Sinking Funds vs. Savings

When you’re working on getting your financial life in order, creating a sinking fund is a great strategy to use for planned, upcoming expenses. Instead of figuring out how to cover a large bill in your budget when it arrives, a sinking fund splits up the expense ahead of time to help you prepare little by little.

Find out how a sinking fund works, when to use one (or more), and how this strategy can fit into your overall savings plan. 

What is a sinking fund?

A sinking fund is a dedicated savings target that helps you financially prepare for an upcoming expense, such as a vacation or holiday spending. Instead of having just one general savings goal, you instead include specific line items in your budget dedicated to individual goals. 

This helps you level up your finances by preparing for future expenses well in advance of actually needing them. Sinking funds may also help you avoid going into debt because you’ll have the cash ready for one-time expenses instead of relying on credit cards or buy-now-pay-later financing.

To figure out your sinking fund goal, you need to know the amount of money you need and your timeline for saving. Let’s say it’s the beginning of January and you want to save up $2,000 for holiday spending by the end of November in the same year. That gives you 11 months to save up. Divide the amount you want to save by the number of months left in order to find out how much to put away in your sinking fund each month. In this case, the calculation looks like this:

2,000 / 11 = $181.80

You need to set aside just over $180 for 11 months in order to reach your $2,000 savings goal. Consider creating multiple sinking funds to save for multiple events and expenses in your life, both short term and long term. 

What should you have sinking funds for?

A common financial mistake is not saving up for one-time expenses you know about. Instead of figuring out how to pay for it when the time comes, you’ll be prepared with a well-stocked sinking fund.

Common examples of sinking funds include:

• Holiday spending
• Birthday gifts and parties
• Vacations
• Weddings
• Kids’ activities (like camps, sports, and after-school programs)
• Home repairs and maintenance
• Car maintenance
• Health insurance deductible 
• Annual bills like insurance premiums, taxes, or vehicle registration
• Clothing
• Back-to-school expenses

To create your own list of sinking funds, Think about your entire year ahead and map out events, celebrations, and seasonal needs. Even if you don’t know exactly how much you’ll need and when, saving a portion of an expense can relieve a lot of stress when you need the money.

How to set up your sinking funds

Once you identify your sinking fund goals and calculate how much to save each month, decide where you’re going to keep the funds. An easily accessible account like a high yield savings account or money market account are smart options because you’ll earn interest as your balance grows. A CD could be a good choice if you don’t need to access your sinking funds until a certain date. You get a guaranteed savings rate, but just remember that you could incur penalties for early withdrawals.

When researching your account options, think about how you want to track your goals. Keeping each sinking fund in a separate account helps you immediately visualize your progress every time you log in. Some financial institutions even let you name your accounts so you can immediately see how much you have saved in “holiday spending” or “wedding guest fund.” Alternatively, you can also keep all of your sinking fund savings in one account, then manually track how much you apply to each separate goal (such as in an app or a spreadsheet).

After opening your account, automate savings transfers so you stay on top of your goals. If you really want to fill those sinking funds fast, boost your savings by tackling a no-spend challenge.

Pros and cons of using sinking funds

There are several benefits that come with creating sinking funds, but also some potential drawbacks to consider. 

Sinking funds vs. emergency fund vs. savings 

A sinking fund can be part of a broader savings strategy to create a solid financial safety net. 

Why you need different types of savings 

Different types of savings strategies help address the different needs you may have come up in life. An emergency fund, for instance, should pay for a sudden expense you didn’t plan for; even better, it could cover a few months’ of expenses in case you lose your job. 

Sinking funds give your money specific jobs so that you don’t blow your budget every time an annual bill or expensive season in life appears (like the holidays or back-to-school shopping). A traditional savings account can either be used to store all of those sinking funds in one place, or hold extra cash that comes your way until you’re ready with a plan. 

The bottom line

A sinking fund can be a huge confidence booster when you know a large expense is on the horizon. Instead of stressing over how to cover a major bill when it arrives, chip away at it little by little with a sinking fund. More planning leads to less worry and less debt; plus, using sinking funds helps build financial muscles to manage your money throughout every stage of life.  

Prosper does not provide tax, financial or legal advice and this post is not intended to be tax, financial or legal advice. We recommend that you consult with your financial or tax advisor if you have any questions.