Originally, sinking funds were extra money or revenue set aside by governments and businesses for future expenses and debt repayment.
Today, individuals have also adopted this idea of setting aside money little by little for big purchases to avoid the “shock” of spending a huge amount all at once.
How a sinking fund works
You can set up a sinking fund for something you know you’ll need or want in the future — like a family vacation, a new car, or Christmas gifts.
Instead of scrambling for cash or going into debt at the last minute, you save gradually until you reach your goal. All it takes is setting:
- A goal (what you’re saving for)
- A target amount (how much you’ll need)
- A deadline (when you’ll need it)
You can put the money in a savings account or in low-risk, highly liquid investments that allow you to withdraw whenever you need to.
If you want to grow the money faster than it would in a savings account, you can also consider investing in assets that offer higher potential returns. However, this comes with higher risk of getting less than what you put in.
Investing in higher-risk assets is an option if you have years to go before needing the money and can accept the ups and downs.
Why a sinking fund helps
Having a sinking fund can help make major expenses feel less stressful and more intentional. It can also allow you to spend on your wants with no regret or guilt since you’ve budgeted for them.
By planning for these expected costs, you’ll feel more in control of your finances and avoid going into unnecessary debt.
You’re also less likely to disrupt your progress towards other money goals (like investing for retirement or other long-term goals) by not having to deplete your resources to come up with money for an expense you already know you’ll make.
Sinking fund vs. emergency fund
A sinking fund and an emergency fund can both bring peace of mind and help you achieve financial stability. However, they serve different purposes and so it may be wise to have both.
Here’s an overview of their differences:
| Sinking fund | Emergency fund |
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These methods of saving money can allow you to look forward to the good things in life and not let bad events get in the way of reaching your goals.
You may want to have a dedicated savings account, investment portfolio, or tracker for each goal to easily manage your money and view your progress.
