What is a Sinking Fund, and How Do I Use It?

what is a sinking fund used for

A sinking fund can play a valuable role within your larger budget, which is designed to manage your spending based on what you can afford. It also allows you to cover significant expenses without having to deplete your emergency savings fund. You may be a pro at padding your emergency fund or sticking to a monthly budget. But adding sinking funds to your financial skill set can help you better manage your money and focus on your financial goals.

  • Also, take advantage of specialized accounts designed specifically for sinking funds — think Vacation Club or Christmas Club accounts — that are easy to set up and access.
  • As a result, the company is usually seen as creditworthy, which can lead to positive credit ratings for its debt.
  • Rather than dipping into your emergency fund for a new couch or a weekend away, you can save money over time when you use a sinking fund.
  • The disadvantage of not having a sinking fund is that you will have to pay back the loan over a much longer period.
  • John opens a sinking fund and contributes a set amount each month for the next twelve months.

Plus, you give yourself more negotiating power when it is time to purchase. Some businesses also use the term sinking funds for planned expenses. You can also use a regular savings account for your sinking fund.

What Is a Sinking Fund?

A sinking fund helps companies that have floated debt in the form of bonds to gradually save money and avoid a large lump-sum payment at maturity. Some bonds are issued with the attachment of a sinking fund feature. Of course, you can also use a traditional savings or checking account as a sinking fund. Alternatively, you can itemize money within your existing savings account, so you know how much is earmarked for a specific expense. You need a sinking fund if you have debt, whether it’s a car loan or a college loan or even a mortgage.

You can also use budgeting apps such as Monarch Money or Quicken to keep tabs on your monthly expenses, including your sinking fund. The confusion between the words “sinking” and “emergency” can also lead to people using their emergency funds in place of a sinking fund. In finance, a sinking fund is a fund set aside from current income for the repayment of debt. The sooner you start, the more prepared you’ll be for next year’s holidays (not to mention other big expenses). However, an unexpected car repair would be covered by your emergency fund, whereas you would use a sinking fund to replace the tires since that is an expected expense.

what is a sinking fund used for

Most importantly, sinking funds are for things you know are coming. In general, they are much more targeted and specific compared to other types of savings. Now that you know you’ll need to set aside $500 a month, take a look at your current budget or spending habits to determine where that money is going to come from. Maybe it means cutting back in certain areas or looking for ways to earn an additional $500 per month, just make sure you’ve planned appropriately.

Sinking fund vs. savings account

Another example is John, who has been wanting to take the trip of his dreams. John opens a sinking fund and contributes a set amount each month for the next twelve months. Since this account is earmarked for John’s vacation, he doesn’t access any of the funds until he’s ready to take his trip, ensuring it’s an affordable expense to cover.

what is a sinking fund used for

For example, a bond callable at a price of 102 pays the investor $1,020 for each $1,000 in face value, yet stipulations might state that the price goes down to 101 after a year. The information presented here is created independently from the TIME editorial staff. Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. Quicken has made the material on this blog available for informational purposes only.

Savings Accounts

If you want to spend $1,000 on Christmas and it’s September, you only have about three months to save. That means you’ll need a line item in your budget reminding you to stash away about $330 every month until December. No matter what your money tendencies are—spender or a saver, nerd or free spirit, experiences or things—everyone can benefit from a sinking fund. With a sinking fund, on the other hand, you know exactly what that money’s for, and you know when you’ll use it.

Sinking funds are pretty simple to set up once you have decided to go this route. You would have to be spending more time under debt and paying more interest in the long run. You won’t have to spend as much time or money paying back the loan in the long run. This helps you decrease the total amount of interest that you end up paying on the loan. As you build your savings, it will eventually begin to work for you.

She decides to create a new sinking fund to cover all of the expenses of the renovation. Jennifer picks a date to start the renovations and does a few quick calculations to determine how much she will need to save. If you’re not that disciplined with a savings account, another option is to establish a money market account. These types of accounts are a little less accessible compared to a savings account, but they come with other benefits.

Sinking Fund: What Is It, Types & How to Set One Up

While you can use any checking or savings account, having multiple funds under one account can get confusing. Make sure you take time to set up a system for tracking exactly how much you’ve put toward each goal and how much of your account is allocated for each project. This simple step will keep you from accidentally spending the money you’ve put so much effort into saving. For security and simplicity purposes, Tucker prefers a digital version.

A sinking fund is essentially a savings account that you use specifically to pay off loans or other forms of debt. Sinking funds and savings accounts are both very closely related, so if you have a sinking fund, it’s possible that you also have a savings account. As we head into the last few months of the year, holidays like Halloween, Thanksgiving, Hanukkah, and Christmas hold the promise of food, family, travel, and gifts.

What Is the Need for a Sinking Fund?

This is different compared to a traditional savings account or emergency fund. A high-yield savings account has a higher annual percentage yield (APR) than a regular one, which means you’ll earn more interest. Setting up an HYSA as a sinking fund can help you get a greater return on your savings, which could help you reach your goal sooner. You can often find the best HYSA at an online bank offering a higher APY, due to fewer overhead costs than a brick-and-mortar bank. A savings account is an individual bank account you can set up at any particular financial institution.

You can spend without guilt because you haven’t negatively impacted your budget to get there. If you’re just getting started with sinking funds, Tucker recommends holiday savings as a great way to dip your toes. “Write down all the holidays you celebrate throughout the year, including birthdays, then decide how much to budget toward each one,” she suggests.

Sinking fund vs. emergency fund

A sinking fund is a sum of money that you set aside (usually by saving a bit each month) that’s completely separate from your savings account or your emergency fund. Now you have your target amount and date, it’s time to decide where you will keep the money. A high-yield savings account, or an HYSA, is a good option for a sinking fund since you’ll have access to the money when you need it and earn a good return on your savings.