Lifestyle · Personal

A Beginners Guide: Why You Need Sinking Funds

**I am not a professional and information provided in this post is not intended to be financial advice. I’m merely sharing my experience in the hope they can help others**
*This post contains affiliate links

I’m sure you’ve heard about sinking funds, but do you know what they are or how they can help you stay on track with your finances? Well I was in exactly the same position a few years ago and since starting to use them regularly my finances are much more streamlined allowing me to have a better grasp on my income and expenditure. In this post I want to share what I have learnt, explaining exactly what a sinking fund is and how you too can use them to aid better financial planning.

What is a sinking fund?

Simply put a sinking fund is a ‘pot’ of money for a planned future expense. My favourite example is Christmas. As we know Christmas comes around each year on the exact same date, yet every year it kind of sneaks up on you and before you know it you only have one payday left to find the money to buy all the usual presents and food. However this worry and stress can be alleviated by creating a sinking fund which you pay into on a regular basis; weekly, monthly, 4-weekly whatever works best for your finances. By putting a small amount of money in a sinking fund across the year you can spread the whole cost or at very least ensure you have a lump sum to put towards this recurring large expenditure.

Sinking funds can be used for any purpose you can dream up. As I’ve already said they are ideal for those large recurring outgoings, however they are also perfect if you want to plan a treat or splurge for yourself or your family in the future. I’ve listed below some examples of what sinking fund categories, but remember everyone’s priorities are different so create something that works for your family:

  • Birthdays
  • School trips
  • Christmas
  • Car service & MOT
  • Hairdressers
  • Annual recurring bills i.e. car tax, water, council tax if you pay these yearly
  • Holidays
  • New designer handbag for Mum – she deserves it!

What are the benefits of sinking funds?

  • No large unexpected costs – By planning and saving money from your monthly budget you can avoid huge bills and expenditures when the time comes as you all ready have the funds set aside.
  • Easy to budget – We all plan for our regular monthly bills like utilities, rent & mortgage, but by including the larger one-off expenses in your budget it’ll not only give you greater peace of mind as you have money set aside but also help avoid the potential for getting into debt.
  • Better financial planning – By planning for these larger forthcoming payments and events on a monthly basis and spreading the cost it allows you to set a realistic budget that’s more consistent throughout the year. This means your cash flow will be more stable and you will be able to see exactly where your money goes each month.
  • Guilt free planning – You can create a sinking fund for any purpose you like and if you decide you want to buy something extravagant or plan a little trip away you can just go for it without feeling guilty. You are saving towards a fun goal and it’s happening because you have decided to take control of your finances in order to make it happen.
  • Spreading the cost – The biggest benefit I think has to be the ability to spread the cost. Sinking funds are designed to be used for those outgoings we know are coming up, unlike emergency funds which are for those unfortunate unexpected incidents, often before using sinking funds those outgoings ended up having to be withdrawn from our emergency fund due to poor financial planning, but being able to spread the cost this now rarely happens.

How to create a sinking fund

Once you’ve identified the areas you’d like to create a sinking fund for you need to decide what your financial goal for each catagory will be. Secondly, work out how long you have until you need to use that money towards your bill or outgoing and divide the total cost by the number of weeks/months you have until you’d like to achieve your desired goal.

For Example You’d like to save £520 towards Christmas and you have a whole year : £520 ÷52 weeks = £10 weekly

These figures can then be added to your monthly regular outgoings, however be sure not to overstretch yourself and make your budget become unachievable as this defeats the object of relieving some of the financial strain with sinking funds. I personally use a regular notebook to create a monthly financial tracker to keep myself on track which is especially useful when using sinking funds as you can see where your money is going and how close you are to your target at a glance.

Where do I keep my sinking funds?

Many people who use sinking funds also use a cash envelope style system in order to segregate their money to ensure it is used for the purpose intended and not absorbed into their bank account. This is a great way to organise your sinking fund categories especially if you already use a cash only budgeting system for your day-to-day spending, however the downside is potentially having a large amount of cash in your house. If you are a visual person having a cash system may also keep you motivated as you seeing your funds grow towards your target is fantastic!

An alternative way of storing your sinking fund money is in your bank. Obviously it is advisable to keep this separate from you everyday spending and monthly bill money to avoid it being spent so ideally you’d open an additional savings account. This however also has it’s draw backs as you may have numerous sinking funds on the go and with all the money going into one place making it can be difficult to keep track of how much you have saved for each goal.  I have however recently discovered Monzo* who allow customers to create individually named pots within their online app to save for different goals. You can personalise your ‘pots’ with your goal total and even a picture to show what you are saving for and the app is formatted perfectly to allow you to see an overview of all of your sinking funds and what you are saving for.Of course having your money in the bank could potentially be problematic too when you need instant access to cash to pay for something (i.e. hairdressers, window cleaner) and you don’t have it on hand or if somewhere doesn’t accept card payments, a more common occurrence post-Covid.

*The Monzo card has personally revolutionised the way I manage my sinking funds as I previously used a cash envelope system for everything, however I now do a mixture of both and it works really well. This isn’t a sponsored post just my personal experience; if you’d like to try Monzo for yourself you can sign up using the link above and you will receive a £5 bonus when you activate and use your card for the first time. Please note I will also receive a bonus if you sign up via my affiliate link.

Cash or bank, the way you keep and organise your sinking funds will ultimately be a personal choice and you will need to find what works best for you and your family. Both have their benefits and drawbacks so a little bit of trial and error is always a great way to figure out the perfect way to manage your own sinking funds.

Good luck with setting up your own sinking funds and be sure to let me know what your goals are going to be in the comments below.

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