Ever get that sinking feeling that you wish you’d saved up extra dollars to pay for a wish list purchase, overdue vacation, birthday present, or other special expense? It’s never too late to avoid such regrets and salt away money for a fun or needed goal. You simply need to set up a sinking fund.
What is a sinking fund? It’s simply a fund you create in which money is strategically saved over time that will be used to pay for one or more large planned purchases or expected expenses in the future. It allows you to salt away dollars, often toward things that you want — not necessarily need or have an urgency to purchase right away — ideally without stress or remorse.
How a sinking fund is different
But wait, you’re thinking: Isn’t this the same as a rainy day fund, emergency fund, or overall savings fund? Not exactly.
You’d use a sinking fund for expected purchases, often the more expensive ones. That can include buying a new car two years from now. It can be used to install new windows on your home in six months to replace those old ones falling apart. That family trip to Disney World next summer can become a reality thanks to your sinking fund. And it’s the perfect way to bankroll that surprise birthday party you want to host for your soon-to-turn 30 spouse.
By contrast, a rainy day or emergency fund is best for unexpected and sudden expenses. Say the dishwasher conks out on you next week. Your car won’t start and you need a new battery. Your child spikes a high fever and you have to make a quick but costly trip to the emergency room. Or your sister is in a personal fix and needs to borrow money with little notice. Scenarios like these are best paid with funds you’ve stashed away in a separate emergency fund.
And a general savings account is best used as a place where money, which can later be used for any reason, is kept and untouched for as long as possible. You can pull sinking fund dollars from your general savings account. However, consider and manage your general savings separately.
Why a sinking fund is worth it
Why bother creating a sinking fund? Doing so helps you better manage and organize your finances. It prevents you from dipping into emergency funds that you’ll need when a pressing and unforeseen expense occurs.
Also, by saving up cash over time, and well ahead of time, for something intended, you’ll worry less about where the money is going to come from. Less stress makes you feel more in control.
Plus, you won’t have to pay for that future planned purchase using credit, which can charge you high interest. Think of a sinking fund like a personal loan. But unlike personal loans, sinking funds don’t charge you any interest or need to be paid back.
Set up a sinking fund
To set up a sinking fund, you simply need to create a new, separate account with a bank or online financial institution. Or, you can use an account you already have.
Experts don’t recommend putting this money into a checking account. That’s because most checking accounts today offer low-yield interest. Instead, you’re better off putting sinking fund money into a higher-interest savings or money market account. Just be sure you won’t be penalized for withdrawing from this account within the set periods you plan to pay for something.
Every bank has different rules and restrictions on savings and money market accounts; read the fine print carefully and know what kind of interest you can expect to earn. Credit unions often offer more flexible accounts, friendlier terms, and higher interest.
Managing your sinking fund
Wherever you end up holding your sinking fund dollars, it’s important to manage the dollars carefully. This will ensure that you stay on track to fund future purchase goals.
For example, say you have 4 sinking fund purchase goals: to buy a bicycle, take a trip to California, install a home security system, and replace your furnace. To meet these goals, you need to forecast when you need the money, how much each item will cost, and how much you need to save for each goal monthly. Doing the math, you may determine:
- Goal 1: Buy a new bicycle in 6 months. Estimated cost=$300. Monthly savings needed: $50.
- Goal 2: Replace your old furnace in 12 months. Estimated cost=$4,000. Monthly savings needed: $333.
- Goal 3: Install a home security system in 18 months. Estimated cost=$1,000. Monthly savings needed: $56.
- Goal 4: Vacation in Los Angeles with your family in 24 months. Estimated cost=$5,000. Monthly savings needed: $208.
And each month, have a little private celebration as you watch each account grow and your goal become increasingly more real.