I know you know setting goals and saving money is important. Blah blah blah. But what if I told you there was a “savings hack” to reach your savings goals? Enter the sinking fund.
I’ve been using sinking funds for years. Calling them a “hack” is probably a stretch, but they are pretty much the easiest way to organize your savings. Humor me a bit, and allow me to share with you why sinking funds make saving money ridiculously easy.
First, let me tell you what they are
Technically speaking, a sinking fund is a fund containing money set aside or saved to pay off a debt or bond. Companies often use them.
For example, if a company owes a future debt, they can gradually set aside money in a fund to help cover that future debt. It helps to “soften” the blow of having to make a huge payment in the future.
In the world of personal finance, a sinking fund can be used to pay for a future short or long-term spending decision.
Wait, isn’t that just an emergency fund?
Eh, no. An emergency fund is generally used for unknown future emergency expenses. Like that time I had to rebuild my chimney (side eye).
With a sinking fund, you are putting money in a very specific bucket for a known future payment.
Would you like an example? I have plenty
Sinking funds sound pretty good so far, right? They are pretty versatile and can be applied a number of ways.
Here’s a few common ways:
- Periodic expenses: Monthly expenses are fairly easy to prepare for. The reason is because, well, they show up monthly. But what about the known expenses that only show up “occasionally”? You will still need to pay for them and sinking funds are perfect for that. That auto insurance bill you only pay every 6 months? Your annual gym membership fee? Car registration? Annual Apple music bill? These are all periodic expenses that you KNOW you will need to pay at some point. Let’s use auto insurance as a practical example since I pay it every 6 months. I take the total I anticipate paying in 6 months, and divide it by 6. I save that amount each month in a sinking fund. That way when the insurance bill comes due, I know I have the money for it.
- Future renovations and repairs: I plan to renovate my basement in the next year, and I have a rough idea of what it will cost in total. Each month I set aside cash towards it. I do this because I much rather set aside money each month than cough up that hefty bill all at once. This saves “future Ambus” an eyeroll when he sees the balance due. Sinking funds also work great for saving towards routine automotive maintenance like oil changes, and new tires for your car. You know you will eventually encounter periodic routine maintenance, so plan for it.
- Debt: If you plan to make a lump-sum payment on debt in the future, throw it in a sinking fund. This might come in handy if you have been in deferment for student loans. Setting aside cash to make a future payment once out of deferment could help lower interest charges quite a bit. Or here’s another spin, you could use a sinking fund to save towards a down payment on a house or car.
- Savings goals: We talked enough about bills. Sinking funds can be used to save towards the fun stuff too. Future vacations, periodic Roth IRA contributions, or even future holiday/birthday gifts can be funded through a sinking fund. All you have to do is set a desired amount, divide it by the remaining months, and save that amount each month. That’s it.
Here’s why sinking funds work
I love sinking funds. They are an efficient, organized, and effective way to meet a future financial obligation.
But what about them makes them so effective for saving money?
- S.M.A.R.T.-aligned: Remember S.M.A.R.T. goals? When you make your financial goals specific, measurable, attainable, relevant, and time-bound, you have the path laid out for you. Since you know what the desired result is, establishing a sinking fund makes it easy to Measure your progress.
- Visual motivation: Seeing your money grow is a motivator. And watching your money inch closer and closer to a defined goal is delicious. It’s pretty much why those PBS telethons had that giant progress board that showed each donation getting them closer.
- Separation can be good: Yea, you could just track all of your savings in one giant account. When the periodic bill comes due, you just pay it out of that bucket. Ultimately that achieves the same goal, but using a sinking fund as separate categories can be a more organized approach. By using sinking funds, you also won’t risk forgetting about the payment, dipping into emergency savings to cover it, or charging it to a credit card. Make life easy for yourself.
- Keeps you focused: I like accountability tools. Sinking funds are inherently great at holding you accountable. All you have to do is look at it to get instant feedback on your progress.
Tracking your sinking funds
Ok, so now that you know what they are, how they can be used, and WHY you should use them, let’s talk tracking.
I don’t think there’s any ONE way to use sinking funds, but here’s a few options:
- Separate accounts: You could physically open a separate bank account(s) to keep short-term cash for each category. Back in the day, banks had “Christmas” accounts to save towards holiday spending. I don’t know if those are still around (check your credit union), but any ole’ basic savings account would do the trick. Separate accounts are best for those that need help in the “avoiding temptation” department. If you think you may need to physically move the cash to a different account so you don’t touch it, do so.
- Same account: You don’t have to open a separate account to create a sinking fund. You could keep all of the money in the same account and create categories yourself. For example, you could notate in a journal, excel spreadsheet, or electronic app that out of your $2,000 in savings, $600 is to pay for new tires. Or as you add to your savings, notate what the additional contributions are to be used for.
- Electronic tracking: Many budget apps have electronic sinking funds without requiring you to physically move money around. I have been using the free version of the EveryDollar App for a few years. Not because of any affiliation to the creators (there’s none), I just find it easy to use. On the desktop site, you can set up savings categories and then track them on the app without moving any money. While I haven’t checked, I’m sure the other popular free budgeting sites like mint.com have similar features. But whichever method you use, just make sure it’s a method you will stick to.
Before I go
Well, what do you think?
I’m biased, but I think sinking funds should be a part of your savings behavior.
It’s a straightforward way to organize your cash flow as you plan to meet periodic payments and goals.
Sinking funds are pretty easy to set up, and the benefits are fantastic.
Pick a method to track, and start marching towards those goals!
There’s an abundance of various tools, tips, and resources you can use along your financial journey. I share many of them and other insights in my weekly newsletter. Join others like you on the path of improving financial well-being.