How to Use Sinking Funds to Save Toward Your Goals

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Sinking funds can help you save for large expenses by setting aside small monthly increments. Using one is as simple as picking a savings goal, setting a timeline and putting aside monthly contributions until you're able to afford that special purchase, trip, tax payment or new car. For anyone who has a large expense in their future, sinking funds can help you get there—without robbing your emergency savings or using your credit card.

What Is a Sinking Fund?

The term "sinking fund" comes from the world of investments, where sinking funds are set aside to pay off debts or bonds. For individual savers, a sinking fund is simply money you set aside regularly every month to cover a future expense.

For instance, you might establish a sinking fund to save up for your next car. If you set aside $400 a month for five years, you would end up with $24,000 plus interest to spend. But what if your current car's transmission suddenly fails two years into your savings timeline? At that point you would have $9,600 to either pay for a new transmission or use as a down payment on a new vehicle.

Use sinking funds to cover planned expenses that don't fit into your regular monthly spending, including:

  • Vacations
  • Holiday gifts
  • A kitchen remodel
  • Medical or dental expenses
  • A wedding
  • A new car (or a down payment on one)
  • Estimated taxes
  • Donations to charity

If you plan to pay for everything out-of-pocket, you're limited to what the wiggle room in your monthly budget—or the balance of your checking account—allows. Using a sinking fund increases your spending power without causing you to raid your emergency savings or utilize credit. You can also save money this way by avoiding interest on a credit card balance.

How to Set Up Sinking Funds

Getting started with a sinking fund can be as easy as setting a single goal and transferring a payment to a dedicated savings account each month. Are you ready for a bigger, more rewarding challenge? Set up a few sinking funds to help you meet multiple goals. Here's a quick example:

  1. Decide what you want to save toward. Consider choosing a few different goals to start, so you have multiple rewards to work toward without being overwhelmed. For this example, we'll choose a new $2,000 refrigerator, $280 car registration and a $750 anniversary weekend away.
  2. Set timelines and calculate your payments. This will depend on when you plan to spend the money and how much room you have in your budget. More aggressive savings goals will require higher monthly payments.
    • Refrigerator: 20 monthly payments of $100
    • Car registration: 10 monthly payments of $28
    • Anniversary weekend: 5 monthly payments of $150
  3. Choose where you'll keep your money. You have options:
    • Use your current savings account and track your progress as part of your monthly budgeting.
    • Open a new savings account, but avoid accounts that have high minimum balances: You don't want monthly fees to eat up your savings.
  4. Add fund contributions to your monthly budget. Treat sinking fund payments like any other bills: Don't skip them.
  5. Save, save, save—and then spend. Reaching your end date or savings target means using your sinking fund to realize your goal. Enjoy your weekend away, renew your car registration and enjoy that shiny new refrigerator: You can afford it.

Sinking Funds vs. Emergency Funds

Sinking funds and emergency funds may look alike, but they're two different animals. You can save monthly toward an emergency fund just as you do a sinking fund, but an emergency fund is not intended for spending. By definition, tapping into emergency savings means things are not going as planned. With sinking funds, spending is the plan.

To that end, it's important to keep emergency funds and sinking funds separate. You may be able to do this within a single account using a budgeting app, spreadsheet or paper ledger to keep track of your different saving priorities. But you may want to maintain different accounts if you think you'll be tempted to dip into emergency funds or tap into those funds by accident. One of the goals of a sinking fund is to spend while leaving your emergency savings intact.

New Mindset: Saving to Spend

Using the concept of sinking funds to pay for future expenses isn't entirely different from putting a percentage of your income into savings each month. Technically, you could do this and pull money out of your savings account whenever you need to cover a large expense.

But sinking funds can help you develop the skill—and the mindset—of saving to spend. Instead of buying something the moment you decide you want it, you work toward building the funds you need first. Instead of using credit to cover large expenses and paying them off with interest, you save money by saving your money first. And instead of thinking of savings as money you can't touch, sinking funds bring home the idea that saving is also a way to pay for what you want and need when you don't have the cash yet to cover it.

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