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In a given year, you likely have expenses that you know are coming — holiday gifts, the family vacation you take every summer, home improvement costs or membership renewals. But just because these costs are predictable doesn’t mean your budget is always prepared.
If you're pulling from your emergency fund or using a credit card to cover costs like these, you might consider using “sinking funds.”
A sinking fund is a savings account dedicated to a specific expense. It is built up over time with regular deposits. These funds often have a deadline, but not always.
To help your money grow while you save, it's best to keep sinking funds in a high-yield savings account. You'll also be less tempted to dip into these savings if they are harder to access.
» NEXT: Use our savings goal calculator to find out how much to sink each month.
How do sinking funds compare with other savings accounts?
A sinking fund is different from an emergency fund or a traditional savings account in a few ways.
An “emergency fund is for true emergencies, and then your sinking fund is for a dedicated, expected planned purchase in the future that we know is coming,” says Kumiko Love, an accredited financial counselor and creator of The Budget Mom, a website with resources to help people create and stick to a budget.
Because they have different purposes, separating sinking and emergency funds is a smart move.
Keeping sinking funds separate from your emergency fund “ensures you don’t accidentally use those funds for the wrong purpose and helps you stay consistent in your budget,” says Mary Kamelle, marketing manager at the nonprofit credit counseling agency American Consumer Credit Counseling (ACCC).
Sinking funds also differ from traditional savings accounts because each one has a clear purpose and deadline. This makes it easier to track your progress on several goals at once. When you put all your savings into one big account, it's easier to lose track of what the money is actually for.
Nerdy Perspective
My husband and I opened a high-yield savings account with Ally years ago and still keep our joint savings there. One thing I love about Ally is the savings “buckets” feature — we’ve set up sinking funds for emergencies, home repairs, our child’s school tuition, vacations, car costs and holidays. It’s so nice to open the app and instantly see how much we’ve saved for each goal without doing any mental math.
Has seven sinking funds with Ally Bank
The strategy behind sinking funds
Most sinking funds have a target date, and with this deadline “comes a strategic way to plan responsibly for that purchase,” says Love, who has 13 sinking funds. For example, if your homeowners association fees are due in May each year, start planning ahead to have the money ready.
Let’s take the HOA example: If annual dues are $500 and you have six months to save, you need to put about $83 a month in your sinking fund. Break that down even further to roughly $42 every other week or $21 a week.
You can also use windfalls like tax refunds or bonuses to boost these accounts and reach your goals faster. Just keep in mind: Put money into sinking funds based on priority and necessity. Required expenses should come before wants.
If you have leftover money in a sinking fund, you have a few options:
- Leave the extra money there so you’re ahead of the game for next year.
- Move the extra money to another savings goal.
- Put the extra money in your emergency fund, if needed.
Can you have too many sinking funds?
Yes — if they start to feel hard to manage. The goal of sinking funds is to make saving easier, not more stressful. If you’re juggling too many buckets each paycheck, it can feel overwhelming.
To keep things simple, start with just your top priorities. Set up a few sinking funds for the expenses you know are coming up soon or matter most. You can always add more later if the system works well for you.
Automating your savings can also help. When money is moved automatically, you don’t have to think about how to split it each time you get paid. If your bank allows it, look for savings accounts that let you create and label multiple buckets in one place. That way, you can stay organized without opening lots of separate accounts.
Are sinking funds right for you?
This is a low-risk strategy to save for expenses you know are coming.
“I believe sinking funds can be for anybody no matter where they are with their finances,” Love says.
Managing sinking funds also “trains us to create healthy habits in our lives to prepare for the things that are putting us in debt,” Love says.
Stress less. Track more.
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This article was written by NerdWallet and was originally published by The Associated Press.
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