What is the Purpose of a Sinking Fund?
Well, let’s take it a step back, and look at what the sinking funds meaning is.
What is sinking funds meaning?
A sinking fund is a term describing the process of setting aside funds over time to meet a specific future expense. This is similar to automated saving, but this would be saving for a specific item/expense.
The purpose of a sinking fund is to ensure the funds are available when needed.
This post is about what is the purpose of a sinking fund.
The Pros of Having Sinking Funds:
1. Reduced Financial Stress
Sinking funds help manage reducing financial stress because the exercise of creating a plan, allotting a certain amount every so often to that plan makes it much more manageable. Instead of viewing it as a huge 1-time expense, it’s multiple bite-sized amounts that you’re putting away money for. It’s essentially saving up for a specific purchase (car, wedding, down payment, etc).
This provides more peace of mind, since you’ll now have the funds available to cover the specific expense when you need it!
2. Increase Saving
Sinking funds help with budgeting and planning for future expenses. Sinking funds make it much easier to track the progress towards your goal, and gives you more visibility to where your money is going. Therefore, by setting aside a fixed amount every single month, sinking funds as a financial tool help to build a habit of saving.
Ultimately, sinking funds encourage you to save more money.
3. Avoid Debt
When large expenses pop up, if you don’t have the cash to cover them, you might opt for using a credit card because it’s the easiest and most accessible. However, this ends up incurring high interest; therefore, you end up going into debt to cover those large expenses. Instead of potentially going into debt with the 1-time large expense, you’re saving for said expense far in advance.
Therefore, sinking funds help to avoid going into debt to cover the large expense.
4. Compounding Interest
Since the idea of a sinking fund is to save up for a large purchase, these funds don’t need to be very liquid or accessible. You can put these funds into a high yield savings account so that it can be easily transferred when you do need to access it, but it’s also one-step away from your checking account. This ensures you don’t spend it in a pinch. By putting it into a HYSA, this also allows the amount in the account to grow through compound interest.
So, by putting the sinking fund into a HYSA, it doubles up as helping you save, preventing you from easily accessing it, and grows while it’s sitting in the account!
5. Flexibility
Sinking funds are a super versatile financial tool. Why? Because, unlike tax advantaged accounts that are typically restricted to retirement, you can apply the process of saving up for a sinking fund to anything you want to purchase! Traditionally, these purchases include emergency funds, home renovations, weddings, cars, etc. But, as stated before, sinking funds can be applied to just about anything. Personally, I use sinking funds to save up for car insurance, annual holiday expenses, annual subscriptions (Amazon Prime, Costco Membership, and more).
As you can see, sinking funds are one of the most versatile and best financial tools because of its flexibility.
To summarize, the pros of using sinking funds:
1. Reduced financial stress
2. Increase Saving
3. Avoid Debt
4. Compounding Interest
5. Flexibility
There you have it! Now that you’ve read the pros of using sinking funds, how can you apply them to your financial planning? Check this post out for examples you can apply using sinking funds financial tool!
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