Sinking Fund Investment: A Smart Financial Strategy?

A sinking fund is a strategic way to save money for a future expense by setting aside a small amount of money each month. It is different from a savings account or emergency fund as it has a singular purpose. A sinking fund is useful for saving for an expense that you know is coming up, such as a holiday, wedding or new car. It can also be used to pay off debt or bonds.

Sinking funds vs savings accounts

Sinking funds and savings accounts are both useful tools for managing your finances and preparing for expenses. They can help you save for anything from a vacation to a new car, or even just for paying an unexpected bill. However, they are not the same thing.

A savings account is where you save your money, whereas a sinking fund is how you save your money. A sinking fund is a strategic way to save money by setting aside a small amount of money each month for a specific purpose. This allows you to save up for large expenses without having to come up with a large sum of money all at once. For example, you could create a sinking fund for a new car, next year's vacation, or Christmas presents.

On the other hand, a savings account is a place to deposit and store your money while earning interest. Savings accounts offer easy access to funds and the potential for modest interest accrual. They come in various types, including traditional savings accounts and high-yield savings accounts.

One key difference between sinking funds and savings accounts is that sinking funds provide clarity and intentionality by designating what the money may be used for. While you can have multiple savings accounts, each can be designated as a specific sinking fund. For example, you could have one sinking fund for a honeymoon and another for vehicle expenses. With a general savings account, it can be difficult to keep track of different savings goals in one account.

Additionally, sinking funds can help prevent you from withdrawing money from your emergency fund or going into debt to pay for things. They can also help with budgeting by creating tangible goals and serving as motivation to save and budget consistently. However, managing multiple sinking fund accounts may become time-consuming and confusing, and the money kept in sinking funds may earn minimal interest.

In summary, sinking funds and savings accounts serve different purposes but can work together to help individuals manage their finances and achieve their financial goals.

Sinking funds vs emergency funds

A sinking fund is a strategic way to save money by setting aside a little money each month for a specific purpose. It is used for saving up for large, planned expenses.

An emergency fund, on the other hand, is for unexpected expenses. For example, if you lose your job or face unforeseen medical costs, you can use your emergency fund to cover these costs.

Sinking funds are useful for expenses that you know are coming up and can plan for. For example, if you know you will need to buy new tires for your car or a bridesmaid dress for a friend's wedding, you can start putting money into a sinking fund and save up for these expenses over time. This helps you avoid having to pay a large sum of money all at once.

Emergency funds, however, are for unexpected costs that you cannot plan for. For example, if your air conditioner breaks down or you get a flat tire, you can use your emergency fund to cover these repairs.

Both sinking funds and emergency funds are important tools for financial planning and saving. Sinking funds help you save for specific, planned purchases, while emergency funds provide a safety net for unforeseen expenses. By using both types of funds, you can avoid going into debt when you need to pay for a large expense or unexpected cost.

It is important to note that sinking funds and emergency funds serve different purposes and should be treated as such. Sinking funds are meant to be spent on specific goals, while emergency funds are meant to be a general buffer for unexpected costs. The amount you save in your emergency fund is typically recommended to be three to six months' worth of living expenses, while the amount you save in a sinking fund is tied to the cost of the specific purchase you are saving for.

How to set up a sinking fund

A sinking fund is a strategic way to save money for a large expense. It involves setting aside a small amount of money each month for a specific purpose, allowing you to save up over time instead of needing a large sum all at once.

Step 1: Decide what you're saving for

Determine the purpose of your sinking fund. This could be anything from a large purchase like a new car or furniture, to a special occasion like a wedding or holiday, or even something more routine like car maintenance or insurance payments.

Step 2: Choose where to store it

You can choose to open a separate savings account specifically for your sinking fund. Make sure the account doesn't have a minimum balance requirement or monthly fees that could eat into your savings. Alternatively, you can use a budgeting app or tool that allows you to designate specific funds within your budget, such as EveryDollar.

Step 3: Calculate how much you need to save

Figure out the total amount you want to spend and then divide it by the number of months or weeks you have until you need to make the purchase. This will give you the amount you need to save each month or week to reach your goal.

Step 4: Set up your sinking fund in your budget

Ensure that your sinking fund is included in your monthly budget. You can use a budgeting app, spreadsheet, or even just a pencil and paper to keep track of it. If you're using an app like EveryDollar, follow the steps to create a new budget item and designate it as your sinking fund.

Step 5: Make regular contributions

Set up automatic monthly transfers from your main checking account to your sinking fund savings account or app. This will help you stay on track and ensure that you're consistently saving towards your goal.

Remember, it's important not to have too many sinking funds at once, as it may be challenging to juggle them all. Focus on a few savings goals at a time and prioritise accordingly.

Where to keep sinking funds

So, you want to know where to keep your sinking funds?

Firstly, it's important to note that sinking funds are not the same as savings accounts. A savings account is where you save your money, and a sinking fund is how you save your money. You can have multiple sinking funds for different purposes within one savings account.

Now, when it comes to where to keep your sinking funds, you have a few options:

Separate Savings Account

You can choose to open a separate savings account specifically for your sinking fund. This can help you keep track of your savings goals and ensure you don't dip into your savings for other purposes. Just make sure the account doesn't have a minimum balance requirement or monthly fees that could eat into your savings.

Budgeting Apps or Tools

You can use budgeting apps or tools, such as You Need a Budget (YNAB) or EveryDollar, to monitor and manage your sinking funds. These apps can help you allocate your money effectively and ensure you stay on track with your savings goals.

High-Yield Savings Account

Another option is to keep your sinking funds in a high-yield savings account. This allows your savings to grow over time without you having to lift a finger. However, be aware that accessing your funds may not be immediate, as you may need to transfer the money to a checking account first.

Traditional Bank Account

If accessibility is a priority, you can simply keep your sinking funds in your traditional bank account. This option provides easy access to your funds, but it may be too tempting for those prone to overspending or impulse buying.

Remember, the key is to find an option that works best for you and your financial goals. It's important to assess your budget, priorities, and savings behaviour to determine the most suitable place for your sinking funds.

Benefits of sinking funds

Sinking funds are a great way to save for anything and everything. They are a strategic way to save money by setting aside a little bit of money each month. Here are some benefits of sinking funds:

Save for anything and everything

Sinking funds can be used for any financial goal or dream. Whether it's a new car, a vacation, or even an adult-sized scooter, you can create a sinking fund for it. By setting aside a specific amount of money each month, you can save up for your purchase without having to come up with a large sum of money all at once.

Plan for big, extravagant fun

Sinking funds allow you to plan for and save up for big purchases or experiences. Whether it's an Alaskan cruise, a kitchen upgrade, or investing in your hobbies, a sinking fund can help you make it a reality.

Ditch large-purchase guilt

With a sinking fund, you can decide upfront what you're saving for and how much you want to set aside. This way, when it comes time to spend, you can do so without worry or regret and without going into debt.

Prepare for inevitable expenses

Sinking funds are perfect for those expenses that you know are coming up but can't pay for in a single month's budget. For example, if you know your car needs new tires or your house needs a new roof, you can start saving for those expenses ahead of time.

Improved creditworthiness

For companies, sinking funds can improve their creditworthiness. Since sinking funds add an element of security and lower default risk, the interest rates on the bonds are usually lower. As a result, companies are seen as more creditworthy, which can lead to positive credit ratings and increased demand for their bonds.

Improved cash flow and profitability

Lower interest rates due to improved creditworthiness can result in improved cash flow and profitability for companies over the years. This can also increase the likelihood of raising additional capital if needed.

Frequently asked questions