5/24/2022
Use this strategy to painlessly save for big-ticket items
A Sinking Fund is a financial strategy that allows you to not just dream about a large purchase or sunny vacation, but to save the cash to make it happen. Sinking funds become a part of your monthly budget and can even be automated to make saving easy.
What Is a Sinking Fund?
A Sinking Fund is a line item in your budget to save money for a specific purpose by saving a small portion of your income each month.
How does it work?
Here's the plan; decide what you want (or need) to save for and how much. This can be something fun like a vacation, or something much more mundane like your annual car insurance bill. Divide the amount needed by the number of months you have before you'll need that money. That's the amount that you'll need to save each month to make this a reality.
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Where to keep your Sinking Fund
Now you need somewhere to put it! By designating a specific savings account for these funds, you'll not be tempted to use them for something else. Set up an automatic transfer each month from your paycheck to be transferred to your sinking fund. Now, let time work in your favor as the money slowly accumulates into that account and is ready when you need it.
If you don't have a specific time frame for when you need those funds, say you're saving for a home deposit but aren't sure when you want to buy a house, just start the fund and let a small amount of money, consistently deposited over time, accumulate. The key is having these funds in a separate account that is specifically for that purpose so that you won't use it for a different reason. Here are some accounts to consider:
High-yield savings account: These savings accounts carry a higher interest rate than traditional savings accounts and are just as easy to pull cash out of when you need the money. These accounts may need to maintain a minimum balance to avoid fees.
Money market account: Money market accounts typically offer higher interest rates than traditional savings accounts, but will require a higher minimum starting balance than other types of savings accounts.
By creating and automating your savings for a specific purpose, you'll feel the joy of being able to pay for an expensive item when the time arises with cash, and experience little financial stress. Saving a small amount regularly for a planned and expected expense will eliminate you needing to come up with a large sum of money on the fly.
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This is a very intentional way to manage financial planning for large ticket items. Have as many Sinking Fund accounts as you see fit. Separating our your financial goals is a great way to keep track of where you are with each target. Several Sinking Funds can be tracked in a budgeting app like Mint. Remember to review your budget at least every 6 months to ensure you are staying on track.
How is a Sinking fund Different from an Emergency Fund?
Sinking funds have a specific purpose and usually a defined target amount that you are saving.
An emergency fund is a separate saving account that will cover unforeseen issues and should contain 3 to 6 months' living expenses. For example, you'll need to use your emergency fund to repair your car, pay a large unexpected medical bill or purchase a new washing machine should yours suddenly die. The only thing that is certain about financial emergencies is that you will experience them from time to time. Emergency funds cover these unexpected items so that they a mere inconveniences rather than financial emergencies.
Creating Sinking Funds that cover your foreseeable financial needs and wants by turning them into small, manageable budget line items, removes the stress around paying for even fun things. Want to save up for a family vacation? Planning ahead with a Sinking Fund so that the money is there when it's time to pay for the flights and hotel rooms will make that vacation much more enjoyable. If you put all of those expenses on your credit card and had to pay them off after you returned from your trip, it would play on your mind the entire time you were away.
Ideally, before you create Sinking Funds for vacations or a new car, you'll have your other debts under control and your emergency fund in place. If you need help gaining control over your unsecured credit card debts, consider a credit counseling session with aCertified Credit Counselor.
Lori Stratford is the Digital Marketing Manager at Navicore Solutions. She promotes the reach of Navicore's financial education to the public through social media and blog content.
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FAQs
In personal finance, a sinking fund is simply a savings account that you use to save for an expense that you know you will need to pay for in the future. The goal is to set aside enough money to cover this known expense so that you don't blow a hole through your budget when the bill eventually comes due.
How do you use the sinking fund method? ›
Initially, a sinking fund is created and a fixed amount of money is allocated to it every set period. Over time, this pool of money will become larger, and then there are available funds to pay an old debt or replace the asset. Every year you allocate a certain amount of money to a sinking fund.
What is a sinking fund Quizlet? ›
Solution. Answered 2 years ago. Answered 2 years ago. A sinking fund is a bond trustee-managed account to repay the debts. The company pays the trustee annually, which then retains a share of the debt using the funding.
What are the two ways a sinking fund can be handled? ›
Answer and Explanation: The two ways to set up a sinking fund are: The first thing is through trustees who invest the annual payments of the entities in government bonds, and the other way is to either retire the bond issues or selling or purchasing bonds, whichever is lower.
How is a sinking fund used? ›
In personal finance, a sinking fund is simply a savings account that you use to save for an expense that you know you will need to pay for in the future. The goal is to set aside enough money to cover this known expense so that you don't blow a hole through your budget when the bill eventually comes due.
How do you use a sinking fund explain your answer in detail? ›
The sinking fund method is a technique for depreciating an asset while generating enough money to replace it at the end of its useful life. As depreciation charges are incurred to reflect the asset's falling value, a matching amount of cash is invested. These funds sit in a sinking fund account and generate interest.
What is the 50 30 20 rule? ›
The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.
Can you withdraw from a sinking fund? ›
If one sinking fund has a shortfall for an expense, you can always withdraw from another sinking fund to avoid going into debt. For example, if you need $500 for car repairs and your car repair fund only has $300 in it, but you've got the extra $200 in your house down payment fund, then by all means, use it.
What is a good amount for a sinking fund? ›
If buying into a large strata scheme, you would expect a sinking fund to be hundreds of thousands of dollars. Equally, if you are buying into a block of six, the sinking fund could be reasonable with a balance of only $60,000, because it is a matter of proportion.
Is a sinking fund risky? ›
Since a sinking fund adds an element of security and lowers default risk, the interest rates on the bonds are usually lower. As a result, the company is usually seen as creditworthy, which can lead to positive credit ratings for its debt.
Typically, a sinking fund's assets are gathered from tenants over time, sometimes by recurring contributions or as stipulated in the lease. By setting aside money regularly, the landlord can ensure they have the necessary funds when the expense occurs, reducing the need to borrow or divert funds from other sources.
What comes out of the sinking fund? ›
A sinking fund is a reserve account that's set up to protect the value of a property. It is often used as an investment vehicle by investors who want to make sure their money will not be lost or devalued over time. Sinking funds can be used for various purposes, including: covering the costs of repairs and maintenance.
How do you solve a sinking fund? ›
How do you calculate sinking fund? First, multiply the percentage interest by the principal amount. This will equate to the interest amount, which is then added to the principal amount. This total is the amount of money that needs to be in the sinking fund to meet the set financial obligation.
What is the biggest benefit to a sinking fund? ›
One of the most significant benefits of sinking funds is their role in preventing debt. By saving in advance for expenses, you can take care of the expenses with cash, avoiding debt.
What are the disadvantages of a sinking fund? ›
Disadvantages of a Sinking Fund
Here are some more disadvantages: Opportunity Cost: The funds set aside in a sinking fund could earn a higher return if invested elsewhere. Over-funding: There's a risk of setting aside more money than necessary, which might affect the cash flow.
How do you use sinking fund factor? ›
The factor i/[(1+i)n−1] is called the “sinking-fund deposit factor”, and is designated by A/Fi,n . The factor is used to calculate a uniform series of equal end-of-period payments, A, that are equivalent to a future sum F.
What are the rules for sinking funds? ›
Sinking funds are in 'trust' for the scheme and should not be returned to lessees upon assignment, or at any time. Interest earned on funds should be added to the funds unless the lease states otherwise. If funds are held in 'trust' then a tax will be charged on the interest earned.
How much should you put in your sinking fund? ›
The amounts you save in your sinking funds can be small or large – it's really up to you. Plan to spend $600 on holiday gifts next year? Then you'll add $50 per month to a sinking fund. Want to set aside 1% of your home's value for maintenance and repairs?
Where do you put sinking funds on a balance sheet? ›
Business Accounting of Sinking Funds
A sinking fund is typically listed as a noncurrent asset—or long-term asset—on a company's balance sheet and is often included in the listing for long-term investments or other investments.
A Sinking Fund is a financial strategy that allows you to not just dream about a large purchase or sunny vacation, but to save the cash to make it happen. Sinking funds become a part of your monthly budget and can even be automated to make saving easy.