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One of the most important tools we’ve used to reach our financial goals is the use of sinking funds. You may not be familiar with the term, but sinking funds are a great way to save money for events, large purchases, and other life and financial goals. Keep reading to learn more about sinking funds can help you reach your savings goals.
What Are Sinking Funds?
Sinking funds are money you set aside each month towards a one-time expense or a short-term savings goal. Typically, you would keep a sinking fund in a separate account from your everyday bank account. Why? You want to keep those funds less accessible day-to-day, so you’re not tempted to touch them for other expenses. Also, keeping your sinking funds separate will help you track your savings progress better. You can look up the account balance and know how much you need to save to reach your goal.
Let’s say you’re planning a party for your child’s 16th birthday next year. You want to plan the best possible party for her, but also want to make sure you have the funds to pay for everything — invitations, decorations, food, presents, a new dress. Instead of waiting until you need to pay for all these expenses or funding the party with a credit card, you can just start a sinking fund now and set aside a specific amount of money each month so you’ll have enough when it’s time to pay for the party. Having a sinking fund keeps you from pulling money from other places just to pay for a party you’ve known was coming for a long time.
Why Do I Need Sinking Funds?
Sinking funds are handy because, with life, there will always be financial costs that pop up at the most inconvenient times. You could assume you’ll have money to pay for the party when it comes around, but you never know what other expenses might require your current cash flow. It happens to us all of the time! Maybe we forgot that soccer fees were due this month or the water bill is a little higher this month for some reason (I’m sure it’s not because we have four teens who take long showers). There always seems to be an extra expense that could easily cut into our savings goals.
Sinking funds allow you to still reach your goals without having to dip into your checking account or, even worse, your emergency fund.
How Do Sinking Funds Work?
Sinking funds are easy to set up. The first step is to start with a goal in mind.
Let’s say you want to take your family on vacation to Walt Disney World next year. The first thing you need is a rough estimate of how much money you’ll need to fund your trip. Think about all of the expenses involved, like airfare, accommodations, a rental car, Disney park tickets, food, souvenirs for the kids, and anything else you want to include. Getting detailed costs on some of these expenses, like the airfare and hotel, could be challenging until you actually book your trip. For now, you can search online to calculate a rough cost. As your trip gets closer, you can get more precise with how much you need to save.
Now, calculate how much time you have to save for the trip. Keep in mind that you might need to pay for some of your trip expenses in advance. You might not need to pay for your hotel in advance or only need to pay a deposit, but your plane tickets are paid for when you book them. Plan to complete your sinking fund by the time you need the money, not when you leave for the trip.
Once you have a date in mind, determine how much money you need to set aside each month to reach your goal. For next-level savings, you can even plan to have funds available before you actually need them, but baby steps first!
Now that you know how much you need to save each month, make a plan to set aside that money from your income each month to fill your sinking fund.
If you don’t have extra funds available to put towards your savings goals, you’ll need to find it somewhere. Some ways to generate additional income for a sinking fund include:
- Pick up extra hours at your job if available
- Get a temporary part-time job or start a side hustle to generate more income
- Sell stuff on eBay
Another simple way to find extra money for sinking funds is to cut out other expenses short-term. Maybe you stop eating out for the next few months or drop a streaming service you barely use. It might not seem like a big deal now, but lowering your expenses now can help you make huge strides towards reaching your savings goals.
The Difference Between Sinking Funds & Emergency Funds
But what about an emergency fund? Is that not just the same thing? An emergency fund is basically a type of sinking fund. It’s just explicitly used for emergencies. An emergency fund is also a constant fund you should always have on hand, whereas a sinking fund might be for a temporary goal like a new car, your next summer vacation, or college tuition for your child.
Sinking funds are expected payments that are planned for and are coming up, whereas your emergency fund is a ‘just in case’ sum of money to help ease your mind, should you ever be in a position where you’re in trouble. It’s also usually a situation that’s out of your control, and with sinking funds, you can anticipate exactly how much you need to pay, and when it needs to be paid.
Types Of Sinking Funds
You can have a sinking fund for pretty much anything and everything. It’s a great way of helping you save your money for all types of purchases. We currently have 15 sinking funds, including:
- Youth sports expenses
- School fees
- Graduation party
- House fund
- Car fund
Sinking funds can literally be for any savings goal or expense. Birthdays, weddings, starting a new business. Whatever you want. We have one set up for my wife so she can get her hair done every few months. It’s something that she loves and makes her feel good, so we set aside money for it to make sure there’s always money available.
Where Should I Keep My Sinking Funds?
As I mentioned earlier, you want to keep your sinking funds separate from other money like your everyday checking account.
You could keep the money in a separate account at your local bank. That’s fine. However, my suggestion is to take advantage of higher interest rates and extra benefits by opening an online savings account. There are tons of reputable online banks that make the perfect home for sinking funds. Plus, just like your local bank account, your deposits are FDIC insured.
We use Capital One 360 Performance Savings accounts for all of our sinking funds. And yes, we keep each sinking fund in a separate bank account. It may seem excessive, but it helps keep each savings goal separate and allows for better tracking. The good news is that Capital One lets you open up to 25 savings accounts. No joke. You can even label each one with your specific goal. How cool is that?!
Opening a new account with Capital One only takes a few minutes, and you can fund it using an existing bank account. When you need the money, you can transfer the funds where they need to go or if you use credit cards to pay for expenses, just set up your sinking fund account as the payment method for your credit card bill.
Take Control of Your Savings With Sinking Funds
Have I convinced you to give sinking funds a try? Start with one savings goal, create a plan to fund it, and start saving towards the goal. It’s that simple.
What savings goals do you have currently and what are you doing to reach them? Let us know in the comments below.
Kevin Payne is the co-founder and budgeting and family travel enthusiast behind FamilyMoneyAdventure.com.
Kevin is a freelance writer specializing in personal finance and travel. He is a regular contributor to Forbes Advisor, MoneyGeek, CreditCards.com, Credit Karma, Money Under 30, and Student Loan Planner.