What is a Sinking Fund? Definition, Types, and Examples

A sinking fund lets you set aside some money each month to prepare for a planned expense. You can use a sinking fund for a specific item or split it between different categories to be used at a later date.

Note that these funds are intentionally used for one-off or irregular expenses and not for routine monthly bills. In other words, sinking funds should be used for things like holiday gifts, travel, a new car, or an irregular bill such as an expensive vet visit or a broken washing machine.

You can even set a line item explicitly for your sinking fund in your monthly budget. This way,  you transfer a bit of money into that sinking account monthly, and you won’t be scrambling to find extra money for those bigger purchases when the time comes.

As an example, let’s say you’ve decided to save for these three things with a sinking fund: wedding, holiday gifts, and summer vacation.

For each expense, list how much it will cost and when you’ll need the money:

• Wedding: $15,000, saved in 15 months
• Holiday gifts: $750, saved in three months
• Summer vacation: $1,200, saved in 10 months

Next, break each expense into the monthly amount you need to save:

• Wedding: $1,000 per month
• Holiday gifts: $250 per month
• Summer vacation: $120 per month

Once you calculate that, include those expenses in your monthly budget and set up a monthly automatic transfer to your sinking fund.

Here are some of the advantages of starting a sinking fund and why you might want to move it to the top of your to-do list.

• Helps you avoid high-interest debt: Many loans come with high interest rates, which could end up costing you a significant amount of money over the life of the loan and leave you with little room to save. You can avoid high-interest debt if you have a sinking fund.
• Dodge impulse purchases: A sinking fund can also be useful in limiting those expensive impulse purchases that can take a long time to pay off. For example, if your washing machine breaks and you need a new one, you will be more likely to stick to the budget in your sinking fund rather than buy the most expensive one at the store because it looks fancy.
• Pay off debt faster: Having a sinking fund means you no longer have to dip into your savings or disrupt your monthly budget to cover certain expenses. This helps you stay consistent with paying off your debt.
• Spend your money guilt-free:  Since your sinking fund is already dedicated to specific expenses, you can spend that money guilt-free, knowing it’s been budgeted for.
• Build better financial habits: Regularly contributing to a sinking fund helps you develop a habit of saving for the future and being more mindful of your spending.

Some people may use the terms “sinking fund,” “emergency fund,” and “savings account” interchangeably, but they’re not the same. Here’s what you need to know about these sinking fund alternatives.

Sinking fund vs. emergency fund

Money in an emergency fund is to be used for emergencies only – like your car breaking down or losing your job. It’s a bad habit to withdraw money from your emergency fund for non-emergencies. When a real emergency strikes, you’ll be glad to have that cash available.

Money in a sinking fund is used for upcoming expenses you can plan ahead for, such as vacations, wedding expenses, concert tickets, or holiday gifts. You can spend that money without the headache because you’ve planned and saved for it.

Simply put, money in an emergency fund is for unexpected expenses, whereas money in a sinking fund is for predictable expenses.

Sinking fund vs. savings account

The main difference between a sinking fund and a savings account is that the former is a savings strategy, whereas the latter is a savings vehicle.

Let’s say you’re saving for next year’s vacation, your kid’s birthday gifts, and your honeymoon all at the same time. In this case, you might want to open multiple savings accounts to keep track of each goal. Each account would act as a separate sinking fund, helping you stay organized and focused on specific expenses. Just make sure the accounts you open don’t come with expensive monthly maintenance fees, as that could eat into your savings.

And while you can put your sinking fund in a traditional savings account, you won’t earn much interest from it, which means your purchasing power could be eroded away by inflation.¹ Instead, look into high-yield savings accounts that offer high APR.

Now that you know what a sinking fund is and how it can help your financial goals and well-being, it’s time to start your own. Here’s how to set up a sinking fund.

1. Determine what you’re saving up for: Make a list of everything you want and need to save for – for example, taxes, vacations, a new car, holiday spending – as well as how much they cost.
2. Find a place to park the cash: Open one or multiple savings accounts to park your sinking fund. You’ll want to keep this money separate from your other accounts so you know exactly how much you have available to spend.
3. Calculate how much to save each month: Next, figure out the date you’ll need the money so you can calculate how much you must put away each month to have the total saved by the deadline.
4. Set up monthly automatic transfers: The simplest way to stay consistent when it comes to contributing to your sinking funds is by setting up monthly automatic transfers from your checking account. This way, you won’t be tempted to use that money elsewhere. Doing so also makes it easier to track your progress in your budget as you go.

If you want to avoid the stress of last-minute expenses, going into debt, or dipping into your emergency savings for planned costs, then yes, a sinking fund is worth having.

Large expenses like honeymoons, home remodels, holiday shopping, and weddings can cause financial strain and derail your budget if you’re not prepared. Building a sinking fund ahead of time helps you spread the cost over time and make it more manageable. Plus, if you park your sinking fund in a high-yield savings account, you’ll earn competitive returns passively and have more money to allocate toward the event or item you’re saving for.

If you find yourself constantly unprepared and reaching for your credit card when irregular expenses arise, it’s time to start thinking about building a sinking fund. While you may have to put in work upfront to set up your transfers, it’s worth it in the long run.

To start your sinking fund, check out the Chime app, which makes managing your money much easier on mobile. You can also use the automatic savings feature to reach your sinking fund goals even faster.

That said, if you don’t yet have a budget, you may want to start there first. Check out our guide on how to create a budget that works for you.