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 ditch large-purchase guilt and avoid adding to your debt. This guide explains what a sinking fund is, how it differs from an emergency fund, and how to start one.

What is a sinking fund?

Sometimes, you set aside money for a rainy day, wondering what the future may hold. 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’s mostly so you can clearly track the progress toward your goal without dipping into other savings you may have allocated for emergency expenses or for a different financial goal.

Some sinking fund example goals include:

• Paying for holiday gifts
• Large appliances or pricey electronics
• Furniture
• An engagement ring
• Vacations

What a sinking fund is not

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 what you’re saving for but you want to be prepared in case a financial emergency hits. An emergency fund can help you pay for unexpected expenses or weather a financial storm, such as a job loss or major home repairs.

When it comes to avoiding debt, there’s some overlap between sinking funds vs. 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.

However, a sinking fund is different from general savings as it focuses on one specific savings goal, whereas someone may use a savings account to set aside money for multiple purposes.

Pros and cons of a sinking fund

The main advantage of a sinking fund is that it helps you avoid developing a reliance 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 only real disadvantage is the amount of discipline required to determine how much money you can responsibly afford to divert from other goals and expenses and to keep adding to the fund slowly.

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

• Envelope budgeting system: This is an old-fashioned but newly re-popularized way of managing money by dividing your cash into envelopes, each labeled with a budgeted category (e.g., groceries, rent, gas, etc.).
• Budgeting 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 budgetary approach, 50% of your money goes toward needs, 20% goes toward savings, and 30% goes toward discretionary items.

Is a sinking fund right for you?

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 earmarked 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 student loan debt, setting aside money for a new laptop in a sinking fund instead of making extra debt payments could harm your overall financial progress.

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How to start a sinking fund

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 establish 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 stash your cash. (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 and do the math of how much money you need to set aside each week or month until you get there.

Where to keep your sinking fund

When it comes 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 given the limited or lack of interest earned.
• High-yield online savings account. For more bang for your buck, open a high-yield 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 without you having to lift a finger.
• Money market account. A money market account allows you to earn interest while having access to your funds. These are typically a bit more flexible than savings accounts, as they give you the ability to write checks or pay bills.
• CD. If you have some time to save and don’t need immediate access to your funds, a CD—or CD ladder—might be a great option as you work toward your goal. You can bank guaranteed returns with a CD if you don’t withdraw your funds before its term (generally three months to 10 years) is up.  

Need to kick-start your sinking fund by opening a CD? A Discover^® Certificate of Deposit gives you flexible terms, reliable returns, and an easy start with no minimum deposit required to open an account. You have 45 days after opening the CD to fund the account. Learn more.

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