Want to Know More About Sinking Funds? Here's What to Know

Saving can be a challenge for some, and often issues like impulsive buying can be the root problem when it comes to mishandling money. When thinking about ways to save, the lengths you're willing to go to keep your money on track is up to you. You could try the Five Dollar Challenge or consider an alternative route.

Regardless of what you're saving your money for, opening a sinking fund is always an option. So what is a sinking fund, and how does it work? Here's everything we know.

Despite its name, a sinking fund is way less depressing than it sounds. A sinking fund is meant to help you reach your savings goal by strategically putting your money into your savings when generating funds for a specific goal. Sinking funds are created to accumulate money little by little as they build up toward a greater amount. Each month, you'll set aside a designated amount of money in one or more categories for where you'd like to save.

Your sinking fund should contribute toward saving for something that can't be paid off within one month's budget, like a car, vacation, wedding expenses, home remodels, and so on. Sinking funds are created with a future budget in mind, meaning they're more intentional than general savings accounts. These funds can also be put towards paying off a debt or bonds you have yet to repay in full.

Sinking funds also help companies that have kept debt afloat through bonds repay their dues by saving enough money to avoid being hit with a lump-sum debt. Some bonds are issued with a sinking fund feature already built in, so companies will have their debt relief working for them internally. These funds also allow the borrower to redeem their bond early and operate in a way where the money saved away can be put toward purchasing other shares or bonds.

If you're considering allocating some of your money into a sinking fund, many benefits come with this decision. Those with a sinking fund aren't responsible for paying interest on any loans, as you don't have to take one out to repay anything more than your debts owed if you're paying off bonds. When opening a sinking fund, your emergency funds also get to stay intact.

When you need cash in a flash, you'll be able to reach for your sinking fund without having to rely on your emergency fund in your time of need. Emergency funds are typically used for unexpected, unknown expenses, whereas a sinking fund is an alternative method for paying off general costs without offsetting your emergency savings. Sinking funds also allow accountholders to pay off multiple debts simultaneously. Stashing extra cash here gives you more to reallocate.

Sinking funds can also assist in breaking the habit of impulse spending. By setting a limit on what's accessible to you through your sinking fund, you can reign in the amount of money you're spending at one time. Knowing the current balance of your sinking fund is a visual cue of what you can— or can't— afford to shell out. We always can't predict the future, and a sinking fund can help contribute to inconsistent costs for insurance rates, monthly expenses, and other monetary changes.

There are a lot of positives when it comes to sinking funds, but in some instances, they can have negative implications. Businessfolk who use sinking funds in conjunction with their bonds may face a greater disadvantage. Company losses may occur when organizations use sinking funds. Depending on the state of the economy, the sinking fund's underperformance may result in loss. The repurchase route for sinking funds bonds may not be ideal for some companies as they wait for interest to drop.

The number-one disadvantage for the everyday borrower who has opened a sinking fund is that they may have less cash readily available to spend whenever. With cash consistently being funnelled into a sinking fund, those with this sort of fund may find their day-to-day spending practice shift a bit more. Additionally, it can become complicated when funding numerous different accounts, all intended to meet the same goal. To avoid spreading yourself thin, it's OK to forego the sinking fund route until it makes sense financially.