You know the feeling.
It’s the run-up to Christmas and you’re feeling anxious about the money you’ve got to treat family and friends with. The only problem? You’re buying all of those gifts from your December paycheck, dipping into your savings, or getting into debt.
(There’s a reason why 28% of people go into debt over the festive period.)
You promise yourself that next year, you’ll be more prepared… But it never happens. You spend the following year forgetting about the upcoming cost of Christmas, and the cycle continues.
That’s because you’re not using sinking funds.
What is a sinking fund? 💰
Before we dive in, let’s be clear on what a “sinking fund” actually is:
A sinking fund is a pot of money you’re using for one single thing. You know exactly what you’re saving for, roughly how much it will be, and when you’ll spend it.
You can have sinking funds for a variety of things, each with different targets and in different accounts. The goal? To spread the cost of planned expenses–rather than taking a huge amount of your monthly budget (or worse, going into debt) to cover them.
Remember: Preparation is key.
Sinking funds vs. emergency funds vs. savings: What’s the difference?
First up, I apologize. There’s enough financial jargon to make your head spin in that header.
But my point is: Sinking funds are different to other pots of money you have. They’re buckets of money you know you’re going to spend on a specific thing–be that a salon appointment, or a car insurance payment.
Saving accounts, however, don’t always have an end-goal. Sure, you might be collecting a nice pot of cash for retirement, but you could use it for a rainy day. The money in your personal saving account doesn’t directly go towards one thing–nor does it need to be spent, at all.
Similarly, sinking funds are different to emergency funds. Sinking funds are pots of money for things you already know about, whereas emergency funds are for, you guessed it: emergencies.
For example: You know you’ve got a holiday coming up, and you have a trip to the hairdressers every two months. Money for those things should going into two different sinking fund accounts.
But something unplanned, like a last-minute trip your kids have only told you about, would come out of emergency fund. (If your emergencies are a similar thing and become a habit that occurs every month/year, consider making a sinking fund for that.)
To summarize: Sinking funds aren’t savings. They’re pots of money you pay into to spread the cost of something over a year, rather than taking it from a single paycheck.
10+ sinking fund examples
Now we know what a sinking fund is, let’s think about the occasions we know will happen, which you might need a spare pot of cash for.
You can create a sinking fund for things like:
- Annual car insurance payments
- Car repairs
- Home maintenance/repairs
- A holiday or vacation
- Pet supplies
- Medical emergencies
- Salon appointments
- Tax payments
Dylan Houlihan, who runs Swift Salary, mentions sinking funds are also superb ways to manage money if you’re self-employed: “Since I’m a freelancer, I typically get paid once a month, so I transfer my money into each sinking fund once a month as well.”
Grab a calendar and make a note of important dates you’ll need cash for–like your partner’s birthday, or the tax deadline.
It’s the best way to see the sinking fund budgets you’ll need to prepare for.
How to start your own sinking fund
Are you ready to spread big expenses over a year, and make them seem less intimidating, by using sinking funds?
Here’s a step-by-step guide to creating your own:
1. Start with your biggest, most-urgent category
Not everyone has tons of disposable income to plug into their ideal sinking funds.
So, start with your biggest sinking fund in terms of cost, or the most urgent. (You’ll might find this is the same expense–like tax repayments, or car repairs.)
You want to have money inside a sinking fund to cover these expenses first. Make a list of the sinking funds you’d like to have, and roughly how much money you’ll need for each.
Let’s say you have these sinking funds on your plan, for example:
- Birthdays: £100
- Car repairs: £250
- Tax payments: £2,000
- Pet supplies: £50
- Salon appointments: £70
- Home maintenance: £35
Tax repayments are the most urgent, and co-incidentally, the highest expense.
So, let’s focus on getting that one up-and-running first–rather than spreading our money too thin and having tiny pots of money in several less-urgent sinking funds.
2. Work out how much you actually need in the sinking fund
Now you’ve got a list of expenses you need to account for every year, we need to set a target of how money much that sinking fund should contain by the time payment date comes around.
A word of warning here: Don’t assume how much you need for each sinking fund. Especially in the world of managing your money, assumptions are the root of all evil.
Always look through old transactions to see how much you usually spend on that sinking fund. (It’s probably more than the first number that comes to mind.)
Eryn Lueders of Successfully Simple Sisters explains: “We decide on the amount of the sinking fund based on previous years’ averages. We use a zero-based budget in spreadsheet form that has our last 5 years’ budgets.”
“Taking a look at those allows me to average each month’s sinking fund amount based on the real expense we had the last time the large expense was made. So far, this has allowed us to build the sinking fund almost to the dollar (with a few exceptions) of what we actually need when the expense comes around.”
The simplest way to do this, though, is to look back in at your transactions. Add up the total amount you spent on something, and take an average. That’s likely your goal for your sinking fund.
3. Go through your monthly budget and automate money for each fund
You should have a monthly budget that tells you how much money you have each month, and the categories in which you’re spending it–be that your mortgage repayment or food shops.
Add a line into your budget sheet for your most important sinking fund.
Because you’ve already set a goal for what each sinking fund needs to include, you can easily build that into your monthly budget by dividing the cost by how many months you have.
Jesse Cramer of Best Interest explains: “In general, each sinking fund gets allotted money based on previous spending rates. Since I spent $430 on Gifts in 2019 (precise knowledge like this is a nice perk of detailed budgeting!), I’m currently allotting about $40 per month to my Gifts sinking fund.”
Here’s what that might look like:
- Christmas: £200 goal: put £18.50 per month from January to November into the sinking fund
- Tax payments: £1,500 goal: put £125 every month into the sinking fund
- Summer holiday: £400 goal: put £57 in your sinking fund from January to July
Top tip: Set-up automatic transfers so you don’t forget to move money into your sinking fund. Set the date for when you get paid. Chances are, you won’t even notice it coming out of your account.
4. Decide where to keep your sinking funds
You’ve got your sinking funds ready to go, and have budgeted a certain amount to move there every month.
But deciding where to store your sinking funds is just as important as the amount itself.
You want to make it easy to access your sinking fund when the time comes. However, you also don’t want to be tempted to spend it because it’s left inside your regular checking/current account.
➡ Buckets (or goals) inside your regular bank account
Money added to a goal doesn’t show in your available balance.
It’s stored in a separate pot which you can still access from your current account, but doesn’t get muddled-up with the spare cash you’ve got to play with.
Here’s an example of two sinking funds I have for my business using Starling:
➡ Multiple savings accounts
Don’t panic if your bank doesn’t offer this feature.
You can use several savings accounts to store your sinking fund, such as:
- Easy access savings accounts: The majority of sinking funds are for things that happen at least once a year, like Christmas or birthdays. An easy-access savings account takes your sinking fund cash out of a checking account (where you might be inclined to use it.)
- Long-term savings accounts: These typically have higher interest rates, but it can be harder to take your money out when needed. They’re better if your sinking fund is long-term, like a holiday you’re planning to go on five years from now.
Be wary about the payout timings of your savings account, as Michael Dickey of Fiscal Fitness Phoenix explains: “The one caveat is that it can take 2-5 business days to get the money back into [a checking account] from savings. This is a great time to responsibly use credit cards to cover the amount; then when you the money clears back into your checking account you pay off the credit card balance immediately.”
➡ Wait: What’s wrong with one savings account for all of my sinking funds?
Notice how we advised to use several savings accounts to store your sinking fund cash?
That’s because bundling all of your sinking funds into one savings account makes it almost impossible to see whether you’re on-track to meet each target.
Let’s put that into practice and say you’ve got three sinking funds:
- Tax payments: £1,500
- Birthdays: £350
- Pet supplies: £200
If you had a single account for all of those funds, you’d see a balance of £2,050. You can’t tell, at first glance, how much you have allotted to each goal–nor whether you’re on track for either.
Creating multiple savings accounts for each sinking fund solves that problem, especially if you rename the account for your goal. (In the case above, you might have: a Santander savings account called “Tax”; a Barclays account named “Birthdays”; and a Monzo goal for “Pet supplies.”)
Create your own sinking funds as soon as possible
Even if you don’t have the spare money to start growing your sinking funds today, that doesn’t mean you’re limited.
Make a plan of action for the sinking funds you need, the total amount you’d like to have in each, and when they need to be paid by. You can ease those figures into your monthly budget–starting with your largest, most-urgent planned expense.
David Bakke of Dollar Sanity summarizes: “You’re doing yourself no good if you’re not using sinking funds, and this is especially true if you tend to overspend or if you tend to procrastinate.”