What is a Sinking Fund & How To Set One Up
What is a Sinking Fund?
A sinking fund is a fixed amount of money you save each month to prepare for a non-monthly expense like a car repair, or a twice-a-year insurance payment.
(Side note: Sinking Fund would also be a great name for a boat. I might add that as a wish farm goal.)
Anyway, I know the car will eventually need repairs. We all know that. Although it always feels like a surprise when it happens, it’s actually a known expense. How much will these repairs cost? I have no idea (hopefully very little).
I know that our life insurance premiums are due annually. It’s a known expense. How much will the premiums cost? We have term insurance, locked in for at least a decade, and it comes to $840 per year.
Some other common examples of sinking funds are home repairs, medical expenses, vacations, Christmas or birthday gifts, building an emergency fund, or even an annual subscription like an Amazon prime membership. None of these are actually unexpected expenses, but they still manage to feel that way when they pop up again.
See a list of other sinking fund categories you might want in your budget!
How Much Should I Set Aside in My Sinking Funds?
Based on past experience, let’s say we spend $2,000 per year on car repairs. That means I need to be socking away $167 into my Car Repairs savings account (or YNAB category, but we’ll get there). For the life insurance premium, $70 per month means we’ll be able to pay for that premium easy-breezy.
A calculator and a reasonable estimate of the total cost of your upcoming expense and how long it will take to occur makes it easy to set up a sinking fund: Divide the cost by the number of months until you’ll have to pay it and start setting that cash aside in your budget each month.
Why Do I Need a Sinking Fund?
Picture this: you open your mailbox, see a bill, and all of a sudden you need $700 for a car insurance premium! If you don’t have the money, what’s the first thing you do? Pull out your credit card, and into debt you go! It’s disheartening, to say the least.
But how about this instead of borrowing money, you just set aside a manageable amount for a number of months to reach your goal. The bill arrives, and you have money sitting there ready to pay for it.
Yes, it’s utter bliss; a low effort, high impact financial safety net. Already have a sinking fund? Well, consider it a badge earned on your sash of personal finance accomplishments. Want one? Keep reading, we’ll tell you how to set one up.
How Do I Create a Sinking Fund?
How do you start establishing a sinking fund? Some non-YNABers advocate setting up a separate savings account or checking account and then keeping a lot of separate “accounts” within that bank account for all of your sinking funds. And if it’s a large amount of money for a big purchase (say, for a new car or a down payment on a house), it can be beneficial to save money in a high yield savings account or money market account to take advantage of higher interest rates.
This can be a great setup, but depending on your bank, it may be a little complicated to get just right. Instead of having 24 different sinking fund accounts for all your savings goals and financial goals, we set up ours in a YNAB budget (see an example here), which gives an all-in-one view that feels a whole lot simpler to manage.
The beauty of the YNAB system is that all of these accounts can be easily managed right in your budget. When you’re setting up a sinking fund, you just create a Car Repairs category in YNAB, and then you just “sink” or set aside money into it every month and watch the balance rise. Then those new tires you’ll need become a planned expense versus a budget-busting surprise.
In order to keep the number of physical accounts down at our household, I only use a separate account for our New Car Fund (I wish). All of the other accounts are small enough that I don’t bother earning any interest. It’s your personal call though.
At the end of the day, implementation details aren’t the important part. What’s important is that you’re looking ahead and actively planning what your money is going to do and when.
You’ll then find that all of those “emergencies” that used to knock you off your financial feet are now not a problem at all. Expect your “unexpected” expenses by setting up a sinking fund to pay for them when they pop up.
Want to start getting ahead of your bills instead of constantly playing catchup? Start your YNAB budget to streamline your sinking funds and simplify your financial life. Try it free for 34 days!