In this post you will learn what a sinking fund is and how to utilize this savings strategy in your monthly budget to purchase large ticket items.
When my husband and I bought our house in 2020, it came with an air conditioning unit that was 30 years old. Although it cooled like a champ for a while, it started showing signs of failure. When it was serviced in 2022, it came as no surprise when we were told that the type of coolant it used was no longer manufactured and that we should consider a replacement. So, over the winter we got serious about saving for a new air conditioning system. We did some price checking and decided to save $6,000 to replace the air conditioning unit outside and the furnace system inside our house prior to the start of summer 2023. We were able to achieve this short-term savings goal by utilizing a sinking fund savings strategy.
What is a sinking fund?
A sinking fund is a savings strategy where you set aside funds for a specific purpose. You can use sinking funds to meet any savings goal. But typically, a sinking fund is tied to an asset that will need eventual repair or replacement. It is an account that you use to plan ahead and anticipate big-ticket purchases, like my air conditioner and furnace.
The nature of our automated and technology-driven world is that our gadgets will eventually fail or need repairs. When that day comes, it can really throw a wrench into our budgets if we are not prepared. Yes, we can’t foresee true emergencies that will require emergency fund savings (ask me about the lightning strike that resulted in total electrical replacement for $4,300😅). But we can anticipate and prepare for certain near-future needs. This is where the sinking fund comes in handy.
A sinking fund has a specific purpose.
A sinking fund is not just a normal savings account that you aimlessly deposit funds into each month for a rainy day. You want to have a very specific savings goal, paired with a very specific dollar contribution to that account to meet your goal by the time the asset needs repairing or replaced. You may even want to have a separate savings account or sub-account to keep these funds separate and reserved for their purpose. That way, when the washing machine stops spinning or when the old roof finally springs a leak, you can be prepared to write that check.
In our case, we were aware our air conditioner was failing and would likely need a replacement by the time that summer rolled around the following year. So, we set up a separate sub-account with our bank with a goal of $6,000. Then, each month we contributed funds to make that goal happen. We diverted our regular rainy-day savings contributions and pivoted our focus toward saving for the air conditioner. We saved for about eight months, contributing at least $750 per month into this fund. Our sinking fund on paper looked like this:
Goal: AC/Furnace Replacement
Amount: $6,000
Deadline: May 2023
Monthly Contribution: $750
Sinking fund examples
You can utilize sinking funds for anything; however, they are most commonly used to save up for an asset replacement or repair within six months to five years depending on the cost of the item. Here are a few scenarios where you might use a sinking fund:
- You know your roof is 15 years old. You start a sinking fund for a total roof replacement within two years.
- Your dishwasher has been repaired three times this year. You start a sinking fund to replace the dishwasher at the beginning of fall.
- Your car is from the ‘90s. It’s still going strong but you anticipate needing an upgrade to a more fuel-efficient commuter vehicle within the next five years or so. You start a sinking fund for a down payment on a car. Bonus: You can also utilize this fund to pay for any minor repairs between now and when you purchase in five years.
- You decide to replace your deck, but due to the design changes, you now have to replace your siding. You start a sinking fund to replace the siding at the same time as the deck.
Sinking fund categories
Take a look around at the big-ticket items in your house. What may need replacing soon? What is wearing out? What is something that is probably fine but you want to replace? (I’m looking at you, newest iPhone!) If it’s a big-ticket item or something you don’t want to pay for out of a single month’s budget, you can use a sinking fund.
- Automotive — Consider items like new tires, total car replacement, or a repair that isn’t urgent but necessary.
- Home — Consider items like major appliances, structural or outdoor features, and major appliances.
- Technology — Think about replacing your phone, laptop, or business equipment.
The possibilities are endless!
What makes a sinking fund different from saving for irregular expenses?
A sinking fund follows the same approach as saving for irregular expenses with a bit of a caveat. In each case, you take the cost of the expense and set aside funds for that expense each month. Where the difference lies is with the type of expense you are saving for and the life expectancy of the savings account.
Irregular expenses are items that come up in regular intervals but are not common enough to earn a place as a monthly budget item. Examples include car registrations, annual insurance premiums, etc. You may even utilize irregular expense savings to prepare for Christmas shopping or your annual vacation. These items are expected, ongoing, and regularly occurring.
Sinking funds are specifically targeted toward replacing an asset. Once you fulfill the sinking fund goal (like saving for the air-conditioning system) and meet that goal (replacing the air-conditioning system), you no longer have a need for that fund. These items are not regularly occurring but require planning ahead.
Irregular expense accounts, in theory, keep replenishing themselves month after month. A sinking fund is meant to be filled and emptied once you reach your goal.
How to create a sinking fund
- Identify future purchases that will need to be replaced or repaired. This can be anything from your washing machine to pricier items like a roof or car replacement.
- Research and decide how much you need to save. What is that big number you need to see in your account to feel prepared to tackle this repair or replacement?
- Determine your time horizon and monthly savings target. Will you need to cash in on this sinking fund in six months or three years? Take the total cost of the item and divide it by the months you have until your goal deadline.
- Store your savings. Ideally, you should keep your sinking funds separate from your regular savings. You can easily do this by opening multiple savings accounts or sub-accounts with your bank. If managing too many accounts isn’t really your style, consider a visual savings tracker to note how much of your savings are allocated toward the sinking fund.
Succeeding at sinking funds
I have some friends who are always working on replacing or repairing something in their home. They’ve replaced their siding, removed damaged carpet, and are now rebuilding their rotting deck. You know how they pull off these big house projects before they become financial emergencies? They utilize sinking funds (and a little elbow grease!).
Sinking funds are a fantastic way to prepare for inevitable expenses without the panic of something failing when you least expect it. By utilizing sinking funds, you stop that unexpectedness in its tracks! To master this method, keep these concepts in mind:
- Be specific. We LOVE specific savings goals around here, and the sinking fund helps keep those specifics in the forefront. Don’t just randomly put money toward that thing that is probably going to fail next year. Identify the cost, and make a plan.
- Keep sinking. Once you complete one goal, make sure you periodically look around to see any other expenses you can anticipate. When we replaced our air conditioner and furnace, we also replaced our very old water heater shortly after.
- Identify extra benefits. When it comes to sinking funds, you can cash the funds in at any point of your choosing. Maybe you don’t need to replace an item just because it is failing. Maybe you set a sinking fund to replace the item for another reason like energy efficiency. Going back to our water heater: it was old but working fine. The decision driver for that replacement was tied to increasing our energy efficiency, which has done wonders for our monthly utility bills!
Sinking funds are a great strategy to incorporate into your monthly budget. Anticipating expenses helps you stay on track financially and avoids utilizing your emergency funds or charging a credit card when something comes up. If you need a little help identifying ways to use sinking funds in your budget, check out our individualized financial counseling programs. Our financial counselor will work with you to identify your savings goals, make an action plan to achieve those goals, and cheer you on every step of the way.
Happy sinking (saving)!
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