Why a Sinking Fund is Important for Financial Stability

Why a Sinking Fund is Important for Financial Stability

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I have been using sinking funds for years without even realizing it! Though I am familiar with the concept of an emergency fund, I have only recently learned of the term “sinking fund.” A sinking fund is one of the best ways to avoid debt. It helps with planning or budgeting for future financial needs, which can ultimately lead to achieving long-term financial stability.

What is a sinking fund?

Similar to an emergency fund, a sinking fund is a designated savings account with a specific goal in mind. However, rather than saving for an unexpected emergency that could occur at any moment, the goal of a sinking fund is to save for a planned future expense. This fund is separate from both an emergency fund and a general savings account.

It is a strategic way to accumulate money over time in order to pay off a recurring expense or make a significant purchase without having to scramble for cash at the last minute. Consistently setting aside funds for car maintenance, vacations, home repairs, holiday shopping, and other anticipated expenses can help avoid the need to tap into emergency savings or rely on credit cards, reducing financial stress.

Sinking funds are useful for major expenses that are not manageable (or practical!) within a monthly budget. Other examples include:

  • Property taxes
  • House down payment
  • New car or car replacement
  • Home renovations
  • Electronics
  • Pet-related expenses
  • Credit card annual fees
  • Membership dues
  • Birthdays and special occasions
  • Annual subscriptions
  • Tuition

What does a sinking fund provide?

Of course, it feels great to save money and pay for future expenses without going into debt. There is a certain peace of mind that comes with the ability to plan for expenses without worry. With that being said, a sinking fund not only offers security and flexibility, it also provides some important key benefits!

Opportunity to exercise financial discipline

If it’s time to rein in overspending, creating sinking funds for certain goals will certainly help develop a routine for tracking expenses and saving.

Personal accountability

Setting and working towards saving goals helps cultivate personal accountability. It requires an individual to monitor their progress and take responsibility for their actions in reaching those goals.

Pre-planned fun

As the old adage goes, “Control your money, so it doesn’t control you!” Taking control of how one saves and spends their resources can lead to more enjoyable and stress-free experiences. It’s an opportunity to discover the anticipation of saving for a fun goal, such as travel or a home renovation.

Guilt-free spending

Money is spent for the purpose for which it was saved. A sinking fund helps one feel prepared to take on expenses without the guilt that the money should be used elsewhere.

Minimizing/eliminating the need to access emergency funds

Emergency funds are for catastrophic or unexpected events, such as natural disasters, job losses, or unexpected medical expenses. They aren’t intended for foreseeable costs; tires go flat, vehicles require maintenance, appliances age, and electronics slow down and no longer perform at their optimal level. Using sinking funds to save for these kinds of expenses minimizes and even eliminates the need to access one’s emergency fund.

Clarity of values

Individuals change, as do circumstances. Creating and building sinking funds provides the chance to visually prioritize and align spending with personal values and goals over time. For instance, one could be highly focused on saving for a new car only to realize that as they get closer to their savings goal, they no longer feel the need for a new car. Perhaps they have come to love the one they already have, or they have discovered they would rather focus on saving for a different future goal, such as a home purchase or a baby fund.

How to Create a Sinking Fund

There isn’t a one-size-fits-all approach to creating a sinking fund. People have different savings goals, varying levels of disposable income, and different priorities when it comes to allocating their funds. The common component, however, is that there exists an intentional interest and ability to save for a specific goal.

Define goal(s)

It’s important to clearly establish savings goals and set timelines for achieving them, if applicable. Defining goals helps to see the bigger picture, allowing for more effective planning, tracking, and adjusting as needed so these expenses don’t come as a surprise.

Fund an account

Some choose an existing savings account, some open a new one, and others file away dollar bills in physical envelopes. Whatever the method, it’s ideal to fund an account that does not charge fees or require a minimum balance. I personally have my funds sitting in a high yield savings account (HYSA) with Ally Bank. Ally has a buckets feature that allows the account holder to separate savings into different categories.

Many other savings accounts offer a similar kind of bucket feature. While useful, I didn’t take advantage of this feature until the last few years. As I mentioned earlier, I had been saving via sinking funds without even realizing it! I have a few different savings accounts and would mentally keep track of the expenses and the amounts I needed to save. I still do much of my saving this way!

Build it into the monthly budget

For a low-effort way to save, consider breaking up the overall goal amount into manageable monthly installments. One could choose to set up automatic transfers or simply make manual transfers each month. Thinking of a sinking fund as just another monthly bill can make it easier to save regularly!

Secure a Financially Stable Future

Despite the multitude of ways life can change, being financially prepared can help us navigate both unexpected and expected challenges that come our way. Incorporating a sinking fund into a budget is a smart way to build not only the future that is desired but also one with a strong foundation of financial stability.

Start small and see where your savings take you!

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2 Responses

  1. I’m still not clear why it’s called a ‘sinking fund’. However I like the idea of setting up buckets in a savings account. What a great way to save, putting aside a little each month and having it automatically go proportionately to various possible outlays. Do you know if it’s possible to periodically adjust the percentages of buckets as your needs change?

    1. Interestingly, the term originated in England during the 18th century, which referred to a fund used to repay debts. Though the term has been around for ages, the meaning has changed over time. I didn’t know what a sinking fund was until recently, which is interesting since it’s a concept that has been around for a while.

      Yes, targets/percentages of buckets can be changed as needed, at least this is the case for Ally. It’s an incredibly useful feature as life can change in an instant. Other banks may vary in how they offer the ability to adjust specifications.

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