Sinking Funds Explained: How to Afford Everything

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Sinking funds are my favorite way to save for specific large purchases or to ensure I always have money for big budget categories, like travel. They are the ultimate savings hack, and can make even big savings goals seem easy and manageable.

Sinking funds get their name from “a fund containing money set aside or saved to pay off a debt or bond“, but in personal finance they are primarily used for savings, not debt. When you set up a sinking fund, you usually do so by opening a high-interest savings account for a specific purpose.

What are sinking funds?

A sinking fund is a savings account or cash allocation that you regularly contribute to for a large purchase or one-time expense. Having a dedicated sinking fund for a specific purchase or budget category means you will not have to make any withdrawals from your Emergency Fund or make cuts to other spending areas to afford it.

For example, say you know you will eventually need to replace your car, but you’re not sure exactly when. You set up a car sinking fund and contribute $100 per week. When your current car breaks down or you decide it’s time to upgrade, you already have savings set aside to replace your vehicle.

You can do this with smaller purchases as well, like Christmas gifts. You can set up a present sinking fund and contribute $10 per week. This is such a small amount you may not even notice it. But when it comes time to buy your holiday gifts in December, you’ll have over $500 saved!

Sinking funds are like tiny little budget buffers with specific purposes. They take a little bit of effort and time to set up, but once you get them going, you’ll feel richer than ever.

What are examples of sinking funds?

You can set up sinking funds for anything. I personally use sinking funds for budget categories, but they work just as well for specific expenses so do whatever works for you!

My favorite sinking funds are:

  • Christmas sinking fund
  • vehicle sinking fund
  • pet sinking fund
  • vacation sinking fund

I contribute to all my sinking funds on a weekly basis, because I find I don’t even feel the pinch of small amounts leaving my budget. For most of my sinking funds, I have dedicated high-interest savings accounts with EQ Bank. For my other sinking funds, their balance simply sits in my chequing account but it dedicated to their specific category and identified as such in my YNAB budget.

I do find You Need a Budget (YNAB) the best tool to manage sinking funds, because they are the basis for the YNAB method!

How much should I put in a sinking fund?

How much you should put in a sinking fund really depends on what the sinking fund is for. I like to keep most of my sinking funds with at least $1,000 in them, but up to $3,000 depending on the purpose of the account.

For a sinking fund for a specific category, there might be a balance that feels comfortable. If you create a sinking fund for gifts, you might contribute up until you hit a balance of $500 or $1,000 and then stop adding to the balance. When you use some of your sinking funds to buy a birthday present for a friend, the balance will fall below your target so you will restart your contributions to your sinking fund again until the amount is replenished.

For a sinking fund for a specific purchase, set the goal amount and timeline and work backwards from there. For example if you are planning to go on a vacation next winter for $2,400 you know you’ll need to save $200/month. You’ll set up a travel fund and start contributing until you hit your goal. You may even decided to keep the travel fund open after your reach your goal and go on your trip, so you can start accumulating cash for your next adventure.

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1 Comment. Leave new

  • Katie @SolopreneurCafe
    October 28, 2021 9:39 pm

    I am a huge fan of the concept of sinking funds – but not the term. I use “slush fund”, which Investopedia defines as “a sum of money set aside as a reserve, functioning either as an innocent rainy-day fund or a platform to finance illicit activities”. That last part gives it a bit of an edge, lol…like rainy day makes me think necessities, like a new radiator for the car or wedding gift. While illicit activities makes me think of indulgences, like a weekend away or concert tickets. But they all come from a place of “comfort” knowing that money is both necessary and not rigidly assigned to an expense.

    Reply

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