If you have read anything about personal finance, chances are you have heard about sinking funds. They don’t sound particularly fun or snazzy, but I believe they are one of the most underrated tools in budgeting. Let’s dive right in.

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What is a sinking fund?

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A quick internet search will give you several definitions. For the purposes of this blog, sinking funds are dollars set aside for a specific future purpose. Ideally, these are areas in your budget that you regularly stow money away. Some people prefer to save monthly, others prefer to set aside money from each paycheck, and some can only afford to contribute sporadically. There is no wrong way to save, but sinking funds can give you guidance on where to park your extra dollars.

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Sinking fund vs. Emergency fund

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Does that sound familiar? Sinking funds are often confused with an emergency fund. Emergency funds are great to have, but can be nebulous. Some experts recommend saving 1-6 months of income, while others suggest saving 1-6 months of expenses. But how do you know what is considered an emergency? Unless you have clear rules for yourself, that large sum of money becomes tempting to spend. Trips, holidays, and unexpected expenses can quickly be labeled as “emergencies”. I have even coached clients who are tempted to drain their savings accounts to pay off high interest debt, which is still not an emergency. If you throw all of your savings into debt, what will you do if you have another emergency? You will simply accrue more debt, and usually in a rushed manner. If you have to quickly take on debt, you lose the opportunity to shop around and compare interest rates. 

Sinking funds have a specific purpose. I usually set up budget categories for things that will inevitably break or need maintenance. I prompt clients to come up with sinking funds based on past experiences. “When was the last time you were caught off guard and wished you had been more prepared?” This is a great question to ask as you decide which situations to save up for. 

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You can have a sinking fund for emergencies, but I would caution against such a broad term. By keeping a note in your budget category (MyBudgetCoach can do that!), you can set terms for what is considered an emergency. Your budget coach can help you come up with this so that you are not tempted to dip into it for other purposes. Is your car breaking down an emergency? Then you will need to plan for car maintenance, not just “emergency fund”. 

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How much do I save?

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So, when is it enough? There are many rules of thumb. For example, experts suggest setting aside 1% of a home’s value per year for routine maintenance and other needs. I would suggest pulling back even farther. Review the previous calendar year to see how much you spent on things like your home, pets, medical expenses, and other unexpected events. Then, take that number and divide it by twelve. This is a rough estimate of how much you should set aside each month. A budget coach can work with you to see if this is realistic, however any amount is better than nothing. You should be setting money aside for these goals without having to dip back into them each month. 

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A great example would be unexpected veterinary care. Fido needs routine checkups and vaccines, but what about larger expenses like dental bills or surgeries? If you didn’t have money set aside to cover this, you would be forced to take on more debt. 

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Deciding on a goal can be paralyzing. Just remember that any amount is better than nothing. If you are quoted $1,000 for car repairs and only have $700 saved up, it’s much easier to find $300 than the entire $1,000. 

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What about having too much money in a sinking fund? There is no such thing as having too much saved up. My clients know that the key to success is flexibility. They may see the household repair category rising but then experience a big hit on their auto maintenance. We discuss how much they can shift from one category to another. Sinking funds are meant to work with your life, not be so rigid that you feel restricted when situations arise. I have yet to see it happen (thank you, Murphy’s law), but if you happen to have “too much” set aside, you can work with a coach to determine if some of it can be spent on fun expenses as a reward or be diverted to paying down debt.

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Sinking Fund Categories to Consider in Your Budget

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What is the best way to organize sinking funds?

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The best way to organize your sinking funds is with a digital envelope system like MyBudgetCoach. Sign up for a free trial to check it out if you have not already. There is no need to have separate savings accounts, as this can make it unnecessarily complicated. MyBudgetCoach lets you have as many categories as you need while only requiring one bank account. 

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To take advantage of interest rates and to fight inflation, I suggest a high yield savings account. You will earn more interest than a traditional savings account without locking up your sinking funds in a CD. The whole point is to have a designated spot for your money that is easy to access when you need it. Generally high yield savings accounts are in online banks which can make some people nervous. Work with your budget coach to determine the best fit for your situation. 

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In a high yield savings account, you earn more interest than you would in a regular savings account. Let’s say you park this $10,000 in an account that earns 4% interest. The first month, you would earn about $33 in interest. If you don’t touch those funds, you get the perks of compounding interest. Your account is now $10,033 and the following month earns $33.44. Your account is now $10,066.44. You see where this is going! One of my clients likes to pull out the interest at the end of the year to celebrate not touching that money. She then uses that for a total guilt-free shopping spree. Keep in mind that interest rates fluctuate based on the federal rates, so you won’t always have the same rate. However these accounts are almost always better than average savings accounts for interest rates.

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I manage my personal finances and my clients’ with one savings account. With MyBudgetCoach, we do not care about the total amount in that account. You may be used to budgeting by checking your account balances, but we want to get away from that method. Here is an example of a savings account with a $10,000 balance.

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Auto Maintenance: $2,000

Home Maintenance: $2,500

Vacations: $2,500

Pet Expenses: $1,000

New Car: $2,000

Total: $10,000

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As you can see, there is only one account but five different goals for that money. Digital envelope budgeting apps make this simple. Had I just seen $10,000 sitting in an account, I may have been tempted to spend it on a big trip or use it to pay down debt. By labeling our dollars with a purpose, I think twice before spending. If you don’t have a plan for your money, it will seem like life “just happens” and you have no control. 

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Let’s look at those numbers again. Say you get an estimate and need $3,000 for roof repairs on your home. You only have $2,500. What do you do? When we organize our finances, we are faced with real choices and scarcity. You only have $10,000 set aside. You just took your cats into the vet and they are healthy, so you can pull $500 from that category. Or maybe you aren’t planning a vacation for several months. That is another category you can dip into. Spending the money we have saved can be nerve-wracking. At the end of the day, the point of saving money is to spend money, but with intention!

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Should you use sinking funds?

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To determine if you should use sinking funds, ask yourself the following questions:

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1. Do I have large items that will eventually break or need expensive maintenance?

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2. Am I prepared for an unexpected expense for my loved ones or pets?

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3. Do I have enough set aside for expenses without incurring debt (credit cards, personal loans, loans from family or friends, etc.)

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4. Do I like to have fun and plan for travel, holidays, and gifts?

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You can see what I’m getting at here. I believe everyone needs sinking funds! Did you notice the fourth item? These are not just for those dreaded mechanic visits. I want you to intentionally spend your money for fun as well. It is so satisfying to pay for a trip in full up front. Holidays do not have to mean debt in February. The possibilities are endless!

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Examples of sinking fund categories

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Earlier I mentioned asking yourself when you were caught off guard financially. It may have been a large Christmas gift, a flat tire, or your dog getting into the Halloween candy. Here are some other examples you may want to consider:

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1. Holidays and holiday meals
2. Birthdays and anniversaries
3. Pet expenses
4. Car maintenance (expected work, new tires, insurance deductible)
5. Home maintenance (water heater, air conditioning, appliances, insurance deductible)
6. Medical expenses (including dental)
7. Travel
8. Clothes and shoes
9. School supplies
10. Insurance deductibles (reading it a third time should signal this is important)
11. Guilt-free shopping

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This list isn’t exhaustive, but will give you a good idea of where to start. Remember, you don’t have to save for all of these at once. Start with two or three and get your bearings. If you list too many categories, you will find frustration and guilt if you cannot contribute to them. Start small and work with your budget coach to determine which categories take priority.

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If you choose three sinking funds to start, make sure one of them is for fun. This will keep you motivated to save when you have the reward of spending it at the right time. You can practice determining when it’s time to tap into those funds. It also prevents you from being nervous to lose that money. Remember: it is meant to be spent, but at the right time. If a situation arises where your sinking fund is needed, that should be a guilt-free transaction. These categories can, and will, be refilled again.

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How MyBudgetCoach Can Help

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Learning how to budget and save money is a skill. Why do it alone? MyBudgetCoach pairs you with a coach from day one. Each coach shares their unique personality and budgeting approach. If you choose to start with me, I begin by having you focus just on your checking account. Starting something new can be exciting but also overwhelming. You will feel tempted to start it all at once: budget, save money, and pay down debt. Rarely can someone work on all three at the same time without going crazy.

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Start by learning how to track your expenses first. Earlier I mentioned adding up the transactions from the previous year to determine how much to save. This only works if you track your spending! You can find this information on bank statements, but let’s streamline this process. You can link your bank accounts to MyBudgetCoach and it will simply pull in transactions as they happen. When you label transactions to a category, that starts the tracking process.

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Once you have an idea of the budget skills, we can start to interpret that information. You can meet with your coach to strategize your dollars. Should you be putting more towards debt? Do you have enough money set aside in a savings account? Are you stuck in the paycheck-to-paycheck cycle? A coach can help you answer these questions for your unique situation. 

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I have worked with clients who were too nervous to spend, and had huge savings accounts. Others can barely make it to the next paycheck, so saving seems like an impossible task. For these situations and everything in between, a coach is your ally.