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Sinking Funds: Why You Need Them and How to Get Started

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How many times a year do you plan on putting some cash in your savings account, but you get hit with a bill that seems to pop out of nowhere? Or how often do you find yourself scrambling to find a way to pay for a large, but predictable expense like new car tires?

My guess is this happens probably more times than you would like to admit. 

And most likely, these situations come with a bit of anxiety. Stressful thoughts like “How am I ever going to pay this bill?” or “I just can’t get ahead—how am I ever going to get control of my finances?” can take over.

This is where sinking funds come to the rescue.

Sinking funds are one of the best strategies that I use to take control of my finances. As a result, I feel less stress around money. I strongly believe they are one of the core components to set yourself up for financial success. 

Let’s take a look at what sinking funds are and how we can use them to feel at ease with our finances. 

What is a Sinking Fund?

A sinking fund is a way to save and set aside small amounts of money, gradually and consistently, for an expected future expense.  

Sinking funds can be used to save up money for just about anything that you foresee needing money for in the future. This could be things like the holiday season, back-to-school shopping, a new tv, medical bills, or car repairs. 

When it comes time to pay an expected expense, you can turn to your sinking fund to cover that expense pain-free. It’s a pretty liberating feeling. 

Why Is it Called a Sinking Fund?

When I first heard the term sinking fund, my first thought was “That’s an odd term for what just seems like a specialized savings account.”. 

So I did some digging and found out that sinking funds are used in business accounting and that is where its name comes from. 

Sinking funds, when used in a business setting, are used to set aside money each month to pay off a future debt such as a bond. The term “sinking” is thought to refer to the decreasing amount of debt. 

In personal finance, we typically use sinking funds differently. Instead of using them as a place to store cash to pay off the debt we use them to save up for upcoming expenses.

What is the Purpose of a Sinking Fund

Sinking funds are one of my favorite things in personal finance. This is because they help you plan and prepare for upcoming expenses. And not being surprised by an expense is what can take your finances to the next level. 

Let’s take a look at what sinking funds can do for you. 

Sinking Funds Help You Avoid Debt

Let’s say your 20-year-old furnace breaks down in the dead of a Midwestern winter. Since it’s winter, you have no choice but to repair your furnace ASAP. If you don’t have a sinking fund set up for your old ass furnace, you may find yourself having to take on debt to buy a new one.

But if you have a sinking fund already set up, knowing that sooner or later that 20-year-old furnace will eventually break down, then you’d have set yourself up to buy a new furnace without going into debt.

Sinking Funds Help You Stay Focused on Your Money Goals

Let’s look at the same example as above—the broken furnace that needs to be replaced immediately. Only this time, you haven’t set up a sinking fund for your furnace.

In this case, since you don’t want to go into debt to pay for the repairs, you search your budget to find the money to pay for your repairs elsewhere. You find enough money in a vacation fund you started for a big trip you want to take next year. You then decide that the vacation will just have to wait so you can use that money to buy a new furnace and not go into debt. 

It’s beyond frustrating when you have to steal money from another priority to pay for something, especially when the expense was expected.

If a sinking fund had been put in place for a new furnace, then you could still go on that vacation as planned. 

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Sinking Funds Reduce Your Stress Around Money

When you have a stash of cash tucked away for that washing machine that has been making horrendous noises, you are not even going to bat an eye when the darn thing finally craps out on you. 

You will be able to head straight to that appliance store and pick out a new one without worrying where the money is going to come from.

This, in turn, reduces your stress around money. With a sinking fund, there is no reason to stress about where the money is going to come from to allow you to wash your clothes at home again. 

Sinking Funds Eliminate After-Purchase Guilt

Purposefully and gradually saving for something helps you make intentional purchases. When you make an effort to put away a bit of money each month for a new video game system, you won’t feel guilty when you finally bring it home. 

This is because you intentionally saved that money to buy a video game system. It wasn’t an impulse buy, which is usually the reason we feel guilty about a purchase. 

Now that we understand how much of a game-changer and stress reducer sinking funds can be, let’s take a look at some that might be helpful to start right away.

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How Sinking Funds Work

Sinking funds are simple, in theory. You set money aside regularly to pay for your expenses and the things you want in your life.

For example, I pay my car and homeowners insurance once a year. And it’s a pretty hefty bill of over $1600!

I don’t want to be scrambling to come up with $1600 when I get the bill, so I set aside $133 each month into a sinking fund for my insurance. It’s an amazing feeling when the bill comes and I can pay the bill in full, stress-free.

When to Use Sinking Funds

Sinking funds are used any time you have an expense you want to plan for. 

They are used when you are trying to save up for something or for preparing for those non-monthly bills that tend to sneak up on you. 

Everyone will have different sinking fund categories, as everyone’s financial needs are a bit different. 

Here is a list of different sinking fund categories to get you thinking about when you need to use sinking funds for your finances.

  • Insurance Premiums (if not monthly)
  • New Car Fund (this one is a game changer to avoid a future car loan)
  • Car Maintenance
  • Home Maintenance
  • Vacations
  • Home Furnishings
  • Pet medical expenses
  • Annual subscriptions (Amazon, Costco, Sam’s Club, etc)
  • Extracurricular activities for yourself and/or kids
  • Gift giving for holidays, birthdays, weddings, etc
  • Back-to-school supplies and clothes
  • Out-of-pocket medical expenses
  • Anything you want to save up for!  TV, Video games, new bike, etc

For an in-depth look at different sinking funds check out this post, Sinking Fund Examples, by Educator FI. 

What’s the Difference Between a Sinking Fund and an Emergency Fund

You may be thinking, “I have an emergency fund, so why would I need sinking funds for some of these expenses?”

The big difference is that the emergency fund is money that is set aside for exactly that—an emergency. But what constitutes an emergency?

The best way to tell if something is an emergency or not is to ask yourself, “Do I expect this expense to occur?”

Do you expect to get into a car accident? No

Do you expect that a 15-year-old air conditioner will die soon?  Yes

Do you expect to pay your annual car registration or insurance?  Yes

Every time you say “yes” to these questions, it’s a sign that a sinking fund is more appropriate than dipping into the emergency fund. 

As it turns out, an emergency fund is simply a type of sinking fund that is established to pay for those unexpected situations.

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What’s the Difference Between a Sinking Fund and a Savings Account

Another question you may be asking yourself is “I have money stashed away in a savings account, so why do I need sinking funds?”.

Sinking funds give your money a specific job, while money in a savings account is just that – money in a savings account. 

When you have sinking funds, you know exactly how much money you allocated for each expense. If all of your money is in one big savings account, you don’t know how much you can take from the savings account and risk not being able to pay for the next expense.

For example, let’s say it’s Christmas time and you spend most of your savings on presents because the cash is there in your savings account. Now, in early January, your annual insurance premium comes due. You forgot that some of your money in your savings account was supposed to be used to pay your insurance bill, but you spent it all on Christmas presents.

If you had your money separated into sinking funds, you would have realized some of your money was earmarked for your insurance premium and not for Christmas presents. 

How to Create a Sinking Fund In Four Simple Steps

Now that I’ve convinced you that you need sinking funds in your life, follow these easy steps to start your sinking fund (or funds). 

  1. Choose which sinking fund(s) you are going to start.
  2. Figure out the total amount of money you eventually want in the fund.
  3. Pick a date when you want to reach your goal amount
  4. Determine how much to put into your sinking fund each pay period or month to reach the total amount in the timeframe you chose.

Here’s how this would look if you were going to start a sinking fund for Christmas presents at the start of the new year. 

What sinking fund are you starting? Christmas

How much money do you want in the fund? $1000

When do you want to reach this goal? October 31

How much do you need to put into the sinking fund each month to have $1000 by October 31st? $1000 ÷ 10 months = $100  

There you have it. 

Four simple steps to get started with sinking funds. 

How Many Sinking Funds Should I Have?

The number of sinking funds you have is completely up to you. It’s all about what your savings goals and finances look like. 

And, honestly, your sinking funds are going to change as time goes on and your money goals change. 

But when you first get started with sinking funds, I suggest you start with only a few. 

Start by focusing on the non-monthly bills that you know will pop up first whether you like it or not. These are things like your insurance premiums, car registration, annual subscription fees, etc. 

Once you get a handle on creating and funding sinking funds for your non-monthly bills you can start to add more sinking funds for your other priorities.

How to Organize and Keep Track of Your Sinking Funds 

There are many ways to organize your sinking funds. 

When I only had a few sinking funds, I kept separate savings accounts for each one. But as I increased the number of sinking funds, this became too hard to manage.

The key is to find a way that is simple and works for you. Something that you can stick with.

For me, I use YNAB (You need a Budget) to help keep track of my sinking funds. YNAB allows me to put all of my sinking funds in one savings account while still being able to see how much money I have allocated to each of my sinking funds. 

Other options for keeping track of your sinking funds are:

  • Use a spreadsheet (create printable)
  • Keep a cash envelope for each of your sinking funds
  • A savings account that allows you to have “buckets” like Ally bank 

Where’s the Best Place to Keep My Sinking Funds

Most of the time the money in your sinking funds sits untouched for a while as you are working to accumulate all of the money you need.

For this reason, I recommend keeping your sinking funds in high-yield savings accounts.

A high yield savings account can typically be found with an online bank that can offer higher interest rates on savings accounts than your brick-and-mortar bank. 

These online banks include:

These high-yield savings accounts help you make a little bit of money while you wait to fill up your sinking funds. 

Yes, you could keep your sinking funds in a traditional savings account, but then you’d be missing out on a few extra bucks each month. 

Another benefit of using high-yield savings accounts is that the money is not as readily available as your traditional bank account. 

It will take several days to transfer money from your high yield account. This will make it hard for you to “steal” money from your sinking funds. 

You Got This

Sinking funds are a great tool to use to help you feel less stress around your finances. They allow you to feel prepared and ready to take on the expenses of life. 

But they won’t magically appear overnight. They take time to fund, and patience and commitment are key. 

If you keep at it, slowly but surely you will have established and funded a plethora of sinking funds. They will become your best friends, relieving you of the stress your living expenses can often throw at you. They will also allow you to fund your priorities, such as a great vacation, guilt-free.

So go ahead, pick a few sinking funds to start with. Figure out how much to add to them each month and slowly start to feel the anxiety around money fade. You got this.

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Picture of Melody Creator of Cash for Tacos

Hi! I’m Melody and I want to help you create a vision for your life and provide you the necessary tools to use your money to make your vision a reality. 

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