A sinking fund is money saved up or set aside for a specified use at a stipulated time. You can establish a sinking fund by saving a bit of your income each month, completely separate from your savings account or emergency fund. Sinking funds are an effective way to save and pay for large expenses such as ugrading your home, buying a new car, settling large medical bills, or going on vacation.
How a Sinking Fund Works
A sinking fund provides a strategic means to save a fixed amount of money by setting aside a small amount each month. Every month, you’ll set a little bit of your income aside for use at a later date. Depending on your financial goals, you may divert money into a single sinking fund or multiple funds for different purchases. Typically, you’ll need to set a projected timeframe before you can spend the money. A sinking fund works great for things you don’t plan to pay for in a single month’s budget. Examples include:
- Home renovations
- Vet bills
- Wedding expenses
- Holiday gifts
- Birthday parties
- School books and supplies
- Plane tickets
- Vacations
Overall, you can create a sinking fund for any long-term financial goal, expense, or dream you have!
Benefits of a Sinking Fund
A sinking fund is a proactive financial strategy since it prepares you for a future expense to be paid. You can benefit from a sinking fund regardless of your current savings or economic objectives. The following are some advantages of creating a sinking fund:
- Set concrete financial goals: A sinking fund prompts you to decide what future purchases are important to save for.
- Plan for big, extravagant spending: You can set up a sinking fund to upgrade your kitchen, go on vacation, invest in a hobby, donate to charity, etc.
- Reduce guilt over large purchases: If you want to make a significant purchase, such as paying for luxury travel of an extravagant wedding, you can decide upfront what you’re saving for and how much to set aside each month. When the time comes to spend it, you can do so without worry or regret.
Sinking Fund vs. Savings Account
There is a slight difference between a traditional savings account and a sinking fund. Both involve regularly setting aside a certain amount of money for future expenses. However, the main difference is that a sinking fund is set up for a particular purpose and is intended to be used at a particular time. A savings account is typically set up without a specific purchase in mind, and its uses may fluctuate over time.
Sinking Fund vs. Emergency Fund
An emergency fund is quite different from a sinking fund in that the latter is purposely established for a definite purpose, while an emergency fund is for unexpected events. An emergency fund is set aside to cover costs that are not known but could happen at any time, such as car repairs or medical expenses.
Final Thoughts
Overall, a sinking fund is relatively easy to establish. It simply requires a future financial goal and the discipline to set aside a specific amount of money every month. Once you’ve reached your goal, the long-term value of a sinking fund will be clear.