You know that sinking feeling you get in your gut when an unexpected or forgotten bill shows up in your mailbox?

The almost immediate sense of dread that leads to overwhelming stress as you try to figure out how you’re going to pay it?

If you want to never feel that again, sinking funds are your answer.

What Is a Sinking Fund?

Sinking funds may sound complicated, but they’re really just money set aside for infrequent, unpredictable, or even forgotten expenses.

Use sinking funds for things like car repairs or Christmas gifts that you know are inevitable and you need to save for, but that always seem to catch you off guard.

Sinking funds let you save up money over time so that you won’t be surprised by these expenses.

Unlike an emergency fund, which is intended to cover unexpected expenses, sinking funds are for your sometimes forgotten true expenses.

What is the Purpose of a Sinking Fund?

Setting up sinking funds is one of the best ways you can prevent getting knocked off course as you follow your path to financial freedom.

By planning for these expenses in advance, you make sure you’re able to handle them in stride without breaking your budget.

And, by spreading the savings out over time, you make it a painless process that you’ll barely even notice.

Let’s pretend you’ve just laid back on the sofa after your family’s Thanksgiving feast when out of nowhere your mom asks for Christmas lists from everybody.

Your initial reaction may be thinking about your list, but quickly your thoughts shift to the fact that you need to buy gifts for everyone else and you’ve completely forgotten.

Great.

Now you have 3 or 4 weeks to find the perfect gift and not only do you not have any ideas, but you also don’t have any money.

What do you do?

Well, if you’re like most of us, you put it on a credit card and hope for the best come the new year.

Now picture how it would feel if you had been setting aside $25-50 a month all year long.

You may still feel the stress of having to find the perfect gift, but you’ve got a nice little sinking fund that you can use to cover your expenses.

No more starting a new year with the stress of overspending in the last one.

How Do Sinking Funds Work?

In practice, sinking funds are no different than any other savings account or budget category.

If you’ve been giving every dollar a job with a zero-based budget, adding in sinking funds is really just creating new jobs.

If you prefer to work with cash envelopes, you can just create some new envelopes for each sinking fund.

For example, say your car is becoming a little less reliable as the years go on so you think a sinking fund for car repairs is probably a good idea.

First, think of a goal amount you want to save.

This can be either a total amount (like $1000 in case your brakes go bad) or a monthly amount (like $50 every month). Your choice will probably depend on how old your car is and how willing you are to repair it.

But keep in mind you can always use any repair funds to go towards buying a new car when the time comes.

Once you’ve set your goal, start putting aside money each month to hit it.

When the inevitable repair bill comes due, you deduct it from your sinking fund and smile, knowing you didn’t have to play whack-a-mole with your other budget categories trying to find the cash to cover it.

What's the Difference Between a Sinking Fund and a Savings Account?

A savings account is the place where you store your money. A sinking fund is the purpose you’ve given that money.

Traditionally, savings accounts are big pools of money we try not to spend. We sock money away without much thought about what it’s meant to do.

Setting up sinking funds is a way to give that cash pool a purpose.

In practice, you can either set up multiple savings accounts for each sinking fund, or you can use a single savings account for all of them.

Either way, you’ll want to make sure the sinking funds are well defined in your budget.

What's the Difference Between Sinking Funds and Emergency Funds?

Emergency funds are savings meant to cover unknown expenses you couldn’t have predicted - like a tornado ripping through the desert and destroying your fence.

Sinking funds are savings for a predefined and specific purpose.

Sinking funds may or may not have a defined date attached (like Christmas vs car repairs), but they are linked to a specific goal.

How Do I Create a Sinking Fund?

Convinced that sinking funds are an awesome way to protect your financial progress and ready to start making your own?

Awesome!

The first step to creating sinking funds is to brainstorm your true expenses.

What large, irregular expenses can you envision coming up in the next year?

List out as many as you can think of. Then order them by priority.

Sample Sinking Fund Categories

Some common examples of sinking fund categories are:

• Christmas

• Birthdays

• Medical expenses

• Car repairs

• Insurance premiums

• Prescription medications

• Home repairs

• Vet bills

• Travel & vacations

• Summer camps

• Back-to-school clothes

• Seasonal activities

Once you’ve decided on some sinking fund categories, you’ll need to decide how much you can reasonably contribute to them.

Determining which funds get how much money will depend on your priorities and your current financial picture.

Look at expenses that may be coming up sooner and consider funding them first.

For example, Christmas may be fast approaching and take top priority. Or your 10-year-old car's transmission may be starting to slip, moving the car repair fund to the top of your list.

Put more money toward the sinking funds you expect to need in the near future while dialing back some other sinking funds.

How Many Sinking Funds Should I Create?

Your sinking funds are simply named spending goals, so the amount you choose to create depends on how granular you want your budget to be.

The best place to start is by thinking back to the “oh crap” moments you got hit with last year.

What bills came that stressed you out?

You might also want to look through your credit card and bank statements for any annual or irregular expenses you’ve forgotten about.

This is a good time to review these recurring expenses and determine if they still line up with your priorities. If so, set up a sinking fund to start saving for them.

You can create as many sinking funds as you can think of, but when it comes to funding them, make sure you're doing so according to your priorities.

How Much Money Should I Put Into a Sinking Fund?

How much you choose to put into your sinking funds will depend on the purpose of the sinking fund.

You may have time-sensitive spending goals for some (like Christmas) and planned indefinite contributions to others (like housing repairs).

For targeted sinking funds, you’ll need a rough idea of how much the expense will be.

The easiest way to determine that is to look back and see what you spent in that category over the last year.

This may be easier said than done if you haven't been tracking your spending, but you can get a rough idea by looking through your old credit card and bank statements.

If you've been using some sort of software like YNAB to track your spending, you can use reports to find this info pretty quickly.

Once you have an idea of how much you want to save, determine how long you have to save it. Then divide by the months left to see how much you should be saving each month.

For example, if you spent $600 for Christmas last year and you've got 6 months left before you need to start buying this year, set a goal to save $100 a month.

Where Should I Save My Sinking Funds?

If you're using a budget to track your money instead of looking at your bank balance to determine your spending, it really doesn't matter where you actually keep the money.

That said, there are a couple of reasons you may not want to keep your sinking funds mixed into your regular checking account.

First, if you have any tendency to overspend, keeping that savings in a separate account or even at a separate bank will make sure it’s out of sight and out of mind.

Second, while you may not have much money in your sinking funds to start, eventually, the amount will grow, and you'll want to earn as much interest as possible on it.

Since sinking funds are considered short-term savings, it’s not a good idea to invest that money in the market. But you can put it into a high-interest savings account to earn some interest while it’s waiting to be used.

What's the Best Way to Track Sinking Funds?

There are a couple of different ways to keep track of your sinking funds. Which you choose will depend on how you prefer to handle your money in general.

I like to set up different categories in my budget while leaving the actual cash to accumulate in a single, high-yield savings account. It’s just simpler for me.

Lots of people prefer to keep their sinking funds separated into different savings accounts. Some banks let you create multiple accounts for free, while others mimic separate accounts with buckets or goals on their platforms.

Regardless of how many accounts you use, make sure you have easy access to withdraw or transfer that money when the time comes.

A Final Thought

Sinking funds are a great way to help you organize and prioritize your expenses.

But they’re also a good way to avoid dipping into your emergency fund for things you simply forgot about.

Setting up sinking funds will help you take control of your finances and avoid getting caught off guard by predictable expenses that can derail your progress.

Now go brainstorm and create some sinking funds today!