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What is a Sinking Fund and its Purpose?

Do you have financial goals like purchasing a home, home repairs, or debt repayment and you don’t have enough finances? You can open a sinking fund and start saving up for your big purchase.  A sinking fund is an account where you save some up for a specific project for a certain period. Instead of having to raise a huge chance of money at a go, you save up for it in small amounts for a specific period.

In this article, we will tell you what a sinking fund is, how to set up one, and its benefits.

Meaning of Sinking Fund

A sinking fund is a kind of a fund set aside to repay debt, bond or for a specific goal. The account holder deposits some amount of money regularly in a sinking fund. A sinking fund is commonly used by corporations to save in order to pay off bonds and debts before the maturity date. It makes it very easy to repay debt since there is sufficient money set aside for that.

How a Sinking Fund Works

Banks have a different kinds of savings accounts. You can open a sinking fund and start saving up for your project. You can then start making regular deposits to your account for a specific period until the maturity date.

When opening a sinking fund account, check out for minimum balance requirements. Go for accounts that do not have minimum balance requirements. Consider a locked savings account so that you don’t have easy access to the money until the maturity date.

Also read: Is renting a waste of money?

Sinking Fund Example

Many times you want to buy something; let’s say a car but you don’t have sufficient money. As a result, you set aside some money for your project. Every month or week, you set aside some money; let’s $50 so that at the maturity date, you will have sufficient funds to finance your purchase.

How to Create a Sinking Fund

Now that you know how a skinning fund works, this is how you can create one:

Step 1: Know What You are Saving Up For

First, you need to have a goal or a target. In simple terms, get to know what you are saving up for. For instance, your plan could be to save up to buy a home.

Step 2: Decide How Much You Need to Save

To know how much you need to save for your project regularly, calculate the total value of the project. Then divide its value with the number of weeks or months you want to save up for it.

Step 3: Decide Where to Store Your Sinking Fund

You can open special savings account for your sinking fund. Ensure the account does not have a minimum balance requirement. You can consider locked savings account so that you don’t have easy access to your savings.

Step 4: Include Your Sinking Fund in Your Budget

You need to adjust your budget to accommodate your sinking fund. You can use budgeting tools like EveryDollar. Find ways you can adjust so that you have enough money to save in your sinking fund.

Benefits of a Sinking Fund

Having a sinking fund has many benefits for an individual or a company. These benefits include:

1. Attracts investors. Investors are usually aware that corporations with huge debts are always at a risk of going bankrupt. However, if a corporation has a sinking fund, it gives investors the confidence that the company will repay the debt since it is saving up for it in a sinking fund.

2. Lower interest rates on loans. If a company has poor credit ratings, it becomes difficult to attract investors. Alternatively, the company would need to offer higher interest rates to attract investors. However, if the company can provide alternative security towards investors’ funds using a sinking fund, it can get loans from investors at lower interest rates.

3. Provides financial stability. Financial stability is when you are able to meet your goals and expectations. When you save up for a project through a sinking fund, you are in a position to meet your goals and expectations. It helps you become financially stable.

4. Build wealth. A sinking fund can help you save for a project like buying a home, which in the end helps you create wealth. You need to plan your finances well and come up with goals. Besides, a sinking fund helps you increase your sources of income and track your financial progress.

5. Improves your credit ratings. Your credit ratings determine whether or not you can get a loan. If you have good credit ratings, it becomes easy to get a loan at lower interest rates. If the lender is aware that you have a sinking fund, it becomes easy to qualify for a loan.

Sinking Fund vs Saving Account vs Emergency Fund

A sinking fund is almost related to a savings account and an emergency account. However, these three are different.

  • A savings account is an account where one makes regular deposits in the long term (no specific period) without a specific goal.
  • An emergency fund is a special account where you deposit funds for unexpected life curvatures such as loss of a job, business failure, or medical expenses.
  • A sinking fund is an account where you save up money for a specific goal; like debt repayment or purchasing a home for a specific period.

Summary of What a Sinking Fund is and its Purpose

If you have a goal and don’t have the money, why not save for the big purchase in a sinking fund? You can use a sinking fund to save money to buy a car, a home, or even repay a debt. A sinking fund helps you avoid disruptions from big purchases. However, to set up and save through a sinking fund, you need financial discipline and planning. 

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