What is a Sinking Fund?

There are a few expenses that you can plan for using a sinking fund.

A classic example of the sinking fund is money for holiday gifts. Christmas comes at the same time every year, and if you know ahead of time that you want to spend, say, $600 on gifts, you can start saving for that well ahead of time. Save $50 every month for a year, and you'll have that $600 ready when it's time to go Christmas shopping.

You can often save money on your premiums for homeowners insurance, auto insurance, and more if you can pay the full six-month or one-year premium cost upfront. This could be a 5% discount, which is worth pursuing. Just like saving for holiday gifts, if you save your monthly cost over the course of a year, you can make a one-time payment and not have to worry about paying those insurance bills for the rest of the year as long as you're saving up for the next annual expense.

If you own a home, you likely already know how expensive home repairs and maintenance can be. On average, you can expect to pay about 1% of your home's value in maintenance and repair costs every year. So if your home's value is $300,000, that might translate to $3,000 every year. Of course, this varies, and chances are, you will have a large expense every few years, rather than small ones on a more predictable schedule. For example, if your home needs a new roof, it might cost you $15,000. Thankfully, you shouldn't need a new roof every year, but if you make it a point to save up that 1% every year regardless, you'll end up with a stockpile of money you can tap when something goes wrong with your home.

Just like owning a home, owning a car also comes with some unavoidable bills and maintenance (and don't think your car's warranty will save you these costs). New tires are a good example. Chances are, you won't need new tires every year, but if you're putting money aside for them every month, it'll be ready for you when you need it. This is a good strategy for oil changes and other routine maintenance, too.

A lot more of us are working from home on our own computers these days, so that means we have to pay to replace or repair those computers over time. You might expect to get three to five years out of a computer, maybe longer with a desktop model (laptops wear out faster because of the battery). If you put aside, say, $100 per month for computer equipment, you'll have the money ready to replace your old machine when it dies.

If you own a house and a car, and intend to create sinking funds for those expenses as well as future holiday gift or computer purchases, it may start to get a little confusing to keep all those funds straight. Luckily, your savings account might have tools that can help. Some accounts offer "buckets" or similarly named ways to separate different pools of money within the account. These are accessible in your mobile banking app or on the bank's website. This makes it easy to manage more than one sinking fund. You could also keep track in a spreadsheet. Just remember to update your amounts every time you add more money. You might consider visiting your sinking funds and checking your progress when you sit down to review your budget.

Sinking funds are a great way to pay for big expenses or purchases you might not be able to manage from a regular paycheck. And it's a lovely feeling when you can pay for that new roof, new tires, or new computer without going into debt on the purchase.