Last Updated on June 21, 2021 by Melissa S.
What is a sinking fund and why do you need one?
When sorting out a budget, the rules can be simple enough. Work out your monthly expenses, including any debts and spending money, and if you’re super savvy, put the rest into savings and investments. For a lot of us, the latter might not happen, and we’re just happy to get through the month with enough.
However, there are some expenses that may not have a monthly direct debit attached to them, and although they are predictable, this can make them forgettable. For example, Christmas comes around every year, and according to the Bank of England, the average UK household spends £2500 in the festive season.
Yet according to a 2020 survey, a staggering 45% of Brits have no budget or savings for Christmas, with many turning to debt in order to pay for their purchases, which could then create a vicious cycle of continually paying off last year’s Christmas and having no savings for the next one.
How can a sinking fund help?
Sinking funds are simply savings pots where money is put aside each month for a specific purpose. You could have several sinking funds and designate each one to a separate fund, or have a single sinking fund to cover all expenses. I prefer having different funds for each of my expenses, as otherwise it can be hard to know how much money can cover each category, which can lead to overspending in some areas.
What areas should I save for with sinking funds?
Of course, everyone’s expenses are different, but here are some common areas you may consider sinking funds for:
Birthdays – including any parties
Car MOT/ Service
Home DIY / Refurbishment
How can I work out how much I need for my sinking funds?
The simplest strategy would be to calculate the overall annual cost, or estimated cost, and divide by 12. So, if you estimate you would like to save £500 a year for car costs, you would need to save approximately £42 a month.
Of course, some costs like Christmas and birthdays are a bit more complicated to work out, which is why I have created a Christmas & Birthday budget planner. Simply input the estimated cost of each person’s gifts, as well as extra expenses such as parties, Christmas food etc, and the spreadsheet will calculate the total cost for you. The budget can even be split into two for couples. Check it out here.
What if I can’t afford to save the calculated amount for all my sinking funds?
This is a crucial point – and one that can make you think! As if you cannot afford the monthly amounts, then where were you finding the money from to pay for everything in the first place?! More often than not, credit may have been the answer. If you want to break the cycle and take the first steps towards becoming debt free, then there are a couple of other options:
Adjust the budget accordingly
Spend less so you can afford to contribute to the sinking funds. This is easier said than done, but it is always a good idea to see where you can save money on the amount you currently spend.
Earn extra money through a side hustle
There are so many ways to earn extra money without taking on a second job, and here on the blog I cover lots of ideas in detail. From selling old items on eBay, to Matched Betting, there are plenty of ways to earn a little extra.
Handy tools to help set up sinking funds
Nowadays, it is a lot easier to manage several pots of money thanks to online banking. For many bank accounts, multiple saving spaces can be created instantly without having to formally apply for separate accounts. I use the “spaces” feature in my Starling bank account for this, which I highly recommend.
A sinking fund can also be automated with a savings tool such as Plum. This automated AI calculates how much you can afford to save and sets aside small amounts every few days. Every year, Plum sets aside the money I need for Christmas which means I don’t even notice it – and last year this was over £700! You can find out more about Plum here.
You can also find a sinking fund tracker over on my blog shop that will track multiple sinking funds for you, as well as calculating the weekly or monthly amount you need to save. Find out more here.