Hearing the name "sinking fund" may give you the wrong idea, mainly if you've never heard of one before. A sinking fund differs from a savings account because money is typically for a specific purchase, usually big-ticket items like a car or downpayment on a home.
Increasing your savings account or an emergency fund is always essential, but these typically have a general-purpose. Instead, it may be best to create a sinking fund if you want to save for a specific expense. This article will discuss sinking funds and how to start one.
What's a Sinking Fund?
A sinking fund is a savings account designed to pay for a specific, upcoming expense. They are secure, safe, and liquid, so you can save and access your money effortlessly and risk-free. You can use a sinking fund for almost anything, but you must plan a budget to reach your goal. Knowing the dollars and timeline for saving is best.
Since you can use a sinking fund for just about anything, here are some typical expenses people choose:
- Their wedding day.
- Saving for vacations.
- Buying a car.
- Car maintenance.
- Home renovations.
- Insurance premiums.
- Upcoming medical expenses.
How Does a Sinking Fund Work?
We all wish we could write a check when a considerable expense arrives and not overthink its impact on our finances. But unfortunately, most of us have to be strategic with our money, especially regarding items with higher price tags.
Try using a sinking fund if you want to designate money for an upcoming expense. Each month you can save a portion of your income for the account. Then, if you plan accordingly, you'll have the funds you need when the expense arrives.
Example:
You are looking to go on vacation next summer and determined your total cost will amount to $6,000. The expenses include flights, hotel, dining, traveling, and activities; the target date is ten months away.
You'll need to save $600 monthly for ten months to hit your goal.
Sinking Fund Benefits
Sinking funds offer a multitude of benefits, including:
- They are liquid. Sinking funds are accessible, meaning you can take your money out easily to use at an expense.
- They are secure. Sinking funds typically are located in FDIC or NCUA-insured bank or credit union accounts, so your funds are in a safe place.
- They help you budget better. A sinking fund allows you to budget and plan better for upcoming expenses.
- They keep you organized. Keeping your sinking fund separate from your other savings will help you better organize and manage your finances.
- They allow you to avoid debt. Creating a sinking fund will help you stay ahead of your debt. Knowing exactly how much you can spend will help you not spend on unaffordable expenses.
Starting a Sinking Fund
When starting a sinking fund, reviewing your finances and past purchases is best. Check for any significant expenses and determine any large expenditures for the future. Then, list your savings goals while prioritizing your most important expenses first.
Next, make a timeline. List out the due dates for each expense and determine how much you need to save every month to cover each one. For example, if you want to save $2,000 for a vacation in five months, you'll need to save $400 per month to reach your goal.
Once you've hit your goal, use the money to cover the expense. Then, if you think you've managed your finances better, try using a sinking fund again for any other upcoming payment.
Takeaway
A sinking fund is a great way to manage your money for upcoming expenditures. They allow you to identify an expense, budget your money, and save to reach your goal. Ultimately, a sinking fund will keep your finances organized while leaving your other savings and investment accounts untouched. Consider using a sinking fund for your next expense to ease the overall process and make it more intentional.