Everyone knows it’s important to have an emergency savings fund available for life’s unexpected expenses. But what about future expenses that aren’t so unexpected, like annual car maintenance or holiday shopping?
Even though we know these costs are coming, we often fail to plan for them. Instead, we end up dipping into our emergency reserves or using a credit card to cover them. But there’s a better way: start a sinking fund.
A sinking fund is a useful strategy for saving up for your short-term money goals or predictable expenses on the near horizon. It’s a savings account dedicated to a specific expense, which you gradually fund by making regular deposits or transfers. Think of it as a reverse credit card — you make monthly payments now, so you’ll be able to afford your planned expense or goal by the time the need arises. And instead of paying interest, you’ll earn interest on your balance while you save!
Why use a sinking fund?
You might be wondering what makes a sinking fund different from your regular savings account. The key difference is while a typical savings account serves as a single “pot” for holding all your savings, a sinking fund has a specific goal (and usually a deadline that you set) attached to it. That makes it easier to track your progress toward your goal while keeping your other savings, like your emergency fund, separate and untouched.
“I do think it is kind of a good idea to separate out your emergency fund from a sinking fund just because otherwise it is a little bit tempting to dip into your emergency fund for things that aren't really emergencies,” says Madison Block, a marketing communications and programs associate with the nonprofit American Consumer Credit Counseling agency.
The beauty of a sinking fund is that you can set up a separate account for each of your predictable expenses or short-term savings goals. This allows you to proactively save up for future expenses instead of relying on credit or depleting your other savings to cover the costs. You can create sinking funds for any planned expenses coming up soon. For example, a sinking fund works great for:
Annual expenses such as holiday shopping, vacations, homeowner’s association dues or insurance premiums (if you pay them annually instead of monthly).
Planned maintenance for your home, your vehicle, or any other appliance or equipment you own that needs routine repairs.
Managing irregular income, particularly if you are self-employed and need funds available in case you have a few lean months.
Large purchases such as new furniture or a big investment in your favorite hobby.
Predictable medical expenses such as routine care or enough to cover your annual deductible.
How to use sinking funds effectively
To set up a sinking fund, you’ll first need to identify which specific expense or goal you want to save for. Estimate how much you’ll need to save and how long you need to save up for it. Then calculate how much you’ll need to save each month to reach your goal.
Next, choose a savings account that’s easily accessible and doesn’t charge fees. We recommend a high-yield savings account such as OCCU’s Ignite Savings, which pays 5.25% APY4 on the first $500 you deposit, to maximize the interest you’ll earn while you’re saving up.
How to start saving with your sinking fund
Now it’s time to start saving. A sinking fund works best when you treat it like any other bill. Make it an item in your monthly budget, set up an automated transfer so you don’t have to remember to do it each month, and let your money build up until it’s time to spend it.
With multiple sinking funds, you might not have enough spare cash to contribute to all of them every month. That’s perfectly fine. The idea is to use your sinking funds to prioritize your monthly savings so you’re putting the most money toward your top priority or immediate goal. When you track how much money each fund has, you can easily adjust your monthly savings deposit to make sure your money’s going to the right place.
Financial wellness tip: With MyOCCU Online & Mobile, you can set up and track your sinking funds with ease. To get started, set up Savings Goals with the Financial Wellness feature.
While you can create as many sinking funds as you need, it’s best not to go overboard — especially if you’re just getting started. Too many sinking funds can become overwhelming and difficult to manage. You might want to start with just two or three and add more as you need them.
Sinking funds are a powerful money tool that can help you take your savings strategy to the next level. By learning to use them effectively, you can easily prioritize your savings dollars, manage upcoming planned expenses, and achieve your short-term money goals in an even shorter timeframe.
FAQs
A sinking fund is a strategic way to save money by setting aside a little bit of money each month. Here's how sinking funds work: Every month, you'll save a certain amount of money for a specific purpose to use at a later date.
How do I get started with sinking funds? ›
To set up a sinking fund, you'll first need to identify which specific expense or goal you want to save for. Estimate how much you'll need to save and how long you need to save up for it. Then calculate how much you'll need to save each month to reach your goal.
What is the best savings account for a sinking fund? ›
A high-yield savings account, or an HYSA, is a good option for a sinking fund since you'll have access to the money when you need it and earn a good return on your savings.
What is the sinking fund saving method? ›
Sinking funds are money you set aside each month for specific savings goals. They allow you to save for infrequent expenses and plan for large expenses over time.
What is a sinking fund for dummies? ›
Wondering “what are sinking funds in budgeting?” Sinking funds are funds you set aside to save toward a significant, pre-planned goal. You save money over time instead of dipping into your checking account for a considerable chunk of cash to cover a particular purchase or event.
How much should I put in a sinking fund? ›
To determine the amount to keep in a sinking fund, identify and list the anticipated expenses and their estimated costs. “Then, divide each expense by the number of months until it's due,” Rose said. “For example, if a $300 expense is six months away, allocate $50 per month to your sinking fund.
What is the 50 30 20 rule? ›
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.
Can you withdraw from a sinking fund? ›
On the other hand, with a sinking fund policy, there is no life assured, and the policy will only terminate when the investor withdraws the entire investment or when the investor dies and there is no beneficiary for ownership.
What are the disadvantages of a sinking fund? ›
Disadvantages of a Sinking Fund
Here are some more disadvantages: Opportunity Cost: The funds set aside in a sinking fund could earn a higher return if invested elsewhere. Over-funding: There's a risk of setting aside more money than necessary, which might affect the cash flow.
Where is the best place to keep sinking funds? ›
You could keep envelopes of money in your safe, but that can still be a little risky. Plus, liquid cash doesn't earn any interest. In many cases, it makes more sense to consider keeping your sinking funds in a high-yield savings account instead. Open a high-yield savings account now to earn more interest as you save.
$1500-$2000 per lot. For example, a 10 lot scheme would have a healthy sinking fund if they had a minimum balance of $20,000.
How to track sinking funds? ›
To track your sinking funds, you first need to determine the total amount of the expenses you're saving for and the timeframe in which you'll need the money. For example, if you want to save $1,200 for a yearly insurance premium , and you have 12 months to save, you would set aside $100 each month to reach your goal.
What is the formula for sinking fund? ›
The sinking fund formula is typically calculated as S= (P * i) / (1 - (1 + i)^-n). This formula helps businesses determine the amount of money they need to set aside periodically to cover the total amount due at the maturity of their debt. Why do they call it a sinking fund?
How do you use the sinking fund method? ›
The sinking fund method is a technique for depreciating an asset while generating enough money to replace it at the end of its useful life. As depreciation charges are incurred to reflect the asset's falling value, a matching amount of cash is invested. These funds sit in a sinking fund account and generate interest.
What are the rules for sinking funds? ›
Sinking funds are in 'trust' for the scheme and should not be returned to lessees upon assignment, or at any time. Interest earned on funds should be added to the funds unless the lease states otherwise. If funds are held in 'trust' then a tax will be charged on the interest earned.
What is an example of a sinking fund? ›
For instance, consider company ABC Ltd., which issued ₹200 crores in long-term debt in the form of bonds, paid semi-annually. The company set up a sinking fund whereby they had to contribute ₹40 crores to that fund at the end of each financial year.
Do sinking funds count as savings? ›
A sinking fund refers to a savings account that is designated for a specific purpose or expense. Here are some common expenses sinking funds may be used for: Car insurance and/or maintenance. Home repairs.
How long does a sinking fund last? ›
The 10-year rule
This allows the body corporate 10 years to identify, plan and save for these future expenses. As sinking funds are generally reviewed every 5 years, a quantity surveyor will prepare a 15-year plan to cover 5 annual budgets with a 10-year future projection.
What is the biggest benefit to a sinking fund? ›
Get ahead of debt.
Having sinking funds can help you achieve greater financial flexibility and freedom! When you're well-prepared for future purchases, you'll avoid the need to take on new debt, which could slow your debt repayment progress.
How to make sinking funds work? ›
Here's how sinking funds work: Every month, you'll save a certain amount of money for a specific purpose to use at a later date. That way, you're saving up small amounts over time, instead of having to come up with a big chunk of money all at once.
As per the Bye Law No. 13 (C), “The General Body can decide the Sinking Fund contribution, subject to the minimum of 0.25% per annum of the construction cost of each flat incurred during the construction of the building of the Society and certified by the Architect, excluding the proportionate cost of the land”.
Is sinking fund a good investment? ›
Lower Default Risk
As a result, a sinking fund helps investors have some protection in the event of the company's bankruptcy or default. A sinking fund also helps a company allay concerns of default risk, and as a result, attract more investors for their bond issuance.
