funds may make it easier to track the progress toward each one. Even better, if your savings goals are different amounts, achieving a smaller goal may motivate you to keep saving toward bigger ones.
Reduce Temptation: Since sinking funds help you save for a specific goal, you may be less tempted to use the money on other items or purchases. It may also make you less likely to dip into other funds (like your rainy day fund) to cover a large purchase.
How to Create a Sinking Fund
Creating a sinking fund is easy if you use the following steps.
Step 1: Choose Your Goal
Before you start your sinking fund, decide what goal or goals you’re saving for. Once you know what you’re saving for, decide how much you need for this purchase and create a timeline for reaching this goal.
When creating your timeline, set a realistic date based on the size of the goal. For example, it may take you longer to save enough to pay off your credit card debt than for the down payment on a car.
Step 2: Work Your Sinking Fund into Your Budget
As with any savings goal, you need to make regular contributions to the fund if you want to reach your goal. The easiest way to do that is to make your sinking fund part of your monthly budget.
Take a look at your savings goal and your timeframe to determine how much you need to contribute each month to help you reach your goal.
Say you’re trying to save $20,000 for a down payment on a home in the next two years. That means you want to put $10,000 per year, approximately $834 per month, into your sinking fund.
Once you determine how much you need to save, examine your budget and see where you may be able to adjust current spending to meet this goal. This might mean cutting back on less important expenses (like pressing pause on nightly take-out). Of course, you may still want to splurge during this time, but that’s why you have a splurge fund!
Step 3: Decide Where to Store Your Sinking Fund
Just because you could keep your sinking fund in cash in an envelope doesn’t mean you should. You may want to put that money to work and the easiest way to do that is by keeping it in a high-yield savings account that earns a competitive rate, expressed as Annual Percentage Yield (APY).⁵
Depending on when you need the funds, you may consider opening a certificate of deposit (CD). CDs may have higher rates available than savings accounts in exchange for locking your money away for a set term. Keep in mind that many CDs only let you contribute money when you open the account, so if you plan to make regular contributions to your sinking fund, a CD may not be the best choice.
High-yield savings accounts, on the other hand, are more accessible and let you make ongoing contributions whenever you have the money to do so.
Take your time and compare your savings account options to find an account that helps you reach your goals and meets your needs. When comparing your options review rates, any potential fees, and look for accounts that are FDIC-insured to make sure your money is safe.
Final Thoughts
Creating a sinking fund may make it easier to save for major goals or purchases and plan ahead for future purchases. By keeping your fund in a high-yield savings account, your funds may grow faster and speed up your savings. Whether it’s for your dream home, a new car, or paying off debt, using a sinking fund to set money aside regularly may help you achieve your financial goals .