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Editor’s Note: This story originally appeared on The Penny Hoarder.
Do you wish you had more money set aside? Not a rainy day fund for unexpected expenses but something that can ease the financial stress of a big life event?
When Nora Martin was expecting her first child, she wasn’t letting all the baby costs weigh her down. He had a plan.
Martin said, “I wrote down almost everything we needed … and then divided the total by six months to see how much we would need to save each month to reach our goal.”
This practice of breaking down a large financial goal into more easily manageable chunks has a special name in the personal finance world. This is called setting up a sinking fund.
What is a Sinking Fund?
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A sinking fund is a pool of money that you contribute to regularly so that you can spread the cost of an upcoming expense over time.
It differs from an emergency fund or a standard savings account because a sinking fund is specifically set aside for a major expense or big-ticket item.
The term “sinking fund” comes from corporate finance lingo. Businesses put money into a sinking fund to pay off loans or bonds or prepare for large capital expenditures.
But you don’t have to own a business to benefit from this money-saving strategy.
Learning how to add sinking funds to your budgeting approach is a smart strategy for saving on big money goals, future financial obligations, and recurring bills outside of regular monthly expenses.
Why do I need a sinking fund?
Why set up a sinking fund versus putting all your money in another savings account of yours and calling it a day? Here are some reasons to start a Sinking Fund Account.
Sinking fund helps manage large expenses for major life events
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Saving money in a sinking fund helps you manage upcoming costs that will hit you if you neglect to plan ahead.
If you don’t have a large amount of disposable income each month, it can be difficult — if not impossible — to cover a large expense all at once.
For example, if you waited until December to buy Christmas gifts and planned to spend around $800, you may be forced to spend on your credit card to do so.
If you park the money as a sinking fund in a separate savings account over time — say, $100 a month for eight months — you can avoid going into debt or borrowing money.
Sinking Funds Save emergency funds for true emergencies.
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Having a sinking fund also helps you avoid dipping into your emergency fund when (non-emergency) big expenses come up.
Likewise, you don’t need to stop your progress on other money goals, such as paying off long-term debt or investing for retirement.
Sinking fund can help weather the storm of variable income
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Sinking money makes upcoming expenses more manageable. And when it comes time to actually spend the money, you can do so without guilt because you know you’re saving specifically for that purchase.
Sinking money is also a lifesaver if you have a variable income. Budgeting can be difficult if your income varies from month to month.
With sinking funds, you can set aside money during high earning months and access that cash during low earning months.
Types of Sinking Funds You Can Add to Your Budget
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The sinking fund categories you add to your budget will depend on your individual needs and desires.
In general, there are three types of sinking funds: planned goals, recurring costs, and uncertain future expenses.
Planned Target Sinking Fund
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Some examples of sinking funds that would be considered planned goals include:
Holidays Weddings Expenses for a new baby Down payment for a house Down payment for a new car
These are usually one-time expenses that you can budget for and stop saving once you reach your target amount.
recurring cost sinking fund
Some examples of recurring expenses that you may want to set up a sinking fund for include:
Car insurance premiums Car registration renewals Home insurance premiums Christmas gifts Birthday gifts Holiday expenses Back-to-school shopping Summer camp fees Self-employment taxes Annual memberships Computer software renewals Annual fees for credit cards
These are costs that you know will come up around the same time each year and require planning for on an ongoing basis.
uncertain future expenditure
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Uncertain future expenses are expenses that are bound to happen but you cannot plan when they will happen or how much you will actually need. These may include:
Medical expenses Car maintenance or car repair Home repair or maintenance Appliance replacement
Do your best to estimate how much you’ll need. Reviewing your past spending in these categories can help.
Difference between Sinking Fund and Emergency Fund
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You should have your emergency fund separate from your sinking fund. They are not the same thing and ideally they should be kept in separate savings fund accounts.
Sinking money is for planned expenses that you can anticipate. An emergency fund is a safety net that should only be used in urgent, critical, and unforeseen situations.
For example, you’ll use your sinking fund money on a plane ticket to visit your mom for the holidays.
But if your mom is in a car accident and you need to book a plane ticket at the last minute to help with her recovery, only then will you access your emergency fund.
how to save money from sinking fund
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It takes a little math and some organization, but it’s not difficult to save using sinking funds.
First, you need to figure out the total amount you want to save. Then divide that number by the amount of time you will need to spend the money.
This will give you the amount you’ll need to set aside each month (or week or pay period) in your sinking fund.
For example, if you want to save $1,000 for a vacation over 10 months, you’ll need to add $100 to your vacation sinking fund each month. If math isn’t your strong suit, you can use one of the online sinking fund calculators to figure it out.
Types of accounts for sinking funds
Since sinking funds usually cover short-term savings goals, you’ll want to be able to access your money easily. Keep it in a high-yield savings account or money market account with attractive interest rates.
Those who prefer the envelope method can keep their sinking funds in cash.
If you manage your money with a budgeting app, you can set aside your sinking funds digitally. Mint is one of our favorite budgeting apps that doesn’t charge a monthly fee.
For long-term goals, certificates of deposit, or CDs, are another option to store your money and watch it grow — but only if you know you won’t need to withdraw it before the CD matures. Withdrawing your money earlier leaves you vulnerable to penalty fees.
While you potentially get the greatest returns by keeping your savings in a brokerage account, it is generally not recommended for sinking funds because of the risk of losing your savings due to stock market volatility.
5 Tips For Success With Sinking Money
Become a master of using sinking funds with this advice.
1. Separate Your Sinking Funds From Your Main Checking Account
It’s helpful to keep your sinking fund money in a separate account so you don’t spend your savings on Uber Eats or go shopping on purpose.
2. Name Your Sinking Fund Accounts
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Giving your sinking fund a name — such as “Italy trip” or “my dream house” — can help motivate you to save money and not dip into it for something worthless.
3. Automate Your Savings Transfers
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Streamline the savings process by setting up automatic transfers or direct deposit into your sinking fund accounts so you don’t even have to think about doing it.
Once sinking funds are set up on your checking and savings accounts, it will be easy to automate transfers.
4. Apply Windfall on Sinking Funds
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If you receive extra money – such as a bonus or tax refund – don’t wait. Add this to your sinking fund today to accelerate your progress towards meeting your financial goals.
5. Prioritize Multiple Savings Goals
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When you list all the reasons why you need to start saving money, setting aside money for all these expenses can seem overwhelming. Prioritize necessities – such as tax and insurance bills – over necessities – such as holidays or vacations.
And know that you don’t need to save for everything at once. Establish a plan for reaching your money goals that is feasible for you and your financial situation.