Sinking Funds Explained

The term “sinking fund” is relatively recent in the world of Personal Finance. What is a sinking fund, and should we have one? Let’s find out!

Definition

In Personal Finance, a sinking fund is money set aside for specific goals/purposes, usually on a short-term basis, i.e. from 6 to 18 months.

Basically, it’s planned savings for planned spending.

We all have 1-time big expenses, or expenses that occur on a yearly basis. Expenses like insurance, property taxes, Christmas or our Summer vacation.

Because these expenses are not occurring every month, when the time comes to pay for them, we usually find ourselves struggling to find the extra funds in our monthly budget.

While it certainly would be easy to charge these expenses on a credit card, this pattern could lead to debt.

Hence the sinking fund account.

The amounts you save in your sinking funds can be small or large – it’s really up to you. Plan to spend $600 on Christmas gifts next year? Then you’ll add $50 per month to your sinking fund.

Sinking Fund vs. Emergency Fund

There is some confusion between the 2, but they’re not the same thing.

A sinking fund is for expected, planned expenses.

An emergency fund is for the unexpected/unplanned, like quitting a toxic employer.

Where to Keep Your Sinking Fund

Because of the short-term nature of a sinking fund, investing it isn’t a good idea, despite potential higher returns. If the market takes a downturn, you won’t have the money when you need it.

Use a savings account instead. Find a financial institutions that pays higher interests – won’t be the big 5 Canadian banks-. A TFSA is a good idea. You can have one account per sinking fund.

Your sinking fund needs to be separate from your checking account. You’ll spent it otherwise, guaranteed.

I personally have several sinking funds, in different savings accounts. I have one for my property taxes and home insurance, as well as one for vacation.

When it’s time to pay for these, I have the money set aside. It eliminates financial stress.

Final Word

Don’t let larger, predictable expenses sink you.

Instead of panicking, you can be prepared. Instead of going into debt, you can pay in full. Instead of playing catch-up, you can get ahead.

That’s the power of sinking funds…combined with a monthly budget.