Whether you’re saving for a large purchase, a vacation, or unexpected life events, a sinking fund is one of the best money-saving strategies you can employ.
But what is a sinking fund? And how do you set one up?
That’s exactly what I’m going to cover in this article, along with 12 common examples of sinking funds that you might want to establish.
What is a Sinking Fund and How Does It Work?
A sinking fund is a portion of your savings that you allocate or earmark for a specific occasion, event, or future expense. Sinking funds are commonly used for things like emergency expenses, vacations, large purchases, a down payment on a home, or major life events.
In other words, sinking funds are metaphorical buckets of money that you use to organize your finances and save for specific purchases or events.
How To Set Up A Sinking Fund
If you are ready to set up a sinking fund, you have a few options of where to store your money.
The three most popular methods are the envelope system, a single savings account, or multiple savings accounts.
Honestly, there are pros and cons to each method. So, how you decide to manage your sinking fund will be entirely up to you.
The Envelope System
Cash is the most straightforward way to create a sinking fund. However, this method is the riskiest. For one, cash can be stolen, misplaced, or lost, all of which, defeat the entire purpose of a sinking fund.
And two, when you have cash just lying around, it can be difficult not to dip into it and use the money for other things.
Therefore, I only recommend this method when you’re saving for relatively small expenditures.
So, how does it work?
Basically, you just create an envelope for each sinking fund you want to create, and then you place a portion of your savings each month into each envelope.
The envelopes should be clearly labeled to identify the name of the fund and stored in a secure place like a fireproof lockbox.
One Separate Savings Account
Another option is to set up a dedicated bank account to house your sinking fund.
For one, this is more secure than keeping cash in your underwear drawer. And two, it can also help you avoid raiding your stash of cash for impulse purchases.
That said, with a separate account, you can still quickly and easily transfer the money to your checking account when you need it.
The only challenge with having a single account is that it can be difficult to track multiple sinking funds in one place. A notebook or spreadsheet can be a great tool to use as a ledger so you can keep track of how much money you have dedicated to each fund.
All you have to do is make sure that the total of all the sinking funds equals the total amount of money in the account, and you’re good to go.
If you don’t like the idea of having all of your sinking funds lumped together in one account, you can set up multiple savings accounts.
This is my favorite method (and the one I personally use, as it helps you quickly check the balance of each sinking fund.)
Many online banks make this easy to set up separate accounts and, in most cases, you can name the accounts to match the sinking fund name.
The only downside to this is that it requires additional time and effort to set up, track, and manage the individual accounts. However, in my experience, that isn’t too big of a deal.
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12 Sinking Fund Examples
Each person’s financial situation is different.
So depending on what expenses you have, you may or may not want to set up certain types of sinking funds.
With that in mind, here are examples of the 12 most common types of sinking funds that people use.
1. Emergency Fund
If you are living on a budget, you are going to encounter unexpected events or expenses.
Therefore, if you are only going to set up one sinking fund, an emergency fund is the most critical.
The amount you save for your emergency fund will vary depending on your personal circumstances. However, a general rule of thumb is to have enough money to cover 3 to 6 months of expenses.
2. Car Savings
The cost of owning and maintaining a vehicle is likely one of the largest expenses in your annual budget.
Beyond that, when it comes time to buy a new (or new to you) car, we highly recommend that you pay cash. And a sinking fund is a great way to set aside money over a long period of time.
In addition to buying a car, there are other auto-related expenses that you have to worry about.
Insurance, fuel, maintenance, and car washes can add up to thousands of dollars. You can also use your car sinking fund to cover those expenses as well.
3. Home Savings
Buying a home is likely the largest purchase you will ever make. Additionally, for most people, saving for a down payment can take several years.
A sinking fund can be a great way to save up for your down payment.
Oh, and if you already own a home, you can use a home sinking fund to cover costly repairs such as roof replacements, plumbing issues, or major renovations.
4. Vacation or Travel Savings
If you love to travel or plan to take the family on a summer vacation, you can set up a sinking fund to save up money for the trip.
All you do is calculate how much money you will need, and then set aside the money each month.
Just remember to include all travel-related expenses such as airfare, car rental, hotels, food, and even souvenirs.
5. Baby/Maternity Savings
Babies are expensive. If you are pregnant or planning to have children in the near future, it’s smart to set aside money for things you’re going to need, such as a crib, stroller, diapers, and a car seat.
This type of sinking fund can also be used to reserve money to cover bills if you are on unpaid maternity leave.
6. Rental or Investment Property Savings
Owning rental or investment properties is a great way to boost your passive income.
If your dream is to own cash-flowing property, you can use a sinking fund to save up for the purchase of the property.
Then, once you have your rental property, you can use the rental income to fund your sinking fund to cover repairs and maintenance or the purchase of another property.
7. Gift or Party Savings
Throughout the year, you will celebrate important events such as birthdays, anniversaries, and graduations.
And there’s no doubt about it, hosting these parties and buying gifts can get expensive.
So, instead of trying to account for this in your budget, you can set up a sinking fund to cover gift or party-related expenses.
This is especially important if you have kids that will likely get invited to their friend’s birthday parties all year long.
8. Christmas and Holiday Savings
The holidays are one of the best times of the year. However, between all the gifts, food expenses, and family get-togethers, life can get expensive.
Instead of stressing about the cost of these holidays, set up a sinking fund that you can contribute to year-round.
You can then draw from this fund to cover the cost of holiday expenditures.
9. Pet Savings
If you’re a pet owner, you can use a sinking fund to cover the costs of food, checkups and vaccinations, boarding, and personal care products.
It’s also great to have a fund to pull from in the event that your pet has a medical emergency.
10. Medical Savings
One of the biggest risks to your personal finances is unexpected medical bills.
A single trip to the hospital can easily cost tens of thousands of dollars. While this might just be something you lump into your emergency fund, having a sinking fund specifically for medical expenses can help protect your budget from outrageous charges.
Even if you have great medical insurance, you can use your medical savings fund to cover things like copays, insurance premiums, or prescriptions–which aren’t an emergency.
11. Child Expenses
Throughout the year, your kids will need money to cover things like sports, school supplies, toys, books, and other activities.
By setting aside money to cover child expenses, you can ensure that you always have the money to pay for the things they enjoy.
12. Business Start-Up Expenses
Starting a new business can be an exciting new adventure.
However, depending on the type of business that you are launching, you might need to invest in equipment, inventory, a website, or other business expenses.
Fortunately, a sinking fund is a great way to save up the startup capital you need to start your own business. Just be sure to save more than you need so you have a little cushion for unexpected startup costs.
Sinking Funds Make Life Easier
The greatest benefit to using sinking funds is the peace of mind that comes with knowing you have enough money to pay for the things you need or want.
It is also an easy and well-organized way to plan for large future expenses.
The only question is, what kind of sinking fund are you going to set up? Be sure to drop your answer in the comments below!