If you’ve ever read my book or blog, you know I’m a huge proponent of keeping an emergency fund. Things go wrong and it’s critical to have the money on hand to deal with the unexpected. A close cousin to an emergency fund is the sinking fund, and that’s what I’m going to cover in this post.
What Is a Sinking Fund?
A sinking fund is a pot of money designed to pay for the things that you can reasonably anticipate needing. Things like cars, roofs, HVAC systems, etc.
It’s basically saving up for the things you know will need to be bought or replaced.
How to Use a Sinking Fund: Car Purchase
Here’s an example of how to use a sinking fund with a car purchase. Someone with a 10- year-old car that has 130,000 miles on it knows it’s not going to last forever. Rather than waiting until the car dies and hastily buying a new car on credit, they could start contributing to a sinking fund now and have enough to buy the car in cash when it’s time to get a new one.
Another option is to start contributing to a sinking fund right when you buy a car. That way you put yourself on a payment cycle to yourself rather than financing it. Using this strategy, the advantage is you can contribute less than if you wait until the car is only a couple years from needing replacement.
How to Use a General Sinking Fund
The first example was specific to a car. This example is more general, taking a look at multiple predictable costs. For this example, let’s use a dual-income family living in a three bedroom house and owning two cars.
This family has identified multiple predictable costs.
- 8-year old water heater: Replace in 4 years, $2,000/$42 per month
- 5-year old HVAC: Replace in 15 years, $10,000/$56 per month
- 10-year old roof: Replace in 12 years, $30,000/$208 per month
- 3-year old washing machine and dryer: Replace in 8 years, $1,500/$16 per month
- 5-year old car: Replace in 7 years, $25,000/$298 per month
- 2-year old car: Replace in 10 years, $30,000/$250 per month
The total amount per month that should be contributed to a sinking fund is $870.
Back of the Napkin Math
This is back of the napkin math. We’re just estimating costs and breaking it down to approximately how much we’ll need to cover the costs.
With that said, if you have $100,000 saved up in a sinking fund and have similar costs as the family above, you probably don’t need to contribute so much every month because you already have the cash.
It’s also hard to predict expenses 10 years out and longer, as living situations change. For example, you may not even own the house that needs a new roof in 15 years when the time comes to replace it.
Where Should You Prioritize a Sinking Fund?
For me, having a sinking fund is prioritized beneath an emergency fund and investing. I think it’s essential to carry an emergency fund and invest regularly but I don’t put a sinking fund in this same category.
It’s definitely really good to have but not as essential as an emergency fund or investing. A partial sinking fund is also better than nothing at all. For example, maybe you carry enough money to buy a new (or new “used” car) but not enough for two car purchases.
Things to Think About
If you’re looking at creating or adjusting a sinking fund, here are some things to consider.
Once you reach a certain amount of money in your sinking fund, you may choose to stop contributions until it needs to be re-funded. It would be a rare case for someone to need two cars, a new roof, and a washer/dryer in the same year.
Having no sinking fund is a risk because you don’t have the money for the big, anticipated things. Having too much of a sinking fund is also a risk because that money isn’t being invested. There’s an opportunity cost involved with this money.
There’s no way you can account for every single cost in life. A pool of money for the “stuff that comes up” is often more helpful than trying to itemize everything.
You know your personal finances and money patterns better than anyone. That will guide you to how much money you should have in your sinking fund.
Do you keep a sinking fund or do you have another strategy?
