The concept of a “sinking fund” might be as foreign to you as it was to me when I came across it a while ago. Just looking up the definition can be confusing since there are at least two uses for the term:

  1. A strategy for the repayment of a specific debt over a period of time
  2. A strategy for funding a known future expense
  • Historically, the term originated in Great Britain as a game plan for paying off its national debt.
  • It was also used heavily in the U.S. railroad industry here in the past.
  • Investment companies define the sinking fund as a type of staggered repayment that adds safety to corporate bonds.
  • In the business world, a sinking fund might be created for the expected replacement or repair of assets such as equipment and buildings.

For you and me, the most practical application of a “sinking fund” is to set aside a monthly amount to fund a future expense.

Some financial advisors swear by using sinking funds for everything and anything — from trivial holiday spending to important purchases like a new vehicle or home. Some even use them to create a budget that’s more predictable (for instance, creating one big sinking fund that averages all your utility payments so you ‘pay’ the same amount each month, regardless of billing fluctuations).

Thinking Backwards, Planning Ahead, Waiting in the Middle

The purposes of sinking funds may be diverse, but they all require thinking backward – taking the amount of the purchase you want/need, and dividing it by the number of months you have to work with. For instance, if you know you want to spend $600…

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