Why a sinking fund is a major win for your finances — and a step-by-step guide to creating one

Property taxes. School fees. The quarterly waste-management bill or semi-annual yard maintenance cost. A holiday you know you’ll be taking next year. Taxes on your self-employed income.

When larger known expected expenses occur on an irregular basis, say once or twice a year or every few years, a sinking fund comes in very handy. By stashing cash away ahead of time, you’ll be ready to pay for these larger costs.

A sinking fund differs from an emergency fund, which is used to fund something unexpected like a job loss, urgently fixing your air-conditioning system amidst the dog days of summer, or paying a high price for last-minute travel to attend a funeral.

If you start a sinking fund, what’s in it for you?

A sinking fund helps people stay out of debt, specifically credit card debt. It helps you to avoid a scenario where you have to raid your emergency fund, RRSP or TFSA — again — to pay for costs. The most powerful benefit? A sinking fund forces you to think ahead and really look at what’s happening on your personal financial landscape in the next year or two. Tilting your vision toward the future is extremely motivational, and is directly linked to more accurate budgeting as well as prioritization efforts. 

Want one? Follow these steps 

Step 1: Make a list of big-ticket items you know about, and how much they cost. Personally, I project 12-18 months in advance and for me these costs almost always include known home repairs, vacations, weddings, summer camp fees (don’t even get me started on these), sports memberships and replacement tech (my kids recently jammed a broomstick through the television screen, and I just know there will be more of this to come, so I proactively include technology in my sinking fund). 

Step 2: Tally it up, and try not to fall off your chair. It’s a lot, I know. When you can see the total of what’s upcoming, you can work this back into a manageable weekly, bi-weekly or monthly savings regime. For example, if the total is $6,000 over the course of a year, start saving $250 bi-weekly toward your sinking fund. 

Step 3: Choose a low-to-no-fee savings account with interest. Mostly you’ll be depositing money, then tapping into the account on rare occasions for specific withdrawals. So, your fees should be minimal. I keep my sinking fund in a high-interest savings account (HISA) that allows one free withdrawal per month, so effectively it’s free to me, plus I’m currently earning five per cent interest on the money.

Step 4: Update your budget then automate the contributions. It might be the case that you’ll need to trim other budget categories, like groceries or entertainment, to accommodate a regular savings regime. Maybe you’ve already built one-off costs into your budget as “one-time expenses,” but sometimes they happen and sometimes they don’t. I suggest adding a specific line in your template that says “sinking fund.” Then, make this process simple by setting up automated contributions toward your new sinking-fund savings account at an interval that makes sense for you. That way you won’t forget to set aside these savings.

Step 5: Use the money as intended. When that annual home-maintenance cost creeps up, grab the money from your sinking fund to pay for it. If you’re feeling emotionally torn about spending these savings, that’s actually a sign your money mindset is shifting in a great way — loving your savings, and being proud of your hard work to build it up is the motivation you’ll need to sustain any savings habit. Know that this money is supposed to be spent on the goals you outlined in the first step. If you slip up and blow it on something you didn’t intend, take a breath, learn from it, reset and start again. 

Personally, I use one sinking fund and bucket the savings together versus having multiple accounts for different purposes. It also means I typically earn higher interest, and avoid fees, because the balance is higher. Either strategy will work though, as long as it’s organized in a way that you can see your savings progress.

Because the money in a sinking fund is almost always needed within a two-year period, avoid investing it. I get the appeal of potentially seeing this money grow as the market grows, but there’s too much volatility with the investment market for this tight time frame. You wouldn’t risk losing any of its value.

This article was originally published in The Star. Lesley-Anne Scorgie is a Toronto-based personal finance columnist and a freelance contributing columnist for the Star