Several long-term financial planning activities can be carried out, including a sinking fund.
Sinking funds themselves are often equated with emergency funds, even though the two have fundamental differences in their concepts.
This is because the concept of a sinking fund is savings for the future intended for certain needs.
Therefore, the sinking fund can later function as a fund for debt repayment, educational needs, etc.
Beyond that, managing Debt and maintaining financial stability is very important for anyone.
Sinking funds are also an alternative to long-term financial planning that must be considered.
See the following review to learn more about the definitions, benefits, and differences from emergency funds and tips for collecting them.
Sinking Fund definition
The definition of a sinking fund is one type of savings that is prepared for future needs.
Each person usually collects this special financial budget according to their respective goals.
For example, marriage, business capital, and family vacation funds are for educational purposes.
Therefore, from the definition above, the basic concept of a sinking fund is to set aside and then save a certain amount of funds to be invested.
These funds can later be used to pay off debt obligations, although the concept differs from an emergency fund because sinking funds are closely related to investment activities.
On the other hand, the most important purpose and benefit of a sinking fund is to prevent someone from using the emergency fund they have.
Thus, the emergency fund will remain intact and can be used for other urgent needs.
Sinking Fund Benefits
Sinking funds are very useful for those who want to implement activities in this financial sector.
The reason is, sinking funds can provide big profits for those who want to do it.
It also aims to regulate financial stability as well as a substitute for emergency funds at a later date.
Here are some of the benefits of a sinking fund that you need to know, including:
1. Maintaining Financial Stability
The first benefit of a sinking fund is to maintain financial stability in the future.
The reason is if there is an urgent need at any time, the sinking fund can be used for that.
2. Prevent Debt
Sinking funds are also useful for preventing Debt. The reason is that by providing a sinking fund, there will be no need to lend money to the bank or other parties later.
3. Avoiding Financial Anxiety
Another benefit of having a sinking fund is avoiding financial anxiety.
Thus, more important projects can be carried out with more focus later.
Difference between Sinking Fund and Emergency Fund
As was mentioned at the beginning of this article, sinking funds are often considered the same as emergency funds.
The two differ, especially in the purpose and function of each financial activity.
The difference can be seen in usage, quantity, and priority.
Here are some differences between sinking funds and emergency funds that you need to know, including:
1. Usage
Emergency and sinking funds are known to have differences in terms of use.
Suppose an emergency fund is a special financial budget for emergency/urgent needs. In that case, a sinking fund is a fund that is allocated and set aside deliberately not for urgent needs but to achieve certain goals.
2. Quantity
Meanwhile, in terms of quantity, if a sinking fund has an allocation amount based on the size of the goal to be achieved, an emergency fund is usually set up three times the value of the routine monthly expenses.
3. Priority
Other differences can be viewed in terms of priority. Suppose a sinking fund is usually carried out after the main financial allocation is fulfilled because it is not an emergency/urgent nature.
In that case, an emergency fund is usually a priority that must be budgeted for.
How to Prepare a Sinking Fund
Preparing a sinking fund needs to be done by anyone who wants to manage their finances well.
This is because sinking funds can be used to meet financial needs that are expected to occur in the future.
Therefore, it is important to know how to prepare a sinking fund to protect it from financial risks.
Here are some ways to prepare a sinking fund that you need to know, including:
1. Determine the objectives and the amount of funds to be allocated
The first way to prepare a sinking fund is to determine the objectives and the amount of funds to be allocated.
In this case, determine the specific goals you want to achieve and the amount of funds to be set aside for future needs.
2. Selecting the instrument appropriate investment
The next step in preparing a sinking fund is to choose the appropriate investment instrument.
In this regard, choose an investment instrument by the risk profile and research and review the investment instrument.
This is important so that the sinking fund funds that have been allocated do not cause losses when invested.
3. Allocation of funds regularly and consistently
To prepare for the next sinking fund, allocate funds regularly and consistently.
Related to this, funds allocated/set aside for sinking funds must grow consistently.
Thus, sinking fund funds can later be collected and invested wisely.
Sinking Fund Risk
Sinking funds can be very important and of great benefit to plans.
Of course, this one financial activity is still inseparable from the risks surrounding it.
This risk can be related to fluctuations in the investment’s value and failure to reach the target of the funds you want to raise.
The following is a complete explanation regarding sinking fund risks that need attention, including:
1. There are fluctuations in the value of the investment
The first risk associated with a sinking fund is the fluctuation in the value of the investment made.
This is because the investment value that has been selected may change in line with fluctuations that occur in the market.
Therefore, before choosing an investment instrument, it is important to examine the potential risks of the investment instrument.
2. Failure to achieve funding targets
The other risk of sinking funds is failure to achieve the target funds.
This is because the target of funds may still need to be achieved even though the allocation of funds to be set aside has been made regularly.
This usually happens, for example, because of inadequate planning, mistakes in choosing investment instruments, and other things.
Tips for Collecting Sinking Funds
As previously discussed, sinking funds are special funds allocated for future needs.
This fund is also very different from emergency funds which are deliberately collected for urgent needs/needs.
Therefore, it is important to understand the tips for properly collecting sinking funds.
Here are some tips for collecting sinking funds that you need to know, including:
1. List of Future Needs
The first tip for collecting sinking funds is to make a list or lists of future needs.
In this regard, it is essential to identify these needs by first identifying them.
By making this list, there will be appropriate guidelines for raising sinking funds.
2. Determine the Target of the Sinking Fund
The next tip is to determine the target of the sinking fund in the future.
In this case, determine the use of the funds to be allocated, for example, for business capital and others.
By setting a target, the step of setting aside money for the sinking fund will go more smoothly and stay in line with the original plan.
3. Determine the money to be set aside every month
Furthermore, tips on collecting a sinking fund are to determine the money to be set aside each month.
In this case, calculate monthly expenses and emergency funds, then set them aside for a sinking fund.
That way, later, there will be no cut-down funds for sinking funds while the allocated needs have been met.
4. Collect Sinking Funds in Separate Accounts
The last tip is to collect sinking funds in a separate account.
That is, create a separate account for funds specifically allocated for sinking funds.
The goal is that these funds are not mixed with other funds or will be used later.
Conclusion
In conclusion, a sinking fund is an alternative to long-term financial planning that needs to be considered.
The definition of a sinking fund is one type of savings that is prepared for future needs.
Each person usually collects this special financial budget according to their respective goals.
The benefits of a sinking fund include maintaining financial stability, preventing Debt from occurring, and avoiding financial anxiety.
Meanwhile, preparing a sinking fund includes:
- Determining the objectives and the number of funds to be allocated.
- Choosing the appropriate investment instruments.
- Making regular and consistent fund allocations.
So, that was the complete review regarding sinking funds, starting from the definition, risks, and tips on collecting them.
Furthermore, you can also read other related articles, such as stagflation to deflation, which are important to know only at INDODAX Academy.
