Just like emergencies are unforeseen, there are likely predictable expenses that you can encounter such as summer vacations, holiday gifts, and Christmas. And most times, settling these needs from your emergency fund or using a credit card can affect your cash flow.
Supporting your emergency fund account by having a sinking fund, would go a long way in bringing you financial stability. A sinking fund helps you pay off your debt easily without any loss.
So, what is this sinking fund, and why do you need to get one?
What Is a Sinking Fund?
A sinking fund, also known as an annual sinking fund, is a separate savings account created or set aside purposely for repaying debts. Corporations often use sinking funds for paying off debt from bonds and deposit money to buy back issued bonds before the maturity date.
Sinking funds differ from other kinds of savings accounts such as traditional savings accounts or emergency funds in some ways. An emergency fund is designed for true emergencies, while a sinking fund is designed for a specific and expected planned future purchase.
Why Should You Create a Sinking Fund?
Just like how having an emergency fund gives you peace of mind, having a sinking fund also does the same thing. Creating a sinking fund will help you pay off your debt easily without making a dent in your savings. It will help you keep your finances on track without going out of your budget.
How To Create a Sinking Fund
Having known what a sinking fund is and why you should have one, it's important you know how to create one. So, here are three easy steps that will guide you through creating a Sinking fund.
1. Decide What You Are Saving For
Ask yourself, what am I saving for? You need to know what you are saving for to be able to build your sinking fund. For instance, you are saving up for your rent. You would want to plan the savings so that the rent will be ready even before the due date.
2. Map Out How Much You Need To Save
One of the ways to build consistency in savings is deciding how much you need to save and set aside. To determine how much to save, divide the total amount you want to spend by the number of weeks or months you have left to make the purchase.
For instance, say you want to spend $1000 in December for an end of the year party, and you have just three months left to save. This implies that you will need to put away at least $334 every month until December.
3. Automate Your Savings For the Sinking Fund
It's one thing to have a savings plan for your sinking fund, and another thing to actually follow the plan to achieve your goal. Automating your savings helps you stay consistent and ensure you don't fall into the temptation of spending the money on something else.
Bottom Line
Planning for future expenditure is a positive step towards better financial stability. The money in your sinking fund, helps you pay out your debt without affecting your finances. If you follow the steps in this article, you can rest assured that you will be well guided in choosing and creating your sinking fund.
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