Sinking Funds: Save Now for Future Expenses (Complete Guide)

A sinking fund is cash savings separate from an emergency fund. It’s money that has been earmarked and set aside for a specific future purpose. Sinking funds are built up over time by making frequent contributions until it has reached the target value.

I’m always looking for new savings tips, tricks, and hacks for our family. The idea of a sinking fund is not a new concept and many people are doing it without realizing there’s a specific nomenclature for it.

I’m going to cover every aspect of a sinking fund so that you may understand how to leverage the power of your income to save for the future.

What is a Sinking Fund?

A sinking fund and a savings account are one and the same. The difference between a savings account and a sinking fund is in their purpose and implementation.

The purpose of a savings account (emergency savings) is to have money set aside in case of an unforeseen financial expense. It’s self-insurance against a costly financial event.

The purpose of a sinking fund is to intentionally save a specified amount of money for a defined purpose sometime in the future. It’s money that’s accrued over time for a set purpose.

A common example is families that save up for a family vacation. The average household has $8,863 in a bank or credit union according to Bankrate. This includes checking AND savings.

Sinking Fund Example

Imagine the average family with $8,862 in cash wanting to go on a vacation. Let’s assume this vacation will cost $2,000. This family now only has $6,862 in cash. This family now has to choose between putting themselves in financial danger or having to cancel their vacation.

Instead, imagine they spent the past 10-months allocating money to a sinking fund. If they simply set aside $200 per month, for 10-months. They could pay cash for the vacation without reducing their cash savings.

Sinking Fund Equation

Future Expense ÷ # of intervals until expense = interval deposit amount

Sinking Fund vs Savings Account

You may be thinking that they will have the same amount after the 10-months whether it’s in savings or in the sinking fund. I disagree, people tend to dip into savings throughout the year for many reasons. Most of which are not emergencies.

If you have money in a specific sub-account, or physical envelope for a specific future purpose, you’re much less likely to dip into it. This is because at the moment you will be conscious of the fact that you’re sacrificing the future vacation for the immediate want/need. That $100 pair of shoes doesn’t seem so necessary now, does it?

I remember being a kid and saving up for a big bedroom stereo. I saved cash from birthdays, allowance, etc… The cash was for a specific purpose and nothing could make me dip into that stash for any reason other than purchasing the stereo of my 13-year-old dreams.

Turn Emergency Fund Into a Sinking Fund

You can most definitely turn your emergency fund into a sinking fund. In fact, I highly recommend it.

Once your emergency fund is fully funded (let’s say $10,000). You can continue to allocate a set amount each month to it. As your family and responsibility grow, so should your emergency fund.

Automatically contributing to your emergency fund each month is a great way to keep it growing without really noticing it.

IMage explanation of a sinking fund. Boat on the water with buckets attached to a rope.

How to Start a Sinking Fund

There are many ways to start a sinking fund. You can simply save money in a physical envelope, use an app, or even your bank account.

Physical Sinking Funds

The tried and true method of using physical envelopes as a sinking fund can change your life. This is probably the most engaging form of a sinking fund, but also the most outdated.

Check out this clever cash envelope budget system.

I rarely deal in cash, if I have cash on hand it doesn’t last long. Some people enjoy working with cash, feeling it, saving it, and physically placing it in a safe place.

The downside to the envelope system is the threat of destruction and theft. Similar to money in a mattress and the house catches fire. You’re adding a level of risk to the situation that should be considered.

Digital Sinking Funds

Many bank accounts today can be used to set up a sinking fund. You can do this by simply opening a sub-savings account with your online bank or credit union.

Some online banks have proprietary products that may support your sinking fund dreams. Ally, for example, has “Savings Buckets.” These allow you to contextualize your savings into individual purposes. Allocations to these buckets can be automated and recurring as well as other neat features.

Kayla and I bank with Ally but have not used the buckets yet. We also use Dave Ramsey’s EveryDollar Budget App (not an affiliate). We both love it because it also has a robust desktop app that connects across bank accounts and devices.

You can set up a sinking fund in EveryDollar by following this step-by-step guide to creating a sinking fund (complete with visuals!). Though it doesn’t actually separate your cash from emergency savings in your account itself, it does help with visualizing and planning.

Types of Sinking Funds

Almost all sinking funds can be placed into one of three categories:

  1. Large purchases like a family vacation

  2. Overlooked expenses like clothes for growing kids

  3. Unexpected events like new car tires or replacing a water heater

The types of sinking funds you use are entirely up to you. This may be a good time to sit down with your significant other and plan out your next 6-12 months of financial goals.

9 types of sinking funds the majority of people should consider:

  • Medical/Dental/Vision

  • Home downpayment

  • Christmas

  • Birthdays/Other Gifts

  • Car Repair/Maintenance

  • Home Repair/Maintenance

  • Vacation

  • Kids’ Sports and Activities

  • Cell Phone Replacement

How Much to Put in a Sinking Fund

The amount of your individual sinking fund depends on the goal you have for that specific fund. If you plan to take a $2,000 vacation in the next 14 months, you will need to set aside $2,000/14(months)= $143 per month to achieve that goal.

I recommend starting small with just a few sinking funds. This will encourage engagement and follow through especially if you’re asking a partner to take this journey with you.

I really like the idea of a Christmas and vacation sinking fund. The reason being is it can have a major impact on your emotional response and therefore drive further engagement.

Imagine saving $143 per month and then spending it guilt-free on a family vacation. You already have the money allocated for the trip, and all that’s left to do is enjoy your vacation. The feeling of providing that experience to your family can be very rewarding.

Can I Invest My Sinking Fund?

I recommend not investing your sinking fund as it’s likely you will need the cash in the next 12-36 months. A kid’s college fund is essentially a sinking fund, but you don’t need to access the money for 15+ years so it’s reasonable to invest that money for future growth.

On the other hand, you may set up a sinking fund for future investments. Let’s say you set aside $50 per month with the intention to invest it ($300) every 6-months.

If you’re new to investing, I highly recommend low-fee index funds as an easy way to diversify and grow your net worth.

Opportunity Sinking Fund

You can set up an “opportunity fund.” Basically, you create a sinking fund with the purpose of saving up cash for investment opportunities.

An investment opportunity could be as complex as a down payment for a rental property or simply $1000 to buy VTSAX during a recession.

Summary

Sinking funds can be a powerful tool in your savings arsenal. The idea of intentionally managing your money for specific purposes is a great way to gain control over your finances.

Sometimes budgeting just isn’t enough to fine-tune your financial life. Being able to further drill down and separate your emergency savings from your vacation savings is powerful.

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