What is a Sinking Fund and Why do You Need One

When it comes to budgeting, using a sinking fund is a great way to plan and save for future expenses. If you are wondering what on earth a sinking fund is, how they work and how to save into one, then keep reading to find out more.

What is a sinking fund and how does it work?

A sinking fund is a financial tool that many people use to save for future expenditures.

It is used with the goal of saving money over time to save towards a specific purchase or a specific cost, like the expense of Christmas or home renovations.

You would save towards a particular sinking fund every payday to help spread out the cost of the upcoming expense.

How do I use a sinking fund?

There are plenty of ways to create sinking funds, including using cash envelopes or using different bank accounts or banking pots.

The first step is to list out what you want different sinking funds for.

You can use sinking funds for all sorts of things, like:

  • Christmas
  • Birthdays
  • Holidays
  • Attending weddings
  • Car repairs
  • Car insurance
  • Car tax
  • Home repairs
  • Home updates

And many more.

Once you have your list of sinking funds you will need to decide how much money each sinking fund would need.

You will then divide the sinking fund amount needed by the number of paydays you have until the money is needed.

For example, if Christmas costs you £1,000 every year, and you are paid weekly, divide £1,000 by 52 to get £19.23. You would then save £19.23 every week (every pay period) into your Christmas sinking fund.

Benefits of using sinking funds

Starting a sinking fund is a great way to accumulate money for upcoming expenses.

The idea behind them is that the money is only used towards that specific expense, so when you look at your sinking fund balance you know how much you have saved towards Christmas, a future holiday, etc.

Having them in place means that you are budgeting ahead for your spending, which means you should have the money available when the expense arises.

This can help you not get into debt or prevent you from getting further into debt.

It also gives you peace of mind knowing that annual expenses are paid for, and you could even save money. For example, if you can afford to pay your car insurance in advance you will pay less than if you paid in monthly instalments.

What kind of sinking funds should you have?

Sinking funds are personal to you, but here are three categories of sinking funds that we would recommend that you look at having:

Long-term purchases

These would be purchases that you can’t save for in a month or two, and might typically be things like a house deposit, home renovations, a new car, a wedding etc.

Regular annual expenses

These are the expenses that happen every year that you tend to know about in advance. This includes things like Christmas, car-related costs, birthdays etc.

Miscellaneous expenses

These are optional but could include expenses like a new haircut, buying new clothing including school uniforms etc

Sinking funds: conclusion

Sinking funds are a well-known method for saving money that has many benefits.

This strategy aims to divide your money into different pots, or funds, to be used at different times.

You can use this technique in your personal finances by saving money every time you receive income.

By doing this, you can save up for large purchases while still having enough saved for emergencies that may crop up.

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