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Budgeting for regular bills and monthly necessities is helpful, but what about those expenses that only come occasionally? Irregular expenses can be hard to plan for, but a sinking fund can help.
A sinking fund helps you save for a particular expense over time. Rather than taking on debt or dipping into your emergency fund, sinking funds encourage you to save a little bit each month for that upcoming vacation, wedding, or major purchase.
Continue reading to learn more about sinking funds, how they work, and how to create one.
A sinking fund is a tool to help you save for irregular expenses over time. Like other line items on your budget, you allot a specific amount of money each month for your sinking fund. But instead of spending that money each month, the fund grows over time until you’re ready to spend it.
A sinking fund isn’t a bank account itself. Instead, you can think of it as a monthly expense category within your budget. You can keep your sinking fund in one of many different types of bank accounts — for example, a savings account, money market account, certificate of deposit (CD), or even a checking account.
You can use a sinking fund for all kinds of purchases — think any irregular expense that you want to save for. The following expenses are popular candidates for sinking funds:
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Weddings
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Vacations
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New cars
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Renovations
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Holiday gifts
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New appliances
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Down payments
It’s also possible to have more than one sinking fund at once. There’s no limit to the number of sinking funds you can have, but the more you have, the longer it can take to hit each savings goal.
An emergency fund and a sinking fund aren’t the same thing. A sinking fund has a specific purpose, like funding next summer’s beach vacation. An emergency fund, on the other hand, is for setting aside money to be used when unexpected but unavoidable expenses pop up or you experience a sudden job loss.
For example, if your basement floods or your car gets a flat; your emergency fund can cover those bills. But you shouldn’t use your emergency fund for things like vacations, gifts, or nonessential home upgrades — that’s what a sinking fund is for.
Read more: How much money should I have in an emergency savings account?
A sinking fund can benefit any budget. For example, a sinking fund can help you:
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Avoid taking on debt. When you plan for large expenses months or years in advance, you can save up and pay cash rather than charge a credit card. This can help you minimize the burden of interest.
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Avoid tapping your emergency fund. Without a sinking fund, dipping into your emergency fund for a vacation or other expense may be tempting. But doing so can hurt you down the road when an actual emergency pops up.
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Stick to your budget. If you don’t plan ahead, you may need to come up with money in a hurry — which can take a toll on your budget. But when you use sinking funds, you can account for all types of expenses without breaking your budget.
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Stay organized and minimize stress. Knowing how much you spend and on what is helpful information when it comes to managing your money. Planning for expenses ahead of time — and knowing how much they’ll cost — helps you stay organized, which in turn may lower your financial stress.
Creating a sinking fund isn’t hard. It just requires some planning and the following steps.
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Decide what you’re saving for and how much it’ll cost. Want to take a vacation? Pay for your wedding? Make a down payment on a house? Get clear on what you’re saving for and how much money you need to save.
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Determine your deadline. Knowing your deadline helps you save at a realistic rate. For example, if you need $2,000 for a vacation in eight months, you’ll know you need to save $250 every month in your sinking fund.
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Choose an account to hold your funds. Once you have your goal, you need a place to put your money. One of the best options is a high-yield savings account, which can pay up to around 5% APY and help your money grow even more. Be sure to look for an account with a high yield and no fees or minimums.
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Work your sinking fund contributions into your budget. Make sure your budget allows for your sinking fund contributions. You may be able to allocate your existing savings toward your sinking fund, or you might have to rework your budget. If you use a money management tool like Quicken’s Simplifi app, give your sinking fund a line item in your budget, ensuring you’ll prioritize it along with your other expenses.
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Automate your contributions. This step is optional, but if you want to foolproof your sinking fund strategy, you can automate your monthly contributions into a separate account. That way, saving will happen on autopilot. When your deadline arrives, you’ll have a fully funded sinking fund ready to go.
Hot tip: Yahoo Finance readers can try Simplifi free for 90 days. Act now!
Keep in mind you may have multiple sinking funds at the same time. For example, maybe you’re saving for a vacation and a new car. You can have multiple sinking funds with various timelines and price tags — just don’t spread yourself too thin by contributing to too many goals at once. If needed, you can always pick a couple of goals to prioritize before moving on to secondary goals.
Read more: Struggle with budgeting? Following the 50/30/20 rule could be your solution.