What You Need To Know About a Sinking Fund

Sinking funds have long been helpful for companies and bondholders to minimize risk. For example, when corporations need to raise capital, they may issue a bond that matures in 20 or 30 years.

Many bonds now have a sinking fund managed by a trustee who oversees the fund. Money is set aside periodically with a trustee for repayment of the portion of the principal. This action eliminates the need for a significant cash outlay for the company at maturity.

There is less risk of the company defaulting using the fund if it doesn’t pay back the principal to bondholders. The fund adds protection and security for the bondholder that the company can pay off their debt.

A sinking fund allows a company to raise capital with a lower interest rate to bond investors. As such, it improves a company’s creditworthiness.

Similarly, you or someone in your family can create a sinking fund, dedicating a savings account for a specific household expense that may be too large to handle without borrowing the money.

Once you determine what you want, say a new couch for $1,000-$1,500 for your living room, your sinking fund is for the sofa, not for another expense. You intend to save money to buy a couch, making monthly contributions to the “couch” sinking fund.

With a bit of planning, you can have what you need or want in your life without guilt. For example, if you have your heart on a particular $1,500 couch within a year (i.e., 12 months), your monthly savings goal is to contribute $125 to the sinking fund each month. Then, break the estimated spending amount into the monthly savings you plan to deposit into the respective savings account.

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