What is a Sinking Fund?
What is a sinking fund?
A sinking fund is a savings fund with a specific purpose, and often a specific date associated with it. Let’s assume for a moment that you pay $4k in property taxes each year. It would be a great idea for you to open a savings account and put $333/month into it. At the end of a year, you would have the full $4k for your property taxes. In fact, this is such a great idea that a majority of mortgage loan companies require you do just that in an escrow account they hold on to. They do the same thing for your home insurance.
How might a sinking fund help you?
When you use a sinking fund for a specific purpose, you can set aside money ahead of time, so that when the expense comes up, you have the cash you need.
Possible examples include:
- Upcoming vacation
- Your next car purchase (buy a used car with cash instead of financing it)
- Kid’s braces
- Future home down payment
- Annual Insurance premiums or membership dues
How can I get started using sinking funds?
It is easiest to work with sinking funds if you already have a budget. The budget will allow you to identify the money to set aside each month for your goal.
Step 1. Estimate how much money you will need. For example, you might want to put away $3k for a vacation.
Step 2. Estimate when you will need the money. Your vacation may be 12 months in the future.
Step 3. Calculate monthly savings requirement. $3,000/12months = $250/month
Step 4. Budget for your goal, and transfer the required monthly amount to savings each month until the big day.
There are lots of ways to keep track of your sinking funds. You can have separate savings accounts for the big items, like Taxes. You may keep a spreadsheet or a manual ledger to track multiple goals in a single savings account. EveryDollar and Mint budgeting software both have savings goal functions you may use to do the same.
However you track it – learning to save for the big items before you need them is a great way to stay out of debt.