Sinking Funds – How To Calculate Them

I live by sinking funds and use them for absolutely everything possible – I’m talking holidays, Christmas, birthdays, graduation, pre-planned events – you get it! They are honestly one of the most valuable budgeting tool out there. However, when you are starting out, understanding how to calculate your sinking fund goals can be hard. Enter this blog post!!

What the hell is a Sinking Fund?

A sinking fund is a budgeting tool that allows you to cash flow an expense, by putting money aside in advance. You essentially add money into a “pot” each month running up to when you need the money so when the time comes you have the money ready to go.

Banks that allow you to split your money into pots (e.g. Starling, Monzo, Chase etc.) are great for sinking funds as you can create a separate pot for each fund.

#1 What are you saving for?

Are you saving for an annual subscription – like Amazon Prime or car insurance. Is it a one-off occurrence like a holiday, wedding or hen party. Or is it a generic thing? Think Christmas, a gift fund, non-specific travel fund etc.

Once you know exactly what it is you are saving for, figuring out how much you need to set aside will be much easier.

#2 Make an estimate

Next step, once you know what the sinking fund is for, is to make an estimate of how much you need to save. If it is a subscription or an annual cost (e.g. car insurance) then this is an easy question. You will know exactly how much you need or be able to make an estimate based off the cost last year.

Something like Christmas is slightly harder to estimate. I recommend writing down all the separate elements and setting a budget for each one to reach the total needed. So if we continue our Christmas example then the separate elements would be things like gifts, food, work secret Santa, transportation – you get the idea.

#3 How long do you have?

Obviously, the earlier in advance you set the goal the longer you will have to build up the pot. But do not despair if you have left it a bit late – having any amount of cash set aside is better than having nothing there. Remember the aims of a sinking fund are to provide peace of mind, security and prevent you taking on debt to pay for these things. Therefore, even if you are only 50% towards your goal when your time runs out, 50% cash flow is better than 0%.

#4 How often will you be adding to the fund?

This question is especially important when testing how realistic your goal is. Most people will be adding to their sinking funds on payday which makes the calculation a little easier. Simply divide the number of paydays you have until you need the money by the total needed to see how much you would need to add each payday.

When you have the amount you can see whether this is feasible for your situation or whether you need to reconsider your goal. Obviously if the calculations state you need to add £200 per month but you only have £100 of disposable income then the goal is not realistic for you.

If it does not seem realistic go back to step three – did you overestimate? Can you cut bits down? Can you extend the timeline?

So that’s it the four step routine I follow when creating sinking funds! Do you use sinking funds? I’d love to hear about your experience in the comments.