What are sinking funds and should you have them? (2024)

Big expenses that don't occur very often can be budget busters. You know you'll need to buy things like new tires for your car every few years, or you have insurance bills that you pay once or twice a year, plus there's all the birthday and holiday gifts you buy throughout the year. But because these expenses may not be every month, when the time comes, you may find yourself struggling to find the extra funds in your monthly budget.

While it's very easy to buy now and pay later using credit cards or payment plans, making it a pattern can lead down a path to debt with expensive finance charges.

That's where having sinking funds can come in handy. CNBC Select how this method of savings can help you be prepared for infrequent expenses.

• What are sinking funds?
• Types of expenses you can use sinking funds for
• Sinking funds vs. emergency funds
• Where should you keep your sinking funds?
• Should you use sinking funds?
• Bottom line

Sinking funds are money you set aside each month for specific savings goals. They allow you to save for infrequent expenses and plan for large expenses over time. Having sinking funds can help prevent you from withdrawing money from your emergency fund or going into debt to pay for things.

You can use a budgeting app, like You Need a Budget (YNAB) or PocketGuard, to monitor your sinking funds. Setting up automatic monthly transfers from your main checking account to your sinking funds account can help you stay on track.

The amounts you save in your sinking funds can be small or large – it's really up to you. Plan to spend $600 on holiday gifts next year? Then you'll add $50 per month to a sinking fund. Want to set aside 1% of your home's value for maintenance and repairs? On a house valued at $400,000, that's $4,000 a year or $333 per month. You may not spend that much every year, but it'll likely balance out in the run as some years you may have more expensive home tasks, like replacing your HVAC system.

If one sinking fund has a shortfall for an expense, you can always withdraw from another sinking fund to avoid going into debt. For example, if you need $500 for car repairs and your car repair fund only has $300 in it, but you've got the extra $200 in your house down payment fund, then by all means, use it. But if you find your sinking funds are consistently coming up short, then reassess and adjust how much you set aside each month.

You can create a sinking fund for any financial goal or expense you have. These can be ongoing expenses that occur irregularly, like car insurance that you pay every six months or once a year, or a big one-time expense, like a wedding. Predictable expenses that you pay monthly, like your utilities, should remain part of your monthly budget.

Some examples of sinking funds could include:

• Gifts
• Vacation
• New car
• Home maintenance
• Insurance (health/property/car)
• Car maintenance
• Pet care
• New refrigerator
• Wedding
• Home down payment

Your sinking funds can change over time as you accomplish your savings goals and make the large purchases you planned.

While they may seem similar, there are differences between sinking funds and emergency funds.

An emergency fund is for unexpected expenses, like job loss and medical emergencies. While some home and car repairs can be considered emergencies, if you save for those things in a sinking fund, you're less likely to have to tap into your emergency fund for them.

Your sinking funds are something you set aside in addition to your emergency fund. If you do not have an emergency fund, it may be useful to get one established as well.

You want your sinking funds to be accessible, but not too easy to get. Keeping all of your extra money in your main checking account that's tied to a debit card may not be a good idea, especially if you're prone to overspending or impulse buying.

Keeping your sinking funds in an investment account typically is not a good idea either because investments should be funds you don't plan to withdraw for many years. The value of investments fluctuates frequently, and you could subject yourself to a loss if you're not holding investments long-term. Plus there may be taxes to factor in.

So with that in mind, the best option for sinking funds tends to be a high-yield savings account, like LendingClub High-Yield Savings or UFB Secure Savings. Since many of the banks offering high-yield savings accounts are online only with no brick-and-mortar locations, you can link the account to your checking account and transfer money as needed.

Keep in mind, it may take a couple of days for the transfer to be completed, so you should plan ahead to have the money available in time. Or you can charge your expense to a credit card in order to earn cash back or travel rewards, then use your sinking funds to pay the credit card in full when the bill arrives to avoid paying interest.

Some high-yield savings accounts may also offer ATM cards, which allow for easy withdrawals. However, if you lack discipline to only use your sinking funds for their intended purpose, it may be better not to have an ATM card.

Look for an account with no minimum balance and no monthly fees. For instance, Marcus by Goldman Sachs High Yield Online Savings, CNBC Select's top high-yield savings account for no fees, has no minimum balance or deposit and charges no monthly fee, no excessive transactions fee and no overdraft fee.

You absolutely can have just one big savings account and pull from it for infrequent expenses as needed without tracking specific goals. But for many people, strategically saving for named goals using sinking funds can be both mentally and financially helpful.

Be careful not to have too many sinking funds and spread yourself too thin. Managing multiple savings goals can be a challenge. How much you can set aside in your sinking funds will depend on your budget and your priorities.

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At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every personal finance guide is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of personal finance products. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.

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