It's challenging to cover a significant expense in a short duration. Some people go into debt over it. A well-established sinking fund helps shield life's unexpected events, protects your financial goals, and promotes better budgeting.
A sinking fund is a cash reserve in your account that holds calculated funds for future expenses. There is usually a stand-alone account for each sinking fund category. This account is separate from your regular checking, savings, and emergency fund.
A sinking fund might sound like an emergency fund, but it is not. They have two separate structures. An emergency fund is a general fund, whereas a sinking fund is specific to the expense category. The emergency fund is your last resort; therefore, you do not dig into it until you run out of all your resources. It covers emergency expenses you've never anticipated, like losing an income source and needing to survive for months without a job.
The purpose of a sinking fund is to have enough liquid cash savings to cover anticipated expenses. A sinking fund supports costs related to life events and assets.
- Covered planned expenses - Cover unplanned but anticipated expenses - Protect emergency fund - Promote a good budgeting habit - Avoid debt