What is a sinking fund?

Managing finances can be tricky when big expenses sneak up on you. Sinking funds are a simple yet powerful way to plan ahead, helping you avoid debt and keep your investments intact.

In personal finance, a sinking fund is a pool of money you build up over time to cover a known or expected future expense. Unlike an emergency fund, which is for the unexpected, a sinking fund is for larger expenses that you know are coming down the line.

This could be anything from a car insurance bill to school fees, a tax payment, a holiday or replacing an ageing laptop.

Unlike many financial concepts, this one is simple. If you know you’ll need £1,200 for a holiday in 12 months’ time, you save £100 per month in a dedicated account. When the bill arrives, the money is ready — meaning no credit cards, no stress and importantly, no cannibalising your emergency fund.

How to invest whilst setting aside a sinking fund with us

For those looking attempt to invest while setting aside a sinking fund with us, here's a straightforward approach:

1. Learn more about sinking funds
2. Download the IG Invest app or open a share dealing account online
3. Search for your desired stock or bond on our app or web platform
4. Choose how many shares you’d like to buy
5. Place your deal and monitor your investment

Investors look to grow their capital through share price returns and dividends - if paid.

But the value of investments can fall as well as rise, past performance is no indicator of future returns, and you could get back less than your original investment. The idea is either to invest your sinking fund in low risk stocks and bonds, or to keep it in cash, to be better prepared for future big ticket expenses.

To cover all expected expenses, it can make sense to list all upcoming costs you expect to come within the next year and then estimate a total cost. You then need to divide this total by 12 (the number of months in a year) to get to a monthly contribution figure and set up a standing order to your preferred separate account to ensure it gets set side.

Of course, many choose to keep their sinking fund as cash, though short-term bonds, reliable dividend stocks and Gilts are also popular choices. Critically, any investment needs to sport high liquidity as a sinking fund is all about having capital on hand when an expected expense hits.

Why investors should care about sinking funds

Once you’ve been investing for a while, you’ll know all about market risk. Even the best investors know what it is to take a loss, and the importance of managing volatility, diversification and drawdowns. But when it comes to personal finances, investors often fall into the trap of dealing with big expenses as they happen, rather than planning for them in advance.

This creates unnecessary financial stress. A sudden £800 dental bill paid from your general investing pot can feel like a setback — sometimes triggering potential tax implications or realising a loss and damaging long-term compounding.

Sinking funds reduce this friction. They smooth out expenses over time, matching your cash flow with your liabilities. And if you like order and predictability in your portfolio, you’ll likely appreciate the psychological benefit of having the same in your day-to-day finances.

For example, imagine your car insurance renewal is due in nine months. You expect it to cost around £720. Instead of letting the debit hit your account in one go, you create a sinking fund — dividing £720 by 9 months to save up £80 a month. You then set up a standing order to transfer £80 into a separate investing account every month. When the bill arrives, the £720 is already waiting and the bill is paid with zero disruption.

Alternatively, you may even set up a sinking fund to plan for large life changes — for example, parental leave, a sabbatical or moving house.

Of course, you need to be careful not to make any mistakes. The usual errors include underestimating costs, which can be dealt with by building in a buffer. Some also dip into the pot for non-related expenses or forget to segregate the cash into a separate account. It’s also common to see investors think a sinking fund is only for individuals with large incomes — but even budgeting for smaller one-off expenses can be worthwhile.

Sinking funds can also support long-term financial goals beyond routine expenses. For example, setting up a fund for future home improvements or a milestone celebration — like a wedding or anniversary — can make major life moments feel less financially daunting.

When structured thoughtfully, they become part of a wider financial strategy, working alongside SIPPs, ISAs and general investment accounts. By aligning your sinking fund with a clear goal and timeline, you maintain increased clarity and control of your overall wealth.

Sinking funds vs emergency funds

It’s easy to confuse the sinking funds with emergency funds, especially since they both involve setting aside capital. But they serve very different purposes.

Your sinking fund is for expected known expenses — planned in advance and covers multiple categories of expense. The amount of capital you set aside is carefully calculated and designed to cover a specific period of time.

Conversely, an emergency fund is designed for unexpected financial strains, and used only in rare, urgent situations. It’s typically set aside and spent as a lump sum and protects you for when life throws a curveball at you — for example, if you lose your job or need to take an extended unpaid break from work. It’s usually between three and six months’ of your typical expenses.

A good rule of thumb is that if you can name the future event and roughly estimate the cost, it’s a sinking fund. If you can’t, it’s an emergency fund item.

Pros and cons of sinking funds

As with all investing strategies, sinking funds have advantages and setbacks.

Pros of sinking funds:

• Predictable cash flow — large expenses no longer come as a surprise. By breaking them into monthly chunks, you get improved consistency in your budgeting
• Avoids unnecessary debt — you don’t need to rely on credit cards, overdrafts or personal loans when big bills arrive
• Protects your emergency fund — because you’re planning for known expenses, your emergency savings can stay reserved for true emergencies, like job loss, medical issues or sudden home repairs
• Encourages intentional spending — knowing you’ve saved for something in advance makes spending less stressful. There’s arguably a psychological benefit to paying with confidence rather than guilt
• Easy to automate — modern banking apps and investing tools make it easy to track and automate sinking funds

Cons of sinking funds:

• Requires planning and discipline — you need to be proactive, organised and consistent. Skipping months or underestimating costs can undermine the system
• Money may sit idle — cash in a sinking fund might not earn much of a return, as it tends to sit in low risk investments. This opportunity cost can be a downside if funds accumulate for extended periods
• Can feel overly restrictive — for people who prefer flexibility or looser budgeting, earmarking money in advance for specific categories might feel too rigid
• Risk of overcomplicating — managing too many small pots or accounts can become confusing for many investors if not well organised

Sinking funds summed up

• A sinking fund is a dedicated capital pool you build up over time to cover known, planned expenses like insurance, taxes or holidays, helping you avoid debt
• You can keep sinking funds in cash or invest them in low-risk, highly liquid investments to potentially earn some returns while keeping the money accessible
• Using sinking funds helps protect your emergency fund for true emergencies and smooths out your cash flow, reducing financial stress and disruption
• Sinking funds are popular with many investors given the importance of personal finance, though require discipline and aren’t for everyone