What Is A Sinking Fund?
Have you asked yourself, “How can I save for large future purchases?” Big, one-time purchases can put a dent in your finances. Whether that’s a vacation, a new car, or a down payment on a house, you can plan for the financial impact in advance. That is where a sinking fund comes into play.
What Is A Sinking Fund?
A sinking fund is money periodically set aside into an account to save for a planned upcoming expense, such as a vacation, a new car, etc. This is in contrast to an emergency fund, which is a savings account dedicated to unexpected circumstances, like losing a job or a medical emergency. With a sinking fund, there is a specific, targeted amount you are saving up to. Emergency funds are in preparation for the unknown.
For example, let’s say you want to go on vacation to the Bahamas next summer. After figuring out how much the vacation will cost, including flights, lodging, and entertainment, you have 12 months to save! Whatever the total cost of the trip is, divide it by 12 months. Then, each month put that money aside into a savings solutions, like a savings account, savings certificate, or money market account. By next summer, you will have enough money to go on your vacation without having to dip into other savings to finance your trip. Other sinking fund goals could include:
- School supplies
- New car
- Down payment on home
- House appliances
- Weddings
Why Sinking Funds Are Helpful
Did you know a sinking fund can reduce stress? Sinking funds serve as a financial cushion. When you have money set aside for a specific purpose, it alleviates the stress of taking money from other funds:
- Emergency fund
- Monthly budget
- Borrowing extra from your credit card or loans
With the money already saved up, you don’t have to do money gymnastics with your budget, you don’t have to put items on your credit card and let the interest build, and you don’t have to take money away from your emergency fund for a non-emergency. Sinking funds keep your finances on track!
Show Me The Math
Let’s see how a sinking fund works using the example of the Bahamas. The average cost for one person to spend a week in the Bahamas is approximately $2,000. This estimate includes accommodations, food, local transportation, and entertainment. That number can look daunting, but with a year of prep and saving, you can easily finance this trip of a lifetime with help from a sinking fund.
To make this trip more manageable, first choose how often you want to save. Weekly, biweekly, or monthly? The easiest solution may be to set up an automatic transfer every payday. From there, you take the total amount of the trip and divide it by how often you plan to save.
- Weekly -> $2,000 / 52 weeks = $38.46 per week
- Biweekly -> $2,000 / 26 weeks = $76.92 every two weeks
- Monthly -> $2,000 / 12 months = $166.67 every month
These are the amounts you would need to add to your sinking fund to reach your savings goal.
When you start thinking about how to save for a future vacation, wedding, new car, or even a new home, a sinking fund can make those goals feel much more achievable. Instead of letting those future expenses linger in the back of your mind, you can create a dedicated fund that helps you plan ahead and stay in control of your money. Over time, this simple habit can strengthen your overall spending patterns and help you build real confidence in managing your finances.