HomeBankingWhat Exactly Are Sinking Funds, and Why Are They So Important

What Exactly Are Sinking Funds, and Why Are They So Important

Many responsible adults understand the value of having a savings fund to rely on in times of emergencies or when a non-emergency need can no longer be postponed. Often, people rely on their emergency funds or separate savings accounts to finance these expenses.

However, there’s another savings strategy that just about anyone can use to purposefully set aside money for a future need: creating sinking funds.

What Are Sinking Funds?

A sinking fund is different from an emergency fund, though it can be considered a more specific type of savings. While emergency funds are set aside for unexpected and unforeseeable expenses, sinking funds are put together for a particular purpose. Examples of such purposes include financing a holiday, paying for educational expenses, or purchasing more coins for your Monero wallet.

While an emergency fund is designed to help you stay afloat during challenging periods and situations, a sinking fund can be used to help you acquire both your wants and needs.

Also, since a sinking fund is put together to attain a certain objective within a specific length of time, it’s easier to determine exactly what your goal amount should be.

By contrast, it’s much more difficult to pin down an exact amount for emergencies due to their hard-to-predict nature.

How Can You Set Up Your Sinking Fund?

To demonstrate how to set up a sinking fund, it’s important to be clear about three things first: how much you need to save, how much time you still have to come up with your target amount, and if the amount of money you’ll save during this time will fit right into your budget.

Say you want a new dishwasher that’s worth USD 600 and you want it in three months. In this scenario, you’ll need to save USD 200 per month until you’re ready to buy the unit you want.

If you can spare at least USD 200 from your regular budget each month, then you’re good to go. But if setting aside this amount will put you in the red, then you need to either adjust your timeline or choose a less expensive dishwasher model instead. Adjust either your goal amount or your timeline as needed until you can arrive at a monthly savings number that’s amenable to your budget and goals.

What Advantages Do Sinking Funds Offer?

Opting to use a sinking fund to finance your future expenses is a practical way of getting exactly what you want when you need it, all without compromising your liquidity or budget for your monthly expenses. In particular, using this savings strategy enables you to do the following:

  • Allocate your finances to just about any type of expense you want. Again, this kind of savings can be used not only for emergencies but also for needs and wants. As long as you plan for the said expense in advance and you’re consistent in following your savings plan, you’ll be fine. 
  • Save and plan for fun leisure activities without going beyond your means. This savings strategy empowers you to pursue experiences or purchases that may otherwise seem inaccessible to you, all without compromising your capability to fulfill your financial responsibilities.
  • Do not feel guilty about spending significant amounts of money on non-essentials. Financial experts warn against taking out loans for things that don’t have a return on investment. If you’re of the same mindset, then you might not feel too good about financing a carefree cruise using a loan. However, if you have a sinking fund just for this trip, then you can go on the cruise without second thoughts, worries, or regrets.
  • Prepare your household for inevitable expenses that might otherwise hurt your budget. Purchasing a new, top-of-the-line computer to replace your old one will hurt your budget if you’re not ready for it. But if you’ve already anticipated the inevitability of your computer eventually breaking down one day, then you can prepare for this expense without taking out a loan. Giving yourself a generous timeline will also make budgeting for such a huge expense much easier for both your present and future selves.

Of course, there are downsides to this savings strategy. If you’re saving for too many things all at once, then you’ll have to divide your sinking fund into smaller portions to ensure that every item is making a bit of progress toward its target amount.

This can take a lot of time and may not be sustainable in the long run, especially since you’ll need to wait a while to see the fruits of your hard work and self-discipline.

Fortunately, there’s also a way around this. You can organize your priorities for your sinking fund or highlight only a few items to fund at a time. Then, you can replace each item as you finish funding them.

If you have items and activities that you want to attain in a financially responsible manner and with minimal stress, how about starting a sinking fund as early as now?

Who knows, you might find this savings strategy a great fit for the lifestyle that you want to lead. And thanks to the many benefits it can provide you with, it may just become your new favorite financial practice, too!

Ajeet Sharma, the founder of Financegab and a well-known name in the field of financial blogging. Blogging since 2017, he has the expertise and excellent knowledge about personal finance. Financegab is all about personal finance which aims to create awareness among people about personal finance and help them to make smart, well-informed financial decisions.


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