What is a sinking fund, exactly?
To me they sound like something you sink your money into, never to be seen again. Which of course they absolutely are not.
If they are a bit of mystery to you too then this post is for you.
Sinking funds for beginners; taking you from not sure, to knowing everything you need to know.
In the UK, we tend not to call them sinking funds, instead they are referred to as savings pots. Which to me makes more obvious sense.
And calling them savings pots gives you a hint of what they are and what you are trying to do.
We can move onto what they are and why they are so important for your financial health and well-being.
What Is a Sinking Fund?
The definition of a sinking-fund in it’s simplest form is that it is a (temporary) savings pot.
One where you put aside money every month and then spend from that pot on certain expenses.
Your sinking funds are expected expenses as you know they are going to happen.
You sink some money into a fund (savings pot) ready for when you need to pay for a bill or something you know is going to come along.
You know the bill is coming so you are just storing your money in that fund until you need it. That’s why it definitely isn’t your savings or your emergency fund.
Sinking Funds For Beginners: What You Need To Know
Differences Between Your Savings And Sinking Funds
Your sinking-funds are parts of your monthly budget that don’t conveniently happen at the same time every month.
Whereas your savings is money you are building up to provide you with long term financial security, wealth and achieve your financial goals.
The ideal scenario for your savings is for this money to grow every year with you rarely dipping into the pot.
Because for all costs that you incur, you can pay for them via either your monthly budget, your sinking funds or, in the case of an emergency, your emergency fund.
Sinking fund vs emergency fund
Aren’t sinking funds the same as emergency funds? No! Is the short answer.
Emergency funds are your savings that you have squirreled away for unexpected expenses that might (or might not) occur at some point in the near or distance future.
Your sinking funds are expected expenses. You know they are going to happen and have an idea when.
What Is The Purpose Of A Sinking Fund?
A sinking fund is designed to be a savings pot for those parts of your budget that don’t happen every month or on a very regular basis.
Sinking fund examples include car insurance, house insurance, birthday presents and the like.
These bills are an integral part of your budget but they don’t conveniently happen at the same time every month. Nor are they conveniently the same amount each month or even every month.
The purpose of your sinking fund is to have the right money available to pay these bills when they pop up, without going into debt or having to resort to using your credit cards.
How Do You Start A Sinking Fund?
When you are looking at how to budget your money, not only do you need to allocate money for regular bills like utilities and groceries, you need to set aside some money into your sinking funds.
How do you start doing that you might ask?
There are two ways you can get started with your sinking funds. The best way, which takes a little time, is to work out exactly how much you are going to need in your sinking funds over the whole year.
This involves looking at all your adhoc bills and your bank statements for the past year.
You are looking for bills and expenses such as; car insurance, house insurance, car repairs, home maintenance, medical and dentist, vacations, birthdays, Christmas.
Plus add in money for things you know you are going to need to replace like white goods or your boiler or your car.
The list can get quite big and it can take some time. The more time you devote to this, the better information you have.
Sinking Funds For Beginners
However this post is about sinking funds for beginners and I do NOT want to put you off starting right now.
The easier way, to get started this year, is to think about the bills I have listed above. Try and remember the amounts but don’t sweat it too much.
Better to have started a sinking fund than to have been put off by the work you think it involves and then get caught with a big bill.
Next year you won’t be a beginner. Next year you will know what your sinking fund savings pots were used for and be able to be more exact with your figures.
I would hate for you to not start just because you haven’t got last years bills or the thought of trawling through bank statements is too off putting.
Once you have this list, add up the total amount for the year and divide by 12 or 26 or 52, depending on how often you get paid.
This final amount is how much you need to save every payday and needs to be added to your budget.
It’s not savings as such, more putting aside regular money in order to pay those bills when they pop up. This money is purely for this purpose and is not designed to be saved long term.
Sinking Funds Categories
Everyone is different so your sinking fund list of categories will likely be different to mine.
When I got started with my savings pots my essential sinking funds list looked like this:
- New (to us) car
- Car repairs & annual bills
- Home maintenance
- Birthday presents & other gifts
As I am in the UK I did not have to think about medical bills. I would definitely have this category if I was in the US.
If you are wondering, what types of sinking funds should I have? Then I have a whole post about sinking fund categories that will help you find the right ones for your life.
Here are some examples of sinking funds you might want to consider:
- College costs
- Kids expenses
- Yearly subscriptions
- New appliances & furniture
- IT upgrades
- Medical, optical & dental costs
- Personal taxes
- Annual insurances
If you are self employed or usually have a tax bill at the end of the year, you will definitely want a fund to cover this expense. You do not want the IRS or the taxman chasing you for their money!
Why not download your free sinking funds tracker and category planner from my resource library?
How To set up and organize your Sinking Funds
Needless to say there is more than one way to organize your sinking funds. There is no right way or wrong way, only your way.
1. An all-in-one Sinking fund bank account
With an all-in-one type of sinking fund example you have one bank account and save all your sinking money into it regardless of the category.
It keeps your bank accounts down to a minimum which can be helpful.
To use this type of sinking fund it is best to track how much you have in each category separately.
You can use the tracker in my free resource library.
The main thing is to keep track of the money you are putting into this one pot approach.
Otherwise you run the risk of spending too much on say, Christmas, because you haven’t tracked how much you were saving for that particular category.
2. Different bank accounts for each sinking fund
When you have different sinking fund bank accounts, each category has it’s own account.
There is no risk of not realizing how much you have saved for each category as your bank balance will tell you.
The potential downside to this way of organizing your money is that you need to open as many bank accounts as you have fund categories. Which you might not be so inclined to do.
3. Using a savings account with multiple pots built in
This type of sinking fund bank account could give you the best of both of the above. You only need to open one account but within that account you can have separate pots.
Alternatively your bank might allow you to open multiple savings accounts which you can review easily through online banking.
This is what I have. With my bank account I can have up to 5 saver accounts.
Because I was already a customer I did not need to do any ID checks or credit history questions. Each savings account was opened in about 60 seconds, literally!
The interest is rubbish at 0.2% but the money is not designed to earn interest, it’s to be available for when my expected expenses pop up.
How To Get Started With Your Sinking Fund
Once you have decided how you want to store your sinking funds, open the appropriate accounts. This can take a week or two depending on whether you are an existing customer or new.
Once open, set up a regular auto-payment (standing order) from your main bank (checking) account into this new account.
Set the date for the day after you get paid.
I never set auto-payments for the day I get paid because very, very occasionally I have been paid late by my employer (yes, the UK Government sometimes pays late!).
You DO NOT WANT bounced payments happening.
The day after you get paid is early enough. No later though as you don’t want to risk spending it blindly.
Sinking funds for beginners: Actions To Take
- Identify what bills and costs will crop up during the coming year or so
- Calculate roughly how much these will cost
- Divide by 12 if you get paid monthly, 26 if paid bi-weekly, 52 if paid weekly
- Add this amount into your budget and makes sure your budget balances
- Open your essential sinking funds bank account/s
- Set up an auto-payment from your bank account to your savings account for the right amount for the day after you get paid
- Set it and forget it
- When a large expected bill comes along, withdraw that amount from your sinking fund
- Keep the auto-payments going
- Re-calculate every year
How much should I put in a sinking fund?
Your sinking funds are for all your expected but irregular payments. So you need to calculate how much these add up to. Then divide by the amount of your paychecks. E.g. if you’re paid biweekly then divide this annual total by 26. If paid monthly, then divide by 12.
Are sinking funds necessary?
Most definitely! How else are you going to pay for an annual insurance without using your credit card or overdraft? And what about vet bills that happen when you are least prepared?
If you want be financially sound and have stable finances, sinking funds are essential.
How does a sink fund work?
A sinking fund works by you putting money into each pay period, in anticipation of the bill you know is going to arrive at some point this year.
Putting money in regularly allows you to have enough money to cover those bills, withou stressing about how to pay for it or getting into credit card debt as a result.
I hope this helps you get started with your sinking funds today. For more advice on managing your money have a read of these posts:
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Last Updated on 16th November 2021 by Emma