In last week’s post on How to Budget for Unexpected Expenses, I described sinking funds as “one of the best budgeting hacks ever,” which means it’s time for me to tell you how they work.
Essentially, a sinking fund allows you to sink money into a specific budgeting category so it’ll be there when you need it. A lot of people automatically create sinking funds for big-ticket expenses like holidays, weddings and down payments. We don’t always set up sinking funds for expenses like car repairs, new laptops, or holiday gifts.
When you figure out that the holidays come every year (whether you like it or not) and you might as well start saving for them in January… well, that’s a budgeting gamechanger.
There are a couple of different ways to set up your sinking fund. If your bank lets you create multiple checking or savings accounts, it’s relatively easy to set up individual accounts labelled “holidays” or “car repairs” and transfer a little cash into those accounts every month. (Bonus points if you make those transfers automatic.)
Budgeting apps also let you set up sinking funds and savings goals—YNAB, for example, is designed to practically force you into creating sinking funds for everything from birthday gifts to tech upgrades, not to mention your annual YNAB subscription fee.
If you track your sinking funds through a budgeting app instead of moving money into a unique bank account, remember to use the app as a guide to how much you can spend each month, not the amount of money in your checking and savings accounts. After all, you’ve already told the app that a portion of your money is set aside for the smartphone you’re going to have to buy next year.
When you set up your sinking funds, you can make them goal-based or monthly-dollar-amount-based. In other words, you can tell yourself “I need to set aside $1,500 for a new laptop” and stop putting money in the fund once you reach your goal, or you can tell yourself “I want to save $30 each month for future tech upgrades” and then… well, you’ll just have to keep saving $30 every month forever, because there will always be new tech upgrades.
But that’s the point of sinking funds. There will always be new tech, there will always be holiday gifts, there will always be car repairs and friends’ weddings and annual fees. In some cases, these expenses are rare but predictable; in other cases, they are unpredictable but easily anticipated.
So start sinking some cash away in anticipation.