What Are Sinking Funds and How Can They Keep You Afloat?

Have you ever heard of the term “sinking funds”? What are sinking funds? It sounds like something pretty complicated on the surface, doesn’t it? There is the ring of danger to it and it almost sounds like it’s high finance or big business.

Sinking funds are important tools in planning your finances. Here's how they differ from emergency funds and why you'll want to set them up.

It is, and it does sound scary to some perhaps because it’s a phrase not often found in everyday at-home use. But it is something you need to be aware of, because every one of us at some point needs to have one! Let me tell you about it and how sinking funds can keep your finances afloat.

What Are Sinking Funds?

A sinking fund is a strategic way for you to save your money. The idea is to save money by setting aside a little of your money each month for a period of time you determine and then when you have that money, you use it to purchase some sort of specific asset for which you have a definite need. This is an asset you will buy in your future, but you already know you are going to have to buy it. It’s planning ahead for something very specific and it’s not just saving for that “what if this or that happens” occasion.

A sinking fund is more than just a saving account pool of money. It has a definite purpose and goal and is highly focused as just that.

Whose Idea Was This?

Sinking funds are actually pretty common, primarily as a business or corporate tool. Established by an economic entity like a bank or a business, it is literally the setting aside of their regular revenue over a period of time to fund a future capital expense, or repay some or all of their long-term debt. For you, this type of planning works too.

One difference though is that it is common for public and private corporations to raise funds through the issue of bonds as the usual way. But of course for you and me, issuing bonds isn’t a real option.

Of course if you do find someone willing to float you the money for a bond, it’s probably only a matter of minutes afterwards that you’d be heading for the tropics, leaving with a new name and identity as well. But seriously, are sinking funds for you?

Can’t You Just Call It a Savings Account and Get It Done?

Research shows that the average American just doesn’t save enough money from their weekly paychecks, for anything. So that means that a lot of people have never experienced the magic of a sinking fund and they really need it. A sinking fund for what you ask? Here are some good reasons why…

Sinking funds work great for things you don’t want to pay for from your current monthly budget in one shot. Some of these can get pretty costly in any given month such as new tires for your car, your Christmas gift list, a major health bill, replacing a major appliance, vet bills, upcoming wedding plans, your big annual vacation planning, and of course, remodeling your home in some way…just to name a few. The beauty part is that you can create a sinking fund for any financial goal you have!

Sinking Fund vs. Savings Account – The Big Differences

In a savings account, your money is all lumped together and you actually take some money out of it as you “think” you need it. It’s a potential, blurry event with no focus. So instead of lumping everything together in your savings account, be more deliberate and specific by having multiple sinking funds with each having a specific goal.

A sinking fund is more specific than a savings account and you know exactly how much you’ll save and how you’re going to spend it when you actually do.

You could literally have a dozen sinking funds, each with a specific well-planned purpose.

Why Not Call It an Emergency Fund?

A sinking fund is different from an emergency fund. An emergency fund is money set aside for the unknown or the “what if” factor. The pandemic and your unemployment would have been one major use of an emergency fund if you had one ready for it. Your sinking fund is a “well known way in advance” entity.

Emergency funds are the funds you use as your safety for what can happen in real life. You just never know what will come under an “emergency” heading or when it may happen. But you do know that it will, so you have that money set aside and try to be ready for it.

The sinking fund, while it might be used for what you may call an emergency, is not because it is for the known. The emergency fund is for the unknown. You know your older car is going to need repairs at some point. You know you’re going to give holiday gifts each year. They’re not emergencies, and that’s why you need sinking funds.

The Benefits of Sinking Funds

Everyone can benefit from a sinking fund. We all know that we differ in the ways we save for things. Some do a great job and some just never get around to it. Sinking funds can smooth that road out for you. All that changes when you add a sinking fund is your budgeting routine.

Preparing for the inevitable expenses that we all know are coming down the pike makes so much sense, doesn’t it? Saving over time for expected expenses (like new tires for the car and repairs for the house) will make those purchases much less stressful.

When you open a savings account for a sinking fund, make sure it’s a free account without any fees.

How many sinking funds should you have? Now that you’ve seen the beauty of sinking funds, you may want to assign a sinking fund to everything. Use your best judgment!

Final Thoughts

See what a difference a little strategic saving plan can make? Sinking funds require both thought and patience. Doing that removes a lot of stress from your future spending plans and that’s why a sinking fund is a great option to start right now!

Have you ever been caught short of funds when you could have planned ahead and prevented that stress? Do you see the value of a sinking fund and will you start one or more right away?

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