A sinking fund is a sum of money you set aside monthly to meet a predetermined one-off expense. For a sinking fund, you have an expense in mind and you are saving to get enough funds to finance it. A sinking fund can be used to finance a new car, pay for your vacation or for the Christmas holidays (they sure do come with a lot of gifting) amongst others.
Why do you need a sinking fund? A sinking funds helps you keep your finances in order by planning. With a sinking fund, you get to plan for your expenses. For example, you know the Christmas holidays come with some huge expenses. This can include gifts you want to give out and family events. You can estimate the total amount you may likely need and divide it among four or five months. This helps you not to put so much expense burden on one month’s income or draw out of your emergency fund for expenses you know you will incur (An emergency fund should address unplanned and unforeseeable expenses).
How can you maintain your sinking fund? It is a form of savings, and you can keep it in your savings account; however, if you feel you are not so disciplined with savings or the sinking fund will cover a lengthy period, you can opt for keeping it a money market instrument (such as a mutual fund account) which enables you to top-up your account regularly.
It is wise to save for your expenses ahead of time; it reduces the burden on the income of the month which you will incur the expense.
To your financial independence and freedom!
