What is a sinking fund?

We live in a buy-now-pay-later society, where making purchases mindlessly is easier than ever. The good news: You can use a sinking fund to help you avoid large-purchase guilt and adding to your debt. This guide answers the question, “What is a sinking fund?” and explains how to start one.

Sometimes, you set aside money just in case an emergency happens in the future. Other times, you know exactly what you’re working toward buying. A traditional emergency fund is appropriate for the first scenario. But when you have a major purchase you know you want to make—one you need to save up for first—a sinking fund dedicated to this one goal can help you reach it.

If you don’t see a need to separate your savings, you may wonder, “What is the purpose of a sinking fund?” It helps you clearly track the progress toward your goal without using savings you may be keeping separate for emergency expenses or for a different financial goal.

Some sinking fund example goals include:

• Paying for holiday gifts

• Large appliances or expensive electronics

• Furniture

• An engagement ring or wedding

• Vacations

While it’s easy to confuse the two at first glance, a sinking fund is not the same thing as an emergency fund, which is much less specific. With an emergency fund, you don’t know exactly what you’re saving for—but you want to be prepared in case of a financial emergency. An emergency fund can help you pay for unexpected expenses or get through unexpected events like a job loss or the need for major home repairs.

A sinking fund is different because it’s designed for one specific goal or expense. A savings account, on the other hand, can be used to set aside money for multiple purposes.

When it comes to avoiding debt, there’s some overlap between sinking funds and emergency funds. Both are helpful because when you set aside money for a future purchase, whether planned or unplanned, you can avoid taking on debt.

The main advantage of a sinking fund is that it helps you avoid relying on credit when you want to make a purchase but can’t currently afford it. A sinking fund can also help you create positive financial habits. The biggest downside is the discipline required to decide how much money you can comfortably set aside without affecting other goals or expenses. It also takes patience to build the fund gradually through consistent contributions.

Need help sticking to a budget so you can keep adding money to your sinking fund? Here are some helpful ideas to consider.

• Envelope budgeting system: This is an old-fashioned but newly repopularized way of managing money by dividing physical cash into envelopes, each labeled with a budgeted category (groceries, rent, gas, etc.).

• Budgeting and savings apps: These tools can help you track your income and spending to make sure you’re on target to reach your goals.

• 50-20-30 rule: With this budget approach, 50% of your money goes toward needs, 20% goes toward savings and 30% goes toward non-essential items (your “wants”).

Whether or not a sinking fund makes sense for you depends on what you’re saving your money for and how important that purchase is to you. If you’re fully committed to making the purchase, a sinking fund is always a good idea because it helps you avoid borrowing money or dipping into savings set aside for other financial goals.

But if building savings in this way distracts you from working toward bigger goals, it may do more harm than good. For example, if you need to pay down high-interest debt, setting aside money for a new laptop in a sinking fund instead of making extra debt payments could hurt your overall financial progress.

If you think a sinking fund will help keep you on track, these are the steps you’ll need to take to create one.

• Step 1: Pick a goal and an amount. Before you can start your sinking fund, consider your sinking fund goals. Identify exactly what you’re working toward and determine how much you need to save. For example, if your goal is to buy a motorcycle, you’ll need to research the cost of the make and model you want.

• Step 2: Choose a savings vehicle. Whether you keep your funds in a savings account, a certificate of deposit (CD) or a money market account, you need to decide where to put your money. (See the next section for more details.) 

• Step 3: Set a timeline. To ensure you’re making progress with your sinking fund, set a timeline for when you want to meet your goal. Then do the math of how much money you need to set aside each week or month to get there.

When it’s time to set your money aside in a sinking fund, you may want to open a new savings account separate from where you keep your general savings or the money you need for everyday purchases. The good news is that you have a few options for housing your sinking fund:

• Checking account. If you know you’ll make your purchase very soon, you can temporarily stash your sinking fund in your checking account. You’ll have the easiest and quickest access to your money this way. But it’s not a great fit for long-term savings, because you might only earn a small amount of interest or none at all.

• High interest rate online savings account. For higher interest, open a high interest rate savings account, which digital banks typically offer. Because online banks don’t have the expensive overhead associated with operating in-person branches, they may pass their savings on to account holders through higher interest rates on deposits and lower fees. The higher the interest rate, the faster your money will grow. Consider opening a Capital One 360 Performance Savings account, which offers one of the best savings rates in America.

• Money market account. A money market account allows you to earn interest while having access to your funds. In some ways, money market accounts may be a bit more flexible than savings accounts, as they give you the ability to write checks or pay bills.

• Certificate of deposit (CD). If you have some time and don’t need immediate access to your funds, a CD might be a great option as you work toward your goal. With a CD, you can earn guaranteed returns if you keep your money in place until a fixed amount of time has passed. For example, locking in a competitive rate with a 360 CD means your savings can keep growing for you.

A sinking fund can help you save for a planned expense without relying on credit or dipping into money set aside for other goals. With a clear target, timeline and regular contributions, you can make progress toward a major purchase while keeping your broader financial plan on track.

Some things to keep in mind as you determine if a sinking fund is right for you:

• A sinking fund can help you prepare for a large purchase, so you don’t have to make it before you’re financially ready.

• Separating your money by goal can make it easier to track your progress and help keep those funds from getting used for other expenses.

• The best place for your sinking fund depends on how soon you’ll need the money and how easily you want to be able to access it.

Once you’ve decided to start a sinking fund, choosing the right account can help you keep your savings organized and accessible. Whether you’re looking to open a 360 Checking or 360 Performance Savings account, the online application process only takes about 5 minutes to complete.