When Nora Martin was expecting her first child, she wasn’t going to let all the many baby costs bring her down. She had a plan.
“I pretty much wrote up everything that we needed … and then split up the total over six months to see how much we would have to save each month to get to our goal,” said the Palm Harbor, Florida, mom.
That practice of splitting a large financial goal into easier-to-manage chunks has a special name in the personal finance world. It’s calling setting up a sinking fund.
A sinking fund is a pool of money you regularly contribute to so you spread out the cost of an upcoming expense over time. It’s a smart approach to saving for costly goals and infrequent expenses.
What Do I Need a Sinking Fund For?
You might create sinking funds to save for big expenses, such as a vacation, wedding, new baby, new car, home down payment, summer camp or a planned medical procedure.
These funds can help you prepare for annual occurrences, like holidays, birthdays, back-to-school season, taxes, renewing your car registration, renewing computer software, annual insurance bills, credit card maintenance fees or yearly subscriptions.
Sinking funds can also blunt the impact of unexpected expenses like broken appliances or new tires. Patrice Banks, auto mechanic and founder of Girls Auto Clinic, recommends car owners save about $100 a month for future repairs if their car has over 100,000 miles. Common advice for homeowners is to save at least 1 to 2% of your home’s cost each year for maintenance work.
You can also set up sinking funds to better manage the fluctuating costs of variable expenses, like your water or electricity bill. During months when your bills are lower than normal, you put the extra money in a sinking fund so that when you’re hit with a higher bill, you can pull from those savings.
Likewise, you can use a sinking fund to cover fixed expenses if your income varies from month to month. When you make more money than average, save your extra earnings so that in less profitable months, you can use the savings to pay your bills.
Planning Out Your Savings Contributions
It takes a little math and some organization, but it isn’t difficult to save using sinking funds.
To figure out how much to contribute, divide your total savings goal by the amount of time you want to save. For example, if you want to save $800 for Christmas over eight months, you’d be saving $100 each month.
Since sinking funds typically cover short-term savings goals, you’ll want to be able to access your money easily. Keep it in a savings account or money market account. Those who prefer the envelope method may keep their sinking fund savings in cash.
If you manage your money using a budgeting app, you can set up your sinking funds digitally. The software updates the balance so you know how close you are to each savings goal. Try apps such as EveryDollar, YNAB and Mvelopes.
Prioritizing Multiple Savings Goals
When you start listing out all the things you’re saving for short term, putting money aside for all of them may seem overwhelming. Prioritize needs — like taxes and your annual insurance bill — over wants — such as vacation or holidays.
To cut down on the number of sinking funds you need, only use them to save for expenses over a certain cost threshold. For example, create a sinking fund for summer camp if paying the extra $500 a month would break your budget without saving in advance. But don’t set up a fund for your kid’s birthday if you know you can afford paying an extra $50 for gifts all in one month.
Also, know that you don’t have to save up for everything all at once. Knock out less expensive savings goals over three or four months rather than spreading them out over an entire year. You can have different short-term savings goals each season. That way you won’t have so many pots to dump money in each month.
Nicole Dow is a senior writer at The Penny Hoarder.
This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.