A sinking fund is a strategy for helping you set aside money for specific, large expenses. It helps soften the hardship of a large expense in the future. Simply put, a sinking fund is a fancy way of saving for something today that you anticipate having to spend significant money on tomorrow.
When would a sinking fund be of use to you?
Let’s say you purchase a fifteen-year-old home. The home inspection reveals the boiler is the original one installed in the home when it was built. Boilers, similar to cars, perform better and longer if you maintain them properly. Experts generally agree well-maintained boilers could last up to 20 years. So, going into the sale, you understand you’re going to have to invest in a new boiler sometime in the near future.
The issue for some people will arise when a high ticket item sneaks up on them. If your furnace is working, it’s sometimes out of sight, out of mind. Then, one day it stops working and you have to shell out $15,000 to $20,000 for a new one. The sinking fund is a tool to help you start saving now so you don’t get a nasty surprise with this type of expense. You can put a couple hundred dollars aside every month over a five- or ten-year period. That way you’re in great shape to pay for this expense when you finally need it.
The alternative is to rely on debt and having to borrow money. Using your credit card for this type of expense is not a good idea. Right now, interest rates are on the rise. So unless you can pay the credit card bill when it comes due, a sinking fund is a better way. Plus, being bogged down with credit card debt is never a place you want to be. That’s why the sinking fund is a good tool for people who aren’t independently wealthy and aren’t able to take this type of money out of their savings or brokerage account.
Sinking Fund vs. Savings Account vs. Emergency Fund
The sinking fund is a proactive and intentional approach to pay for high-ticket items. Usually, you earmark the account for a specific purpose. If you wish to save for this boiler replacement, a vacation or a new car, the sinking fund has one purpose. If you are disciplined, your sinking fund could be your savings account.
An emergency fund is money you save for the unknown. A fully-funded emergency account will have 3 to 6 months of money saved for any emergency to cover expenses. When your boiler breaks down, that could be an unknown. But for most household expenses of this magnitude, you can estimate how much you will need. An emergency fund should only be accessed for an unanticipated expense.
Benefits of this type of savings
Everyone can benefit from having a targeted savings account. You can:
- Reduce stress. Save for something you know you will need but not sure when. Open that account and assign the potential expense. Then stop worrying about that expense that may happen in the future.
- Avoid guilt about spending money. Create a sinking fund for that large project you want to do, like a new kitchen or addition. By deciding up front what you want to save for and how much, you can then spend the money you put aside without feeling guilty.
- Eliminate surprises. We all like surprises, but not when it comes to a large expense. Having a sinking fund ensures you have the money to cover the cost when it happens.
- Stay organized. If you are disciplined and can put money away regularly, you probably won’t need a sinking fund. But for those who are not, having money put into an account (automatically if possible) for a specific purpose will help you achieve your financial goals.
- Save for that dream purchase. Keep in mind that you can use a sinking fund for other large purchases, such as a vacation home, a new boat or something you’ve dreamed about for a long time.
Reach out to an expert if you want to learn more about how sinking funds can work for you and your personal financial situation.