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While making some updates to the budgeting spreadsheet I use for my budget updates, I got to thinking about the ways that I think about sinking funds. Budgeting is not always as cut and dry as “here are my expenses” and “here is the money I’m putting to savings.” A sinking fund is almost this middle category, where you’re saving – but for future expenses.
And that got me thinking about how, when I was new to the world of personal finance, I had no idea what this term even meant. It does not have a super intuitive name, after all. So I’ve decided to give sinking funds a proper introduction here.
What is a sinking fund?
The gist of it is that a sinking fund is a way to purposefully set aside money in advance of anticipated expenses.
The goal is to contribute to the fund in advance so that when that expense comes up, the money has already been set aside. If you’ve ever put away a little each month toward a vacation coming up, you’ve essentially created a sinking fund.
But a sinking fund also doesn’t have to be for a single anticipated expense like a vacation. You can also have a sinking fund for expenses like car repairs. It can be difficult to anticipate when those expenses will hit, but without money set aside in advance, it might be tricky to cash flow those expenses when they hit without dipping into your emergency fund.
Benefits of sinking funds
I’m a huge fan of sinking funds for a few different reasons.
- A sinking fund spreads out expenses that would be difficult to account for in a single month’s budget. You’re not trying to fund your entire vacation out of that month’s paychecks. You’re splitting the expense over a bunch of different paychecks.
- A sinking fund is an example of being intentional with your money. You’re not just saving money “to save it.” You’re earmarking that money for a purpose.
- Sinking funds help you avoid debt and give your emergency fund a buffer. Say you take a weekend trip out of town, and then on the way back, your car breaks down. AND you have a trip to the emergency room a week later. Life comes at you like that sometimes. Without sinking funds, you’d likely have to dip into your emergency fund or pull out the credit card.
- A sinking fund helps even out expenses that are regularly occurring but which still may vary from month to month. If you like to stock up when things are on sale, your expenses for things like household goods may be higher some months and lower other months. A sinking fund can serve like an envelope (literal or figurative), into which you contribute a set amount each month and from which you draw on an as-needed, rolling basis.
Types and examples
In my mind, there are three different types of sinking funds. My goal here is not to provide a taxonomy, but to give ideas about the different kinds of situations in which a sinking fund may be helpful.
Known expenses in the future
The first type of sinking fund involves saving for some known purchase or expense in the future. Examples in this category could include:
- Saving $1200 for Christmas
- Setting aside $4000 by next May for a trip to Hawaii
- Saving $800 for a new laptop before the next school year
- Amassing $30,000 for the downpayment on a home within the next 3 years
- Setting aside a certain amount each month to cover all annual fees and subscriptions
- Setting aside money each month to pay for your car registration
For this category, you can calculate how much you need to add to the sinking fund each month by working backward from the date you will need the money. You may know you want to spend $1200 on Christmas next year, so you set aside $100 each month, for example.
Unpredictable expenses in the future
Another category of sinking funds involves saving for a future expense that’s a little less predictable. You know these expenses are coming, but you don’t know when or how much they’ll be. Examples here include:
- Car repairs
- Healthcare expenses
- Home or appliance repairs
It can be trickier to figure out how much to contribute to these kinds of sinking funds. You don’t know how expensive your next car repair will be, and you don’t know when it’ll happen either.
If you have records, you can look back at previous years to see how much you tended to spend on this category per year, then divide that by 12 to get a reasonable amount to save each month. For a home repairs sinking fund, you may decide to save a certain percentage of your home’s value each month. You can also look up recommendations online.
Don’t stress when you are just getting started with these kinds of sinking funds. Even if your car breaks down before you’ve had the chance to build up your car maintenance sinking fund enough to cover it completely, you’re still cushioning the blow somewhat. You’re better off than not having the sinking fund at all.
Rolling variable expenses
The last category of sinking funds is for expenses that occur regularly but that have enough variability that it’s difficult to include them as a “normal expense” in your budget. Some months you may spend only a little, but other months, you may want to spend more.
Using sinking funds for these categories helps to even out your budget. For these categories, you’re essentially rolling over any money you didn’t use one month so that you have more available to spend in the next month.
Examples include:
- A certain amount for personal spending each month – anything you don’t use gets carried over to the next month, so if you want to “save up” to splurge guilt-free on something, you can.
- A certain amount for household items each month – some months you’ll need to replenish your supply of toilet paper AND hair products AND detergent AND all the things, while other months you won’t. Having a sinking fund here also gives you the flexibility to stock up when things are on sale.
- A baby fund – set aside money each month, but use the money more flexibly. Buy diapers when they are on sale, or buy toys or clothes your kid will grow into when you find a good deal.
Our family’s sinking funds
On Finance with Intention, I share information about our family’s finances in the hopes that it might be helpful to see how another family sets things up. I know I personally have benefitted from seeing what others are doing because it gives me good ideas for tweaks that I may want to make to our own system.
So in that spirit, here are the sinking funds our family is using for 2022.
Known expenses in the future
- New apartment deposit: This is our biggest sinking fund. We are saving up so that we can move to a better apartment within the next few years. The rental system here in Korea is quite a bit different from the system back in the US. Our goal is to save $50,000, although we’ll adjust that amount as the housing market changes.
- New car: We’re planning to buy a car early on in 2022, so we’re aggressively saving so that we can pay for as much as possible upfront.
- Christmas: It’s only January, but we’re still saving a little bit each month for Christmas 2022.
Unpredictable expenses in the future
- Car maintenance: Once we have a car, we’ll put $100 monthly into a car maintenance sinking fund.
- Vacation: We’re planning a trip to visit family in the US later this year. But we also use this sinking fund for smaller trips within Korea, so we don’t have a particular goal in mind. We just contribute $50-150 monthly as our budget allows.
- Household repairs: Our apartment building is on the older side, so we set aside money each month for repairs.
- Healthcare expenses: We’re fortunate to live in a country where healthcare is affordable, so we don’t set aside nearly as much into this fund as we would if we were in the US. We use a sinking fund rather than cash flowing the expenses as a regular budget line item to even out the expense. Some months we’ll spend practically nothing, but if one of us has a more major health issue, then it’s nice to already have the money set aside for the higher than normal expenses.
Rolling variable expenses
- Personal spending: We have personal spending sinking funds for myself, my husband, and our toddler. We use sinking funds here so that leftover money each month can roll over to the next. (Personally, I’m using mine to save up for a new stand mixer to replace the one I left behind in America!)
- Gifts/holidays: We use to have a single sinking fund that combined Christmas and other gifts, holidays, and birthdays throughout the year. It was a bit tough to plan ahead to make sure we had enough for Christmas, though, so we’re trying to separate out the two this year.
- Household expenses: This category includes everything from toilet paper and shampoo to humidifiers and vacuum cleaners. If it were just the consumables like toilet paper, we’d probably not use a sinking fund. But because we also use this money for bigger purchases (like our fancy espresso machine), we use a sinking fund instead.
How to start
First piece of advice: start small. Don’t try to manage 15 different sinking funds if you are new to this. Pick one or two areas where you think a sinking fund would be helpful for you, and start with that.
A car maintenance fund might be a good one, especially if you feel you’re always just one car breakdown away from going into debt or raiding your emergency fund.
Depending on the impact your last holiday season had on your wallet, a Christmas fund is another great one to start with. There’s no better time to start setting money aside for Christmas than January.
Once you’ve chosen the sinking funds you want to start with, decide on a reasonable (and sustainable!) amount to put into the sinking fund every month. Don’t stress about the fact that your sinking fund is starting out small. Yes, it’s true that $50 isn’t going to pay for a new transmission, but it’ll grow as time goes on. And even if that car breakdown happens before you’ve had the chance to build your sinking fund all the way up to where it can cover the full cost of the repair, remind yourself that you’re at least better off than not having the sinking fund at all.
Where to keep your sinking fund
There’s enough to this topic to make another post, but in the end, it really doesn’t matter too much. Stash it away in cash if you want. Open a separate bank account if you’d like. Or if you can trust yourself not to spend the money for another purpose – and you know whether you can trust yourself or not – use a spreadsheet to keep track of how much money in your regular savings account is dedicated to each of your sinking funds.
There’s really not a wrong way to do it. The best thing to do is to just jump in and start.