What You Need To Know About a Sinking Fund
We all have something special we'd like to buy for our home or in life. That old couch that has seen better days in your living room begging for a replacement or a vacation you thought about for a long time but keep pushing off because it is too costly. Paying for these significant expenses can be challenging, but a sinking fund may pave a better way.
Sinking funds can be a gamechanger for individuals and households. It is a valuable tool to add to your financial toolbox for savings. This strategy helps those who want to manage their finances better and gain peace of mind.
What Is A Sinking Fund?
Sinking funds have long been helpful for companies and bondholders to minimize risk. For example, when corporations need to raise capital, they may issue a bond that matures in 20 or 30 years. Bondholders receive coupons semiannually and the principal (their investment) at maturity.
Similarly, you or someone in your family can create a sinking fund, dedicating a savings account for a specific household expense that may be too large to handle without borrowing the money.
Sinking Fund Vs. Emergency Fund
An emergency fund is for the money you set aside in a savings account for unexpected costs you may face when losing a job, boiler breaks, a medical necessity, or pet surgery. The sinking fund is for saving money for a known purpose you expect to purchase in the future. Typically, your sinking fund is for a specific planned amount.
You can have a sinking fund by categories such as a house, car, vacations, Holidays, Christmas gifts, or charities. Alternatively, you can have sinking funds by being more specific: - Kitchen remodeling - Sofa - Flat-screen TV - Refrigerator - Car maintenance and repairs - Down payment for Car - Down payment for House - Pet bills - Taxes - Vacations
How To Set Up Your Sinking Fund
1. Review Your Budget Before setting up your sinking fund, you should a good grasp of your household's budget. Budgeting is an essential tool for understanding your income sources less fixed and discretionary expense categories.
Please make a list of sinking fund categories, break them down into more specific items. Then determine the target amounts for each. Name your sinking fund by its discreet type. Some funds may have higher amounts and longer timeframes. Divide each type total by the numbers from the planned purchase time.
2. List Your Planned Purchases
3. Where Your Savings Will Go For Purchases
You can open an FDIC-insured saving account for each type or have one large sinking fund named sub-accounts. Keep in mind that the sinking funds are separate from your emergency fund and savings accounts.
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