What is a Sinking Fund? Benefits & How to Create One

What is a Sinking Fund? Benefits & How to Create One
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  • nesto
| Mar 28, 2023
Reviewed, Jun 8, 2023

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    Are you looking to save for something specific, such as a friend’s trip, replace your run-down car, buy a wedding gift for your little sister or even a down payment on a home? While there are different types of savings accounts that can help you achieve your financial goals, are you familiar with the term ‘sinking fund’? In this article, we will explore the sinking fund meaning and its benefits, as well as how to create one to reach your financial goals. So, if you’ve ever asked yourself “What is a sinking fund?” keep reading to learn more!

    Key Highlights

    • A sinking fund is a special type of savings account where you save money for a specific goal or purpose.
    • The great thing about a sinking fund is that you save money gradually and have the money ready when you need it. It’s a disciplined way to save money and can help you avoid financial stress and debt.
    • Regularly monitor your progress and adjust your savings plan as needed to make sure you are on track to reach your goals.

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    What Is a Sinking Fund?

    A sinking fund is a sum of money that you save gradually for something specific over a set period of time. You may decide to use it to pay off existing debt, replace something that you know will need replacement in the future (bike, roof repair, car tires, etc) or cover an upcoming expense (planned holiday, birthday presents, a wedding, vet fees, etc)

    Let’s imagine that you want to replace your current car in approximately two years and you’d like to have a budget of around $10,000 by then. You can start a sinking fund today by putting money aside each month, so you’ll have enough money to buy the car when the time comes. By setting aside a small amount of money each month, you’ll avoid having to borrow money or get a car loan to buy it, which can save you big money in the long run.

    Differences Between a Sinking Fund vs. Savings Account

    A savings account is a special type of account where you put money aside and earn interest on it. You can deposit money into your savings account whenever you want, and you can usually take it out whenever you want too, although sometimes there might be rules about how often you can take money out.

    A sinking fund, as we saw earlier, is also a way to save money, but it’s a little bit different from a savings account.

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    The main difference between a sinking fund and a regular savings account is that with a sinking fund, you have a specific goal in mind, (a wedding gift, family trip, kitchen renovation, etc.)  while with a savings account, you might just be saving money for the future without a specific purpose in mind.

    Differences Between a Sinking Fund vs. an Emergency Fund

    A sinking fund and an emergency fund are two types of savings accounts, but they are used for different purposes.

    If you have an emergency fund, it’s usually a fund to save money for unexpected events that might happen to you, like if you or someone from your household get sick or you lose your job. By having an emergency fund, you’ll be prepared to cover unexpected expenses without having to go into debt or borrow money.

    The main difference between a sinking fund and an emergency fund is that you’ll aim to always have a specific amount of money available, such as enough to cover 3 to 6 months of your expenses. If you ever need to use it, you’ll make an effort to plenish the fund as soon as possible. Whereas with a sinking fund, once you’ve spent, you can either forget about it or set a new goal or purpose.

    Why Sinking Fund is Important To Pay Off Debt.

    One of the biggest risks in personal finances is the unexpected. Personal financial planning is a great way to manage risk and that’s why sinking funds are so important as they put you in charge of your finances. 
    By planning carefully, you’re being truly intentional with your spending and savings.  By setting up various sinking funds, you won’t need to rely as much on personal loans, credit debts or other types of financing to make purchases or pay off bills, thus saving you money in interest and fees.

    The more sinking funds you’re able to set up and gradually grow, the less debt you’ll accumulate over time.

    Sinking Fund Examples

    Let’s look at some of the most common types of sinking funds.

    Vacation sinking fund:

    A vacation fund is designed to help you save for a specific trip or getaway, not just a random holiday sometime next year. By setting aside money each month in a sinking fund, you can avoid having to put your vacation on a credit card and accruing interest.

    Car sinking fund:

    A car fund is designed to help you save for a down payment on a new car or to cover the costs of maintenance and repairs for an existing car. The older your car is, the more likely you’ll have repair costs in the coming months. So why not be prepared and start setting aside money each month in a sinking fund to avoid having to take out a car loan or pay any car expenses with a credit card?

    Home repair sinking fund:

    A home repair fund is designed to cover the costs of maintenance and repairs for your home.

    Education sinking fund:

    An education fund is designed to help you save for college or other education expenses.

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    Here are some answers to frequently asked questions about sinking funds.

    Should you have more than one sinking fund?

    Yes, it’s a great idea to have more than one sinking fund, especially if you have various goals that you’re working towards. Having separate sinking funds will help you keep track of your progress and also stay on course, rather than having one pot for everything.

    In addition, having multiple sinking funds can help you prioritize your financial goals. If needed, you can always send more money to the sinking funds that are most important to you and adjust your savings plan accordingly, because life happens and priorities change.

    How do you calculate how much to put in a sinking fund?

    When you’re planning a big expense such as a dream vacation, a down payment on a flat, or an upcoming medical expense, you need to know how much to put in your sinking fund. 

    The actual amount will depend on your end goal and when you want to do it. 

    Here are 3 simple steps to help you determine how much to put in a sinking fund.  First, determine your savings goal by being as specific as possible. Then decide on a timeline and finally divide your savings goal by the number of months.

    Follow these steps to calculate how much to put in a sinking fund each month and reach your financial goals. It’s important to watch your progress and adjust your budget as needed to make sure you are on track to reach your goal.

    Where does the Phrase “Location, Location, Location” Come From?

    The phrase “location, location, location” is a common saying in the real estate industry, used to emphasize the importance of a property’s location when determining its value. The origin of the phrase is unclear, but it’s believed to have originated in the early 1900s.

    Final Thoughts 

    Having a sinking fund for various savings goals is a great way to minimize stress and keep up with long term plans.

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