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A sinking fund is money you set aside regularly for an expected future expense. With a sinking fund, you can set aside a specific amount every month for that particular expense rather than paying a large amount from one month’s income.
This approach works for expenses such as insurance, vehicle maintenance, school fees, festivals, holidays, home repairs, and planned purchases.
This article explains what a sinking fund is, how it differs from an emergency fund, the expenses you can use one for, and how to set one up.
Key Takeaways
- A sinking fund is money saved regularly for a specific planned expense.
- It helps you handle large or irregular expenses without putting sudden pressure on your monthly budget.
- Sinking funds and emergency funds are different. Sinking funds are for planned expenses, while emergency funds are for unexpected financial problems.
- Start by listing future expenses, estimating their costs, and dividing each amount by the time available to save.
- Keep sinking funds organized and review them regularly so your savings match your actual future needs.
What is a Sinking Fund?
A sinking fund refers to the amount that you save periodically for future expenses. As mentioned before, it is quite easy to understand how a sinking fund works. Instead of paying in a lump sum, the expenses are broken down into smaller amounts to be saved over time.
Let us understand this with an example:
You know that your yearly car insurance will cost ₹24,000 and needs to be paid after 12 months. Instead of arranging ₹24,000 at once from a month's salary, you can set aside ₹2,000 each month until the time comes for payment.
Sinking funds are different from normal savings, since sinking funds usually have an intended use. The intended purposes for which you may need a sinking fund include:
- Maintenance of a car
- Payment of insurance premiums
- Holiday expenses
- Celebrations like festivals
- School and college fees
- Repairs and improvements to the house
- Medical costs
- Subscription payments
- Presents and other celebrations
- Electronics purchase and other planned expenses
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Types of Sinking Funds
There is no set of predefined sinking funds that one can choose from. However, there are several categories that will be helpful in this situation.
Annual Expense Fund
There are some expenses that we have to make only once or twice a year.
Examples include:
- Insurance expenses
- Property-related expenses
- Fees
- Yearly subscriptions
- Educational expense
Calculate the total cost for a year and divide it by the number of months left to save.
Vehicle Fund
Sometimes, a car or two-wheeler may require some extra expense other than petrol. This includes:
- Service cost
- Reparations
- Tyres
- Replacing battery
- Insurance cost
- Registration-related costs
Regular saving for all these expenses will ensure that you do not get caught in some repair bill while working on your monthly budget.
Holiday Fund
Planning a holiday becomes easier when you save for it in advance. You can estimate the cost of travel, accommodation, food, shopping, and activities, and then decide how much to save each month.
For example, if your planned holiday will cost ₹60,000 and you have 10 months to prepare, you could save ₹6,000 per month.
Festival and Gift Fund
Expenditure on festivals, birthdays, weddings, etc., may result in increased spending. Rather than being shocked by these expenses each year, you should make another fund for these expenses. It will especially help if you know that you have higher expenditure in some months.
Home Maintenance Fund
Homes require regular maintenance. Painting, plumbing, electrical work, appliances, and other repairs can become expensive. A home maintenance sinking fund allows you to build money gradually for these needs.
Also Read About: What are Contingency Funds?
How to Start a Sinking Fund?
Starting a sinking fund does not need to be complicated. You can follow a few simple steps.
Step 1: Write down all your expenses
You can start off by listing your expenses over the coming 6 to 12 months. Write down any expenses that don’t happen on a monthly basis but may happen.
Step 2: Work out your monthly contribution
Divide the cost estimate by the number of months left.
For example:
₹24,000 ÷ 12 months = ₹2,000 per month
If you have multiple sinking funds, do the calculations separately for each one.
This will show that you need to save ₹2,000 for insurance, ₹3,000 for travel, and ₹1,000 for car repair. The total amount for your sinking fund contribution will come to ₹6,000 per month.
Step 3: Determine the order of funds
It is impossible to put away money for all expenses simultaneously.
Start with those that are:
- Overdue
- Important
- Hard to defer
- Sufficiently significant to influence your monthly budget
Step 4: Keep the money separate
Managing a sinking fund is easier when the funds remain separate from other money. One can use different savings accounts or labeled savings buckets based on one's preference.
The only thing that matters is that the funds should be distinguishable and not used inadvertently for other expenditures.
Step 5: Automate your savings
If possible, set up an automatic transfer shortly after you receive your salary.
For example, if you receive your salary on the first day of every month, you could automatically move your planned sinking fund amount into your savings account.
Automation makes saving easier because you do not have to remember to do it every month.
Also Read About: What is Debt Fund?
Common Mistakes to Avoid
Sinking funds work best if you use them properly. Below, you can see some mistakes people tend to make.
Saving too little
Even if you misjudge the amount needed and save less than needed, you can still experience problems because of insufficient funds.
Keeping everything in one account without tracking
In case all your savings are saved in one place, it might be hard to track the amount available for certain purposes.
Using sinking funds for everyday spending
A sinking fund should have a clear purpose. Spending it on unrelated purchases can leave you unprepared later.
Creating too many funds
Having 15-20 accounts might be hard to keep track of. Make sure to start with those accounts that really matter and then create new ones when necessary.
Forgetting to update the amounts
It might be a good idea to adjust the amount needed due to changes in prices.
Conclusion
A sinking fund is a simple but effective way to prepare for expenses before they arrive. By saving a small amount regularly, you can avoid the stress of arranging a large sum at the last minute. Whether it is for insurance, a holiday, home repairs, festivals, or a planned purchase, having a separate fund keeps your finances more organized.
You do not need to start with a large amount; just identify one upcoming expense, set a realistic savings target, and begin. Over time, this small habit can make managing your money easier and help you feel more financially prepared.
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