Sinking Funds: What They Are and How They Could Help You (2024)

FAQs

Sinking Funds: What They Are and How They Could Help You? ›

A sinking fund is an account containing money set aside to pay off a debt or bond. Sinking funds may help pay off the debt at maturity or assist in buying back bonds on the open market. Callable bonds with sinking funds may be called back early removing future interest payments from the investor.

The sinking fund method is a technique for depreciating an asset while generating enough money to replace it at the end of its useful life. As depreciation charges are incurred to reflect the asset's falling value, a matching amount of cash is invested. These funds sit in a sinking fund account and generate interest.

A sinking fund is a fund that includes funds set aside or borrowed to pay off a loan or debt. A business that issues debt will have to pay off the debt in the future, and the sinking fund helps ease the burden of a significant revenue outlay.

It is also one way of enticing investors because the fund helps convince them that the issuer will not default on their payments. Basically, the sinking fund is created to make paying off a debt easier and to ensure that a default won't happen because there is a sufficient amount of money available to repay the debt.

Creating a sinking fund may make it easier to save for major goals or purchases and plan ahead for future purchases. By keeping your fund in a high-yield savings account, your funds may grow faster and speed up your savings.

Ideally you should have a different spot for each different sinking fund. If it's all in one account it will be too easy to get each sinking fund mixed up. You can open up high interest savings accounts, or take out the cash every month and keep it somewhere safe.

How do you calculate sinking fund? First, multiply the percentage interest by the principal amount. This will equate to the interest amount, which is then added to the principal amount. This total is the amount of money that needs to be in the sinking fund to meet the set financial obligation.

Example of a Sinking Fund

Interest payments were to be paid semiannually to bondholders. The company established a sinking fund whereby $4 billion must be paid to the fund each year to be used to pay down debt. By year three, ExxonMobil had paid off $12 billion of the $20 billion in long-term debt.

They allow you to save for infrequent expenses and plan for large expenses over time. Having sinking funds can help prevent you from withdrawing money from your emergency fund or going into debt to pay for things. You can use a budgeting app, like You Need a Budget (YNAB) or PocketGuard, to monitor your sinking funds.

To figure out how much to save, take the total amount you want to spend and divide it by the number of months or weeks you have left until you need to make the purchase. If you want to spend $1,000 on Christmas and it's September, you only have about three months to save.

What are the disadvantages of a sinking fund? ›

Disadvantages of a Sinking Fund

Here are some more disadvantages: Opportunity Cost: The funds set aside in a sinking fund could earn a higher return if invested elsewhere. Over-funding: There's a risk of setting aside more money than necessary, which might affect the cash flow.

Typically, you might set up a sinking fund for a substantial purchase that requires saving over time. You can also use one to prepare for expected-but-not-planned-for expenses (like car repairs) that are sure to come in the future.

If buying into a large strata scheme, you would expect a sinking fund to be hundreds of thousands of dollars. Equally, if you are buying into a block of six, the sinking fund could be reasonable with a balance of only $60,000, because it is a matter of proportion.

A sinking fund is a very low-risk way of saving money.

The 10-year rule

This allows the body corporate 10 years to identify, plan and save for these future expenses. As sinking funds are generally reviewed every 5 years, a quantity surveyor will prepare a 15-year plan to cover 5 annual budgets with a 10-year future projection.

Answer and Explanation: The two ways to set up a sinking fund are: The first thing is through trustees who invest the annual payments of the entities in government bonds, and the other way is to either retire the bond issues or selling or purchasing bonds, whichever is lower.

Sinking fund method is a method of calculating depreciation for an asset in which apart from calculating depreciation, it also keeps aside a fund for replacing the asset at the end of its useful life. This method is used when the assets that need to be replaced are of high cost.

Wondering “what are sinking funds in budgeting?” Sinking funds are funds you set aside to save toward a significant, pre-planned goal. You save money over time instead of dipping into your checking account for a considerable chunk of cash to cover a particular purchase or event.

The SFF is the equal periodic payment that must be made at the end of each of n periods at periodic interest rate i, such that the payments compound to $1 at the end of the last period. The SFF is typically used to determine how much must be set aside each period in order to meet a future monetary obligation.