Want to know what the ultimate personal finance hack is? It’s not so much scrimping and saving every last penny or tediously tracking credit card points. It is something a whole lot simpler: automation.
There’s one particular strategy that is geared specifically toward your budget throughout the year. It’s called a sinking fund. With any personal finance tactic, it is critical to plan ahead for both your known and unknown expenses.
While we’ve detailed how to build an emergency fund and described the nuances of a rainy-day account, a sinking fund is a bit different. With a sinking fund, you set aside a certain amount of money aimed to meet your expected financial obligations beyond just a month. Sounds simple, right? But there is a little behavioral trick that a sinking fund employs.
Making it a routine to save and invest with as little brain power as possible takes away the stress and discomfort that comes with deciding how much to save in any given week and where to invest it. At Allio, we make the automation process as easy as pie for a range of investors. If you’re just starting out, without a whole lot to put to work in stocks and the market, you are in the right place to start building long-term wealth.
What is a Sinking Fund?
While finance nerds (like the Allio investment team) might be familiar with a sinking fund in the corporate finance realm, a much more practical and salient version of it is seen when we put the same concept into motion in our everyday lives. A sinking fund is a personal finance hack in which you save a certain amount of cash periodically (usually based on whenever you receive your paycheck from work) and earmark that cash for anticipated expenses months down the line.
Picture this: You feel like you have your monthly money coffer filled up, but then you smack yourself, realizing that a large annual bill is about to come due. While it’s no problem paying for regular items like groceries and your phone plan, we find that folks are sometimes blind-sided by the one-offs that are routine, but just less frequent. That scenario is where the luster of a sinking fund shines.
By having savings on hand, you can happily avoid taking on costly credit card debt or running your emergency fund dry. As you accumulate a larger sinking fund balance, you will find that meeting your routine bills becomes a breeze, allowing your financial focus to be on forging ahead with your investments—that is how you’ll build big wealth over time and, one day, become financially independent.
A Sinking Fund Versus an Emergency Fund
It’s important to recognize that a sinking fund is different from an emergency fund. While the former targets somewhat regular expenses—like summertime travel costs, holiday gifts, or paying for seasonal home projects—the latter is for the unknowns and unfortunate events that could really put your financial path in peril (such as a job loss or health scare). And then there is a rainy day fund that we are big fans of. With that account type, you segregate money for everyday expenses that are not considered part of your ongoing budget.
You might feel a bit overwhelmed by all the account types. But take heart! You do you. That’s the thing about personal finance—it is personal! The over-arching goal here is to boost your savings rate so that you can be financially ready for whatever curveballs come your way. Once you have the little things covered, then you can focus on growing an investment account and see your net worth truly swell.
A Sinking Fund Versus a Savings Account
You might also be curious about where a plain old savings account fits in with all of this. We aren’t big fans of bland labels like that. Here’s why: You worked hard for your money, so it needs to be working hard for you. Cash should be put to work for a purpose, and it helps to have a salient objective for each of your money buckets.
A generic “savings” account does little to conjure up images of what expenses and fun activities that cash will go toward. So, a sinking fund, along with the other accounts outlined, better describes the role of each stash of cash. But technically, a sinking fund can be housed in a general savings account that you could open at a bank or online financial institution. There’s a smarter way to do it, though.
With Allio, you can leverage our team of money pros and investing experts. With our goals-based savings option, your dough can be invested in relatively safe things like short-term Treasury bills and high-quality bonds. These stable assets can earn you more interest income, helping your sinking fund grow faster than you might see in a basic savings account. Always remember that the big monster banks we all know and don’t love are looking to line the pockets of their executives and shareholders—not you! At Allio, we are on a mission to bring financial wellness to all through advanced long-term and short-term money management.
Building Your Sinking Fund
So, let’s make your sinking fund salient to you. We can harness a practice from the Olympic GOAT Michael Phelps. The 23-time gold medal-winning swimmer had a routine he would execute before each race. Phelps would envision how the race would unfold, including all that could go right and wrong. It helped him to focus on the prize.
Now, think about and tally up all the possible things a sinking fund could be used for and estimate the total costs. It might help to go through your old credit card statements and bank account transactions to see all cash outflows. It’s up to you if you want to include or ignore trivial things, but certainly, anything $50 or more is probably worth including in your sinking fund amount goal.
Here are some common expenses your sinking fund can be used to cover:
Annual vacations and any holiday travel
Quarterly or semi-annual subscriptions
Insurance premiums that are due on a non-monthly basis
Seasonal gifts, like those around Christmas, birthdays for special friends and family, Valentine’s Day, anniversaries, and the like
Self-care appointments that are not all that frequent
Have kids? Back to school expenses.
Treating yourself to a phone upgrade
Determine how much you will need over the course of a year. If it’s $3,000, then your mission should be to save $250 per month until you reach that amount. It might also be about $115 per paycheck if you are paid every other week. Then, simply direct that amount toward your Allio account through automatic deposits. You will soon have a solid financial foundation and will be ready to take your next step toward financial freedom. Like any money routine, tracking and making adjustments as life changes are always key.
The Benefits of a Sinking Fund
We find that there are three big ways a sinking fund helps Allio members:
Financial readiness: A sinking fund prepares you for knowable but non-regular cash outflows
Saying no to debt: High-interest debt is a personal finance killer, and ample liquidity available means you can simply tap your sinking fund rather than having to swipe away your future, then face crippling interest charges.
Predictability: A savings mindset means you can better plan for other financial goals. A sinking fund goes hand in hand with simply knowing where all your money is going, smoothing out your overall cash flows.
Personal Sinking Fund, Emergency Fund, Rainy Day Account Summary
Personal Sinking Fund
Rainy Day Account
To set aside money for known expenses.
To provide a financial cushion for emergencies.
To cover everyday expenses that do not often fall into your usual monthly budget.
Known future non-recurring expenses.
Money emergencies like a job loss or major health event
The in-between of ordinary everyday expenses and large, one-off emergencies
Periodic contributions based on anticipated expenses.
Regular contributions and refunding to build a safety net.
Periodic contributions for unforeseen expenses.
Varies based on individual needs and expected expenses.
3-6 months' worth of living expenses.
Smaller amount compared to emergency fund.
Often up to a year.
Long-term (ongoing financial security).
Short to medium-term (months to a year).
The Bottom Line
A sinking fund helps you save and plan for routine expenses that don’t happen all that frequently. Different from an emergency fund or rainy day account, a sinking fund is like a low-risk savings strategy for expected future costs. Automating the saving process reduces money stress and simplifies your financial life. You can grow your wealth faster and easier with Allio’s risk-focused investment options.