What Is a Sinking Fund?
In this article I am going to answer the question “What is a sinking fund?” And I will also list the sinking funds that I think every family should have (and some other fun ones that you might want to have, as well!).
What Is a Sinking Fund? Three Definitions
When I Googled “what is a sinking fund” because I was curious what definitions I would find, this is the first one that came up: “a fund formed by periodically setting aside money for the gradual repayment of a debt or replacement of a wasting asset.” That’s pretty clear—except for the “wasting asset” part.
So here is another definition for what is a sinking fund, from the folks over at EveryDollar (Dave Ramsey and company): “A sinking fund is simply a strategic way to save money by setting aside a little bit each month.”
That’s not too bad of a definition. But here is what I would say, if you asked me “what is a sinking fund”: a savings account that you set up and regularly put money into in order to replace money you regularly or periodically spend on a specific purchase or expense.
Is that pretty clear? If you have an even better definition, comment below and let me know!
What Is a Sinking Fund Used For?
So now that we have given a basic definition for what is a sinking fund, let’s talk about what sinking funds are used for.
In order to manage your money well, it’s really helpful to use individual savings accounts to make sure that you are savings for the things that you need to be. Creating sinking funds will help you to get out of debt and to stay out of debt as you instead save up for and purchase or pay for the things that you need.
As soon as you have a fully funded emergency fund of at least 3 to 6 months’ worth of expenses, you should start setting up additional savings accounts for irregular or unanticipated (though not completely unexpected) expenses.
If your bank doesn’t allow you to easily set up multiple savings accounts, then I recommend setting up an account with an online bank such as Capital One 360. They have been a great bank for us and have one of the best savings interest rates around.
Read on to learn about 9 sinking funds that pretty much everyone should have, as well as a handful of additional savings accounts that may be beneficial (and fun to have!) in your situation.
What Are Sinking Funds That Everyone Should Have?
When you are considering what sinking funds to set up, here are my recommendations. Below I list the different sinking funds I feel that virtually every family (and everyone) should have (and that we ourselves have).
Vehicle maintenance and repairs
One of the most important sinking funds for most families (all who have one or more vehicles) is a sinking fund for vehicle maintenance and repairs. We all love our cars, but the simple reality is that they need regular maintenance and eventually they need repairs. So rather than having to put the bill on your credit card the next time your battery dies or your brakes need to be replaced or your transmission goes out, pull the money from your vehicle maintenance savings account.
Another important sinking fund is a savings account for the purchase of a vehicle. Do you want to know where most people’s wealth is? It’s sitting in their garage. Really. I don’t mean that our vehicles make us rich. I actually mean the exact opposite, because vehicles go the wrong direction—they go down in value. They depreciate. And yet the average car payment in America is more than $400 a month.
Did you know that if you paid yourself that $400 a month for 40 years instead of paying it to the bank in car payments you would have invested $192,000 (can you believe that people spend that much on this depreciating asset?!), and at an average annual return of 11 percent, which is very realistic over the long term, you would have $2,907,969 in your investment account after that 40 years! Isn’t that amazing?
So instead of paying the bank that much money and all of the interest included when you finance a vehicle, set up a vehicle savings account and pay yourself a monthly car payment. That may mean that you want to sell your current vehicle that has a car payment and buy an inexpensive car to get around in until you can buy yourself a car for cash in a couple of years. (And if you cannot pay off your vehicle quickly, that is what I would strongly urge you to do. Please, build your own wealth; not the bank’s!)
If you can pay yourself $200 a month for 2 years while you drive a $1,000 to $3,000 get-around car, you would have about $5,000 to buy a little bit nicer car. And then if you drive that car for two more years, you could then buy a $10,000 vehicle ($5,000 from the value of the current car plus $4,800 from saving $200 a month for 24 months = ~$10,000). And then if you drive that $10,000 vehicle for four more years, you could then buy your next car, with cash, for $20,000. And because you’re going to buy a car that’s at least 2 to 4 years old, since you don’t want to take the huge bite that happens when you buy a new car (save that for when you have a net worth of at least $1 million and can really afford to take that kind of financial hit that comes with the depreciation of owning a brand-new car!), you can get a great vehicle for that price—and you’re just eight years into your vehicle saving plan. You would have a $20,000 car—and it would be paid for with cash! Amazing!
If you want to buy a vehicle for even more than that (though personally I hope to never spend more than that on a vehicle unless it’s an RV or sailboat or something—I like to use my money for things that go up in value), you could save more, such as $300 a month. If you saved $300 a month for eight years and earned a little interest on that, you would have about $30,000 to pay toward your vehicle, plus the resale value of the current car you were driving. And of course you could increase that by about $10,000 for every additional $100 a month that you chose to save—so if you wanted to buy a $50,000 vehicle with cash, you would need to save just $500 a month for eight years. Again, the average car payment in America is almost that much, so please, if you want to buy a vehicle that is that expensive, please save up the money and buy it with cash!
I know that having a car payment in America is normal, but you don’t want to be normal! Normal is broke and in debt and living paycheck to paycheck. Normal kind of stinks. So don’t be normal. Be awesome. And one of the ways you can do that is to get out of debt and never look back. Find out how you can save on the many costs related to car ownership by reading this article.
Auto insurance and vehicle registration renewal
Another important vehicle-related sinking fund is a savings account for auto insurance and annual vehicle registration and related fees (such as vehicle inspection and safety fees). By saving money for these expenses every month you can pay for your auto insurance annually, for example, which will generally save you money over having a month-to-month plan.
Whenever you can, it is generally a good idea to be your own bank!
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When you buy a home, you not only sign up for 15-plus years of hefty payments but you also sign up for the upkeep and repair that a home requires. Home ownership (generally speaking) is definitely worth it, but you need to be prepared for the extra expense of home maintenance in your budget. You should save about 1 percent of the purchase price of your home for home repairs and maintenance each year. (If you have an older home, you may need to save more than that.)
So if you purchase a $250,000 home, that would be about $2,500 a year that you should save, or about $200 a month. This money can then be used for the deductible of your homeowner’s insurance if you need to make a claim, for example.
Note: You should consider putting your homeowners insurance deductible high enough that you never want to make a claim unless it’s something pretty catastrophic. So put your deductible at about $2,000 or more. That will keep your premiums significantly lower, but perhaps more important, it will keep you from making insurance claims that you should not make for things that you should instead pay for out of your house maintenance and repairs savings fund—or even your emergency fund if needed. If you make too many claims, not only will your insurance premiums get raised significantly, but you might even get dropped from your insurance company. And because your claims are visible to other insurance companies (on something called the CLUE, or Comprehensive Loss Underwriting Exchange, report), making too many claims will also make other insurance companies less likely to be wiling to take your business.
So instead, self-insure by having a fully funded emergency fund and then by saving monthly for the home repairs that you will need to make throughout your time in your home.
For more helpful information on saving money on housing, read this article with more than 30 top suggestions for saving money on housing.
Furnishings and appliances
It is also a good idea to include a sinking fund category in your budget for furniture and appliances.
You need to plan to do periodic repairs and replacement of your appliances and furniture. And you don’t want to have to rely on credit cards to do that. So instead, save up regularly for these eventually anticipated expenses. You’ll get a good feel for how much you need to save once you start paying attention to this, but if you’re unsure, start saving $50 a month. If you buy gently used furniture and appliances, you’ll get a great bang for your buck and be able to buy a lot of great things for $600 a year.
Christmas and gift giving
Another important sinking fund is a gift fund.
The way many people act, you would think they don’t realize that Christmas (and the cost of it) are coming until at least Black Friday. But you can plan better than that! If you spend the average $900 that most families in America do, then you can save up for Christmas for just $75 a month. Sweet! So get it done.
Or, you might also consider cutting back on your Christmas spending so you can save less each month and put the money toward other great causes (such as your children’s educations or your own retirement—now those are gifts that keeps on giving!). Read this article for ideas on how to save on your Christmas spending and this article on how to open an educational savings account for your child.
In addition to Christmas, look at saving some money each month for additional gift giving such as birthdays, weddings, and so on.
Another important sinking fund is a vacation fund.
The best kind of vacation is the one that doesn’t follow you home in the form of credit card payments! So set up a savings account to save up for your vacations. You can estimate how much to save each month by looking at how much you have spent in the last year or two on family trips and vacations, but $100 to $200 a month is probably a good place to start.
Do you want to save money on your traveling and family vacations? Of course you do! If you haven’t checked out Airbnb yet, you need to! We love Airbnb for saving money on our accommodations while traveling! Give them a try; they’re awesome! You can get $40 off your first stay by signing up here!
If you have children and you are not independently wealthy (yet! :)), then you need life insurance. And one way that you can save on the cost of your life insurance premiums to pay for them annually. But that also means that you need the money available when it comes time to pay the annual premium. So set up a sinking fund to take care of that, that you fund every month with the amount that would be the annual premium divided by 12.
Miscellaneous/other short-term savings
We also have a savings account for miscellaneous purchases and expenses. You may want to have one to cover things that come up like purchasing electronics or bikes and recreational gear or things like that.
Additional Sinking Funds You Might Want to Have
I’ve listed below some additional savings accounts that you might want to consider when determining what to save money for.
Your utility bill is another thing, as you are considering what sinking funds to have, that you might want to open a separate savings account for.
When we lived in our previous home the natural gas company had a bill pay program where they equalize your payment every month so that it’s easier to budget, rather than having potentially really high natural gas bills to heat your home in the winter, for example. And that was a really handy option. But at some point I decided we could just save the money ourselves during the months when the utilities cost less and pull the money from our utilities savings account for months when our utility bills were higher, like the summer with the AC and the winter with the furnace. I really like being my own bank. 🙂
For ideas on how to reduce your spending on utilities, read this article.
Probably the biggest purchase you will ever make is your home, so a down payment fund is another important item to include as a sinking fund. If you hope to be a homeowner in the foreseeable future, you should start to save toward the purchase of your home.
To be able to save as much money as possible in your down payment fund, rent as inexpensively as you can. Rather than rent a posh place with all of the awesome amenities, rent an inexpensive (but reasonably safe) place for as little as you can, and save the difference. There’s a lot you can put up with if you know that it’s only for a certain amount of time (say two to five years, as you save up a good down payment) and if it’s for a great cause. To learn more about saving up to buy a home, check out this article.
If you know that you are at least five years (and the closer you get to ten years or more, the more this might make sense) away from purchasing a home, you might even consider investing the money in mutual funds to earn more money on your money.
You might even consider what we’re planning to do for our next home purchase—the 100 percent down plan! We are planning to stay in our modest, three-bedroom, 1,300-square-foot home for the next five to eight years (we’ve lived there almost eight years now) so that we can buy our next home (that will probably be close to twice the value of the one we live in now) with cash. It’s maybe a sacrifice to stay in a smaller than average home with our three kiddos, but the payoff of never being in debt ever again is worth the trade-off. And as we save that money for the next several years, because it is a mid-term time frame of more than five years, we are investing the money in mutual funds in our Schwab brokerage account.
If you want to know how we choose the mutual funds that we are investing in to diversify our investments, enter your information below and I will be happy to email it to you, no strings attached.
Another sinking fund to consider setting up is a baby fund.
Those squishy little cherubs not only cost a chunk of change at the hospital, but you may have heard that they cost some money once you bring them home, too! 🙂 The copayment or deductible and all that baby gear add up, so when we’ve been pregnant (and for several months after) with our children we’ve put $100 a month into a savings account to help pay for those expenses.
Read this article to learn ways to save on expenses for your baby.
Recreation and entertainment
Another sinking fund you could set up is a recreation and entertainment fund.
If you spend more money some months on recreation and entertainment than others, consider opening a savings account and just puling the money out when you need it. For example, if you get family ski passes and buy needed ski gear every winter, you might save up for that throughout the year so that it’s not such a hit on your wallet at the beginning of ski season.
For ideas on how to save on recreation and entertainment for your family, check out this article.
If you are engaged, then a wedding fund is another great sinking fund.
When planning a wedding, open a separate savings account to save for it. If you have a specific date in mind and have figured out how much you can afford to pay for your wedding and related costs, you can figure out how much money to save each month for them. And yes, you should create (and stick to) a wedding budget!
RV/boat/ATV purchase and maintenance fund
You might also want to include setting up a recreational vehicle maintenance sinking fund.
Cash is king. Saving up and paying for your recreational vehicles is the best way to go, so if you intend to have these fun toys, save up to buy them and to maintain them after purchase.
OK, this is just one quirky thing that I do—among who knows how many. 🙂 But I don’t ever want to touch our emergency fund if we can help it, so in addition to having an emergency fund for larger unexpected expenses we also have an OC fund. You could say it’s our backup EF—our “Oh, criminy” fund (or another slang word of your choice that starts with C). Since most financial emergencies can be covered with $1,000 or less, that’s how much we have in this OC fund. We have pulled money from this fund and then replenished it, but because of our other savings accounts for car maintenance and home maintenance and car replacement and things, we haven’t yet had to pull money from our EF. (Knock on wood!)
Mission, humanitarian service, or charitable giving fund
If you have children that you hope will serve missions for your church (as we do!) or do humanitarian service trips or study abroad or similar things or if you give a substantial amount to charity on some schedule rather than monthly, you may want to have one or more savings accounts for these funds.
A trip to Disney is another (fun!) thing to consider including as a sinking fund.
We’re planning to go to Disneyland (and other fun places in Southern California) in a few years and then Disney World and nearby attractions within a few years after that, so I just recently opened a savings account to save specifically for these trips. If there is something similar that you want to specifically save for, you might open a separate savings account to do so, since opening savings accounts such as the ones we have with Capital One 360 is so fast and easy. (And having separate accounts is so convenient—and important, so that you do not spend money you intended to spend on one thing on something else!)
Other helpful sinking funds
In addition to those listed above, here are some other sinking funds that you might want to consider setting up:
- Homeowners insurance (if you have paid off your mortgage and need to pay the premiums yourself)
- Property taxes (again, if you need to pay these yourself)
- Medical expenses (if a flexible spending account is not available to you)
- Pet expenses
- Clothing and shoes (if you are like us and don’t buy clothes and shoes every month)
- Children’s sports and other activities
- Spending money (aka fun money, blow money)
- College expenses (if you are close enough to needing the money that you do not want to have the money in mutual funds in a college educational savings account)
- Memberships and subscriptions
I hope that you feel you have a great understanding now of “what are sinking funds?” Do you have more questions about what sinking funds are or how they should be used? Leave a question in the comments below!
If you want to set yourself up for financial success, you’ve got to stop living paycheck to paycheck, like the majority of people do. And one of the most important factors to accomplish that is to have the cash (as savings) that you need to pay for expenses as they come up so that you don’t have to rely on credit card and other debt.
As you are able to get out of debt, as Dave Ramsey says, you are able to free up your most important wealth-building tool: your income. By having the various sinking funds identified above, you can make sure you cover all of your bases so that you are prepared for life’s financial curveballs and opportunities.
Similarly, by putting money aside in your monthly budget to save up for these expenses, they won’t cause you to go into debt so that you’re paying potentially hundreds of dollars in interest and they won’t derail you from your investing or other financial objectives—these (somewhat) unexpected expenses won’t keep you from reaching your awesome goals and dreams!
How would you answer the question “What are sinking funds?” What additional sinking funds do you have that I didn’t mention here? I would love to hear your ideas, so leave a comment below!
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