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Quick Bites
- A sinking fund is similar to an emergency or rainy day savings account, except that it’s meant for planned expenses or goals.
- Automating contributions into an online savings account could help you gain interest on your growing balance.
- Like all financial strategies, a sinking fund has pros and cons, including that you might not like the idea of opening and maintaining yet another bank account.
There’s a big-ticket item you’d like to save for, such as a down payment on a house, vehicle or vacation. Where do you save your money?
A savings account might seem like the obvious answer—but there is a special type of savings account that consumers use for this purpose. It's known as a sinking fund, and it helps you save for a major expense while keeping that money separate from other bank accounts.
Read on to discover how a sinking fund works, how to set one up and more.
Inside this article
What is a sinking fund?
A sinking fund is simply another way to save toward a particular goal. You put (or sink) money into the account. How much you save depends on your goal and time frame.
For example, if you want to use a sinking fund to save for a vacation that costs $3,600, you might set aside $300 a month for 12 months to reach your goal. If that is unrealistic for your budget, put away $200 per month for 18 months to achieve your savings goal.
What Is the Envelope Challenge, and Should You Try It?
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This savings challenge isn’t right for everyone, but it could help you sock away thousands of dollars in just a few months, particularly if you take on the 100 or 200 envelope challenge.
Find out moreHow does a sinking fund work?
Consumers typically open a separate account for their sinking fund and deposit money directly to that account. Separate accounts keep your finances organized and help you know when you’ve reached your goal. (With that said, some financial institutions may offer product features like savings “buckets” within the same account, meaning you don’t necessarily need to open another.)
As for where to sock away your sinking fund, Virginia-based financial coach Seth Connell recommends a high-yield online savings account, in part for the higher interest rate but also because it puts a barrier between you and your money. If your online bank or credit union has limited ATM access, you may need to request a transfer out, which could take a business day, sometimes longer. This is a great hedge against impulse buys.
As mentioned, online savings accounts tend to have higher interest rates than traditional bank accounts, so you’ll earn more interest income (particularly in a rising-rate environment). Here are the best online banks, according to Sound Dollar’s research:
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Pros and cons of sinking funds
Sinking funds are beneficial for several reasons. However, there are some drawbacks to consider.
If you're not a naturally organized person, for example, it might seem too complicated to maintain different accounts. You might not be psyched about tracking deposits to different banks, remembering multiple passwords and handling various tax forms for earned interest.
Pros
- Plan and pay for major expenses on time
- Automating contributions to a sinking fund can help you save consistently
- Paying out of pocket for a planned expense may help you save money by avoiding interest charges associated with financing
Cons
- Maintaining multiple separate accounts requires more organization on your part
Sinking funds vs emergency funds: What’s the difference?
Sinking funds and emergency funds are two types of savings accounts, but they have more differences than commonalities, as this chart explains:
| Sinking fund | Emergency fund | |
|---|---|---|
| Account type | Savings | Savings |
| Timeframe | Known (say, 12 months) | Unknown (you never know when you might need your rainy day savings) |
| Purpose | To save money for a specific, known expense or goal | To save money for an unspecified, perhaps emergency expense |
| Financial goal | Dictated by the specific purpose | Generally, financial experts recommend socking away three to six months of living expenses |
No matter the fund type—sinking or emergency or something else—make sure the contributions are affordable. Creating and sticking to a budget can help. Your contributions would simply be one of many line items on the budget.