How Sinking Funds Can Help You Avoid Debt

Kumiko Love was getting ready for the 2018 holiday season when she noticed something alarming — she was still paying off debt from last Christmas. 

“I was doing a lot of impulse shopping — a lot of guilt spending because, at that time, I was a newly-divorced single mom and I had a lot of guilt over that,” says Love. “I was trying to provide the best Christmas and holidays for my kid.” 

While her son likely had a memorable holiday, that type of spending further delayed a long debt payoff journey she had started in 2011 when she got her first student loan bill. 

Now an accredited financial counselor, founder of The Budget Mom and best-selling author of “My Money My Way: Taking Back Control Of Your Financial Life,” Love points to that moment when she started implementing sinking funds into her financial plan. 

“I was like, I know Christmas is gonna happen every year. I know it’s coming,” she says. “And so I decided at that very moment that I was going to start saving $25 every single month [for Christmas].”

It wasn’t a lot of money, but it was doable for her budget and financial goals. Love thought that if she could just stockpile $200 or $300 that would help her avoid debt the next holiday season.

She also set another goal — she would only use what she had in her fund and not spend over that amount. Little by little, she built this saving strategy into her financial plan, which included paying off more than $77,000 in debt.

“And so that’s what it was. Even when I was paying off really high debt, I still had one sinking fund, and it was Christmas. I knew it was an expense that came up and was putting me into debt over and over and over again. It was this vicious cycle. And so that’s when I started implementing [sinking funds] into my life.”

Today, Love is debt-free, living with her family in a home she paid for in cash and helping more than one million followers build their budgets, pay off debt and save money through her Budget By Paycheck system, which highlights the use of sinking funds.

What is a sinking fund?

A sinking fund is money saved for a specific, expected purpose. You set a goal for how much you want to save in the fund and save that money each month, or paycheck, until you meet your goal. The fund can be used for one purchase, like a car, or for multiple purchases within a category, like home maintenance or holidays.

While it is money you save, a sinking fund differs from a savings account and an emergency fund.

Sinking fund vs. savings account

A savings account is a place to store saved money. A sinking fund is money you can store in your savings account to use for a specific purpose. Having a clear intention with your sinking fund’s money is what makes it different from general savings.

You can have several different sinking funds in your savings account, each named and organized by its purpose. You can list and track sinking funds on your own by noting how much in your savings account should be allocated to each fund. Or, you can open multiple savings accounts or, in some cases, subaccounts to keep your money separate in the bank.

For example, your savings account may feature sinking funds for home maintenance, car maintenance and your annual family vacation, as well as general, unassigned savings to use as a cushion.

Organizing your savings account by sinking funds

Sinking fund vs. emergency fund

“One of the biggest mistakes that I see is people think that their sinking funds are for emergencies,” says Love. But a sinking fund and emergency fund differ in their purposes. As Love explains, “Your emergency fund is for unknown, unplanned expenses. Your sinking funds are for known, planned expenses.”

For example, an oil change could come from your car maintenance sinking fund, while an insurance deductible after a serious accident would come from your emergency fund. Or, you might save up for a bathroom remodel in a home maintenance sinking fund, while pulling from your emergency fund when your furnace breaks in the dead of winter.

Emergency fund or sinking fund?

In other words, a sinking fund may help you avoid using a credit card, while an emergency fund may help you avoid taking out an emergency loan.

How sinking funds could help you avoid debt

Sinking funds help you avoid debt by setting aside money for known expenses so it’s available when you need it. But aside from the tangible benefit of sinking funds, there’s also the financial independence it builds that far outlasts any amount of money saved. 

For many, avoiding future debt may seem like a far away goal when they’re dealing with current debt. And putting money toward saving instead of toward debt may seem counterintuitive. But it can have its advantages, according to Love.

Paying off debt vs. building a sinking fund

“So many of us have gotten in this mindset of [having] to do the bare minimum. We have to eat rice and beans. We have to, you know, literally bare minimum everything in our lives — I’m talking about even the joy that we allow ourselves,” says Love. “But really a debt payoff journey is not about just making the debt payments and saying, ‘Okay, look how fast I’m paying off my debt. Every single penny I have is going towards debt.’ That’s not what a debt payoff journey is.”

A debt payoff journey is learning how to use the money you have in a way that you don’t go into debt in the future.

— Kumiko Love

Love explains that paying off debt isn’t just about becoming debt-free; it’s about forming money habits that keep you debt-free. And, while sinking funds made her pay off her debt a little more slowly, they helped her develop those habits. “I was teaching myself how to not rely on debt in the future,” she says.

Still, people may grapple with whether to pay off their debt before building their sinking funds. If you question what to do, Love suggests these three steps:

1. Know your financial baseline. Have a budget in place so you know how much you can put towards your debt.
2. Understand what expenses you have coming up and if you have the money to pay for those expenses.
3. Ask yourself whether you’re okay with the tradeoffs of having a sinking fund vs. putting everything toward your debt.

When to consider a loan

While sinking funds are there to avoid debt, Love understands that there are situations where using a credit card or loan may make more sense. For example, using a rewards card to earn points or cash back and then paying it off right away — maybe even with a sinking fund created for that specific purchase. 

If you’re in a pinch and need to borrow a large amount of money, a personal loan may be a better option than a credit card because it typically has lower rates and you can receive the money within days. If you decide to go that route, compare personal loan rates and terms to find the option that will cost you the least amount of money in the long run and have a plan in place to pay off that debt.

According to Love, the best option for you will depend on your goals, your timeframe and your unique situation. However, she is quick to point out that, if you have the time, patience and motivation to build that large-purchase sinking fund, that’s always the recommended course.

“It took me almost eight years to buy my house with cash. Do you know how many times I almost got a home loan because I wanted it so badly? But every single time, I stuck to my goal. I continued to save every penny that I had,” she says. 

And when she saved up enough money to buy her dream home, she also got to surprise her son with the news — an emotional moment she shared on YouTube.

Getting started with sinking funds

A sinking fund to buy a home with cash may be a little ambitious for those just starting out. Instead, Love recommends starting small with just one or two funds. 

“I only had a Christmas sinking fund when I had debt, and I had just that one sinking fund for years before I added any more,” says Love, who often sees people start with too many sinking funds and leave no room in their budget for actual bills.

To choose your first sinking fund, Love recommends asking yourself, “Is there a future expense that I’m going to have to rely on debt to pay or that I’ve relied on debt to pay for in the past?”

Whatever that is, make a goal amount and start saving for it now. Little by little. “It doesn’t have to be drastic. It doesn’t have to eat a lot of your cash flow,” says Love. “But you can prepare yourself now and into the future, so when that time comes, you have the money set aside.”

In order to implement sinking funds into your life, Love suggests three steps: 

1. Track your spending to understand where your money is going and where it’s coming from.
2. Create a realistic budget and understand what expenses are wants and what are needs.
3. Set realistic goals that can be turned into sinking funds.

Where to keep your sinking fund

For smaller sinking funds, like a $100 birthday fund, you can also save in physical cash. Just remember that if cash is lost or stolen, it’s gone. Love suggests keeping your sinking fund in an account that’s easily accessible since you’ll likely access those funds faster and more often. She keeps hers in a regular savings account at her bank. And since your emergency fund is likely bigger — or will be one day — and used less often, a high-yield savings account is a good place to put that money, where it can grow at a higher rate. 

Types of sinking funds

Whether it’s your first and only or one of several — the type of sinking fund you have is personal to you and your life goals. The types of sinking funds may also change each year and grow or shrink based on your financial situation. Since Love is debt-free, she is able to put more toward her sinking funds.

While your funds will depend on your situation, they should be for expected costs. A few ideas include:

• Vacation
• Back to school and other education costs
• Home maintenance
• Car maintenance
• Wedding anniversary
• Child care 
• Pet care

Sinking funds can help you avoid debt and build habits that contribute to financial confidence. “Financial confidence is all about financial fulfillment. It’s actually one of the three pillars in financial fulfillment, [which are] confidence, clarity, and stability,” says Love. “And so the fact that sinking funds can help us with one of those pillars is really, really, really important.”