What are sinking funds?
A sinking fund is an amount of money, separate from your savings, that you use to prepare for a one-off payment or specific irregular payments that you know you will eventually have to pay. You contribute money consistently so that when that big bill comes through to renew your car insurance, you already have the amount set aside and it doesn't completely ruin your budget for the month. Some sinking funds may have a specific goal amount for a one-off payment (like Car Insurance or Christmas gifts) while others tend to be ongoing to prepare for certain irregular payments (Car Maintenance, Pet Care) that you will need to pay throughout the year - you just need to work out how much you need to set aside for each one.
Why are they so important?
Sinking funds allow you to set money aside so that it is there ready for when you need it. They save you from dipping into your savings because your money is already allocated to a certain category and you don't need to worry about unplanned payments that aren’t in your budget. For example, if you contribute £30 a month to a Car Maintenance sinking fund when your next service comes around in six months and it's a little worse than you were expecting, you already have £180 set aside to cover it. So without ruining your budget or borrowing money from that all-important Emergency Fund, you can pay for that expense.
Cash or Card?
Depending on your preference, you may find it easier to save in cash or using your banking app or perhaps a bit of both.
Cash – This method involves putting physical cash into labelled envelopes or plastic wallets (whatever you can find) for different categories. Some people decide to take out their whole paycheque in cash and divide it up to assign all of their money to a category. This could be for you if you are less likely to spend cash as you hate to give over physical money, making you really think about each purchase. However, if you find it easy to pay with cash as you don't see your bank account balance dwindling every time you make a purchase, maybe using online banking would be more appropriate.
Card – If cash isn't for you, sinking funds are easy to set up with most banking apps, including Starling and Monzo. You can create 'spaces' or 'pots' for each fund and set up automatic payments so that on payday, your funds are topped up without you even trying. This can make it a lot easier to see how much you've contributed to each pot and the overall total of all of your sinking funds, as well as being able to set goals and track your progress. Also, you can use the round-up function available with many banks and apps to top up a certain goal. It can be surprising how much these add up.