I never actually heard of the term sinking fund before a few weeks ago. I just called them separate savings funds. Which is why I have 15 bank accounts --to separate my savings for different expenses.
What is a sinking fund?
A sinking fund is basically a savings account where you save up for things you will need to replace. A "fund" is money that is saved for a specific purpose. Traditionally for businesses, it was used to save up for when it was time to replace an expensive wasting asset (things that need to be replaced over time) such as a car or machinery. It was also used to pay off a long term debt. The term “sinking” likely refers to the decreasing level of debt remaining as it gets paid off.
How I use sinking funds
For personal finances, sinking funds are used by saving for that new car (since cars don't last forever), house maintenance (which can include appliance replacement/repairs or a new roof), or replacing you i-phone 10 with the i-phone 11 every, single, year. I use this strategy of putting a little away each month for things I get a discount to pay off yearly, such as my yearly auto insurance or daycare/preschool which is often 10% off when you pay yearly. That's a waaay better return yearly return than any stock can give you!
How to use a sinking fund
People also use sinking funds to cover for non-monthly expenses like Christmas, Birthdays, Back to School Shopping, and children's clothes. They don't follow the traditional definition as asset that need to be replaced---but saving separately for this expenses little by little throughout the year will help relieve the financial strain on your budget that can happen if you just try to money. For example, let's say for Christmas you want to spend $240 buying gifts, you would save up $20 a month for 12 months in a separate account instead of trying to come up with $240 in December.
How to set up a sinking fund
It's super easy to start a sinking fund. Just go to the bank or their website and start a savings account. Then track each separate sinking funds using an excel sheet. For example if you want to save $20 a month for Christmas and $100 a month for car repairs, deposit $120 in the bank account and use an excel sheet to track the funds as shown below. This is from my Google sheets budget:
Reflect:
In which ways could you start using sinking funds in your financial strategy?
What unexpected expenses have you had in the past that you could plan better for in the future?
How do you feel when a large expense comes up and you don't have the money to pay for it? How does this affect other aspects of your life?