You may have heard of a retirement fund or an emergency fund. But have you heard of a sinking fund? This is a sum of money that you set aside every month that is separate from your savings account or emergency fund.
Your sinking fund can be used to pay for home repairs, buy plane tickets, or cover a trip to the emergency room. The point of this fund is to avoid touching your emergency fund unnecessarily. Moreover, you give yourself more negotiating power when it is time to purchase. Some businesses also use the term sinking funds for planned expenses.
Essentially, creating a sinking fund adds an extra layer to your financial safety net. It can keep you on budget, out of debt, and on track towards reaching your financial goals.
Types of sinking funds
Experts suggest keeping sinking funds fairly liquid, such as a high-interest rate money market account. The type of account you choose largely depends on your purpose the fund.
For example, if you have a long-term goal for it, it makes sense to put it into an account that is not as easily accessible but has a higher yield. The stock market is not a good option for your sinking fund though. It is better to put the money in a savings account with a higher interest rate.
You can also choose to have separate savings accounts for different sinking funds. Money for car repairs can go in an accessible account since this bill can happen anytime. Meanwhile, if the sinking fund is for a downpayment for your first home, it does not have to as liquid since it will take time before you have to use the money.
How is a sinking fund different from savings?
A savings account is generally used to build wealth. The goal is to get your money working for you. This is not cash that you want to spend. On the other hand, a sinking fund is money that you put together for planned expenses. You save this money with the intention of spending it. A sinking fund is not likely to increase your overall net worth but it allows you to pay for things that you want or need. It is a good idea to create one to stay out of debt.