Sinking Funds

A sinking fund is a dedicated account where money is reserved to repay debts or bonds. It facilitates debt repayment at maturity or allows bonds to be repurchased in the market. Callable bonds with sinking funds may be redeemed early, eliminating future interest obligations for investors.
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3 min
15-September-2025

Big expenses don’t always have to come with big stress—especially if you’ve been planning for them ahead of time. That’s exactly where a sinking fund comes in. Whether you're a salaried professional saving up to buy a car or a company preparing to repay a loan, a sinking fund helps you save steadily over time so you’re financially ready when the time comes.

It’s like setting aside small amounts regularly in a separate pot, knowing you’ll need that money down the road—for a planned purchase, a future liability, or even to replace an asset. Instead of scrambling for a loan or breaking into your emergency savings, you’ve got funds ready to go.

If you are preparing for a financial milestone in the next few years, setting up a sinking fund can ease future pressure without disrupting your current budget. Explore smart mutual fund options now!

This article will walk you through everything you need to know about sinking funds—what they are, how they work, why they matter, and how they can help you avoid last-minute financial pressure, especially when backed by smart investment options like mutual funds.

What is a sinking fund?

A sinking fund is a reserve of money that is gradually built up over time to meet a large future expense or to repay outstanding debt. For instance, companies and governments often create sinking funds to ensure they have sufficient capital to repay loans or bond issues when they mature.

Sinking funds aren’t just for individuals—they’re widely used by companies too. Whether it’s repaying bonds, settling long-term obligations, or replacing depreciating assets, this method helps avoid financial shocks. Instead of bearing the burden all at once, you save steadily, making those large payments easier to manage when the time comes.

By committing to small, regular contributions, a sinking fund allows you to plan ahead without disrupting your daily budget. For businesses, it’s also a sign of financial discipline and reliability, which reassures creditors and investors. Simply put, a sinking fund helps you prepare for tomorrow, starting today.

If you are planning long-term expenses like home renovations or a child’s education, understanding how much to save yearly is key.  Compare mutual fund options now!

Sinking fund example

Let’s look at a practical example to see a sinking fund in action.

Corporate example:
A company issues bonds worth Rs. 50 lakh that will mature in 10 years. Instead of scrambling for the full amount a decade later, it starts putting Rs. 5 lakh aside each year into a sinking fund. By the time the bonds mature, the money is already set aside—no surprises, no financial panic.

Personal example:
You’re planning to buy a car in five years, and it’ll cost Rs. 10 lakh. If you create a sinking fund and save Rs. 2 lakh every year, you’ll be able to pay for the car outright without taking a loan or disturbing your emergency savings.

In both cases, the sinking fund acts like a financial GPS—it helps you reach your goal without detours, delays, or debt.

Sinking fund formula

Ever wondered how much you need to save each year to reach a specific financial goal? That’s where the sinking fund formula comes in handy. It helps you figure out exactly how much to set aside annually to cover a large future expense—like repaying a loan or replacing an expensive asset.

The formula is:

S = (P × i) / [1 - (1 + i)^-n]

Where:

  • S = amount to be saved every year
  • P = total cost of the goal or debt
  • i = interest rate
  • n = number of years you’ll be saving

Let’s break that down with an example. Suppose you have a loan of ₹5,00,000, due in 10 years, and you expect to earn 5% interest on your savings. You’d need to save around ₹65,145 every year to meet that goal without needing another loan or dipping into emergency savings. This makes big expenses feel more manageable and predictable.

Some investors also use this method for investing in mutual funds—whether through monthly SIPs or one-time lump sum contributions—so they can build a financial cushion for upcoming needs.

What is sinking fund method

The sinking fund method is a smart way to prepare for large payments or asset replacements without financial strain. It starts with one simple step: setting aside a fixed amount of money at regular intervals—typically monthly or yearly—into a separate account or low-risk investment.

Over time, this growing fund gives you the financial muscle to handle big-ticket obligations like repaying a business loan or replacing ageing equipment. Instead of scrambling for funds when the time comes, you’ll already have what you need—thanks to steady, disciplined savings.

Here’s how it works in practice:

  • You determine your financial target.
  • Set a timeframe to achieve it.
  • Divide the target by the number of saving periods (months/years).
  • Make consistent contributions until you reach your goal.

It’s a tried-and-tested strategy for anyone who wants to stay ahead of debt or be financially prepared for big expenses.

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Types of sinking funds

Sinking funds aren't just for big corporations—they can be a practical tool in personal finance too. Depending on what you're planning for, here are some common types of sinking funds that help you stay financially prepared:

  1. Debt repayment sinking fund
    If you have a long-term debt like a mortgage, car loan, or even credit card dues, this fund can help. You contribute a small amount regularly so you can pay off the full balance without scrambling when it’s due. It’s a smart way to avoid last-minute loan top-ups or high-interest payments.
  2. Asset replacement sinking fund
    Planning to replace your car, laptop, or an aging appliance? This type of fund lets you save gradually so you’re ready when the time comes. It’s ideal for items that depreciate or wear out over time.
  3. Emergency fund
    Although not traditionally a “sinking fund,” it works on the same idea—setting aside money bit by bit. Whether it’s medical expenses, home repairs, or an unexpected job loss, this fund is your financial safety net.
  4. Education fund
    Whether it’s your child’s school fees or your own plans to study further, an education sinking fund helps you build the corpus steadily, reducing the need for expensive education loans.
  5. Retirement fund
    This long-term sinking fund is for your future self. Investing regularly in mutual funds, pension plans, or other retirement instruments ensures you have enough to retire comfortably when the time comes.

The beauty of sinking funds is their flexibility—you can set one up for almost any goal that requires money down the line. If you are building a retirement or education corpus, sinking funds can complement your investment goals. Explore mutual funds that align with each financial milestone. Compare mutual fund options now!

Uses of sinking fund

For organisations:

  • Debt repayment: Companies, especially those that issue bonds, create sinking funds to ensure they have enough money to repay debt when it matures. This reduces the risk of default and builds investor confidence, particularly for long-term obligations.
  • Asset replacement: Businesses set aside money to replace ageing or obsolete assets such as machinery, vehicles, or equipment. This prevents sudden large expenses and allows smoother planning for future capital expenditure.

For individuals:

  • Loan repayment: Sinking funds help individuals save in a structured way for loan repayments, including car loans or mortgages, enabling faster and more manageable debt clearance.
  • Major purchases: Money can be accumulated over time for significant expenses such as home renovations, buying a new car, or making a down payment on a house.
  • Planned expenses: These funds can be used to meet predictable but irregular expenses like annual insurance premiums, property taxes, or festive/holiday spending.
  • Educational expenses: Individuals often build sinking funds to cover future education-related costs, ensuring financial readiness without sudden stress.

How to start a sinking fund?

Starting a sinking fund is easier than you might think. Whether you're saving for a new car or repaying a loan, it’s all about setting a plan and sticking to it. Here's how to begin:

  1. Set a clear goal
    What are you saving for? A gadget upgrade? Car insurance premium? Debt repayment? Having a specific purpose makes it easier to stay focused.
  2. Figure out how much to save
    Use the sinking fund formula or divide your goal by the time you have. For example, if you need ₹1,20,000 in two years, saving ₹5,000 a month gets you there comfortably.
  3. Open a separate account
    This keeps your sinking fund separate from daily spending, so you don’t accidentally dip into it.
  4. Automate your savings
    Set up automatic transfers—weekly, monthly, or quarterly—so you never forget to contribute. Automation turns saving into a habit.
  5. Track your progress
    Check in once a month to see if you’re on track. If your income or expenses change, adjust your savings amount accordingly.

By following these steps, you’ll be financially ready when your target date arrives—and avoid borrowing or draining emergency savings.

Benefits of investing in sinking funds

Sinking funds might not sound glamorous, but they pack a powerful financial punch. Here are some clear benefits of building one:

  • Avoid debt: Instead of reaching for your credit card or a personal loan, you already have money set aside for your expense. That means zero interest payments.
  • Reduce financial stress: Knowing you’re prepared for big expenses or debt repayments can ease a lot of anxiety.
  • Strengthen your budgeting skills: Sinking funds encourage you to plan ahead and manage your monthly finances better.
  • Ensure timely payments: Whether it’s a car insurance premium or a balloon loan payment, you won’t be caught off guard.
  • Flexibility: You can create a sinking fund for almost anything—be it a phone upgrade, a destination wedding, or annual tax payments.

Ultimately, a sinking fund gives you control over your money and keeps your financial goals within reach—without relying on last-minute loans or financial juggling.

Where should you keep your sinking funds?

Choosing the right place to keep your sinking fund is just as important as setting it up. You want your money to grow a little while still being easily accessible when you need it. So, where should you park this money?

The safest option is to keep your sinking fund in a dedicated savings account. Look for one that offers a decent interest rate and allows quick withdrawals. This ensures your money is both growing and available whenever your financial goal is due.

For longer-term goals—say, 3 to 5 years—you could consider fixed deposits or liquid mutual funds. These options offer slightly better returns without exposing your money to too much risk. However, avoid high-risk investments like equity mutual funds or stocks for sinking fund purposes. The value of these investments can fluctuate, and you may not have the same amount when you need it.

Also, never mix your sinking fund with your regular account. This keeps you from accidentally spending the money and helps you stay on track.

Regularly reviewing your fund’s progress and adjusting it to your changing financial goals can make your sinking fund even more effective.

Sinking fund vs. savings account

While both sinking funds and savings accounts involve setting money aside, they serve different purposes and offer different advantages.

A sinking fund is like a financial to-do list—you save for something specific, like a new laptop or an upcoming insurance payment. Every month, you put in a fixed amount until you hit your goal. It’s intentional and purpose-driven.

A savings account, on the other hand, is more general. It’s there for anything you might need money for—unexpected bills, opportunities, or emergencies. You can withdraw from it anytime, for any reason.

Here is how they differ:

Feature

Sinking Fund

Savings Account

Purpose

Specific financial goals

General savings or emergencies

Usage

Planned future expenses

Day-to-day or unplanned needs

Interest rate

Moderate (depends on investment)

Typically lower

Accessibility

Restricted to specific goals

Fully flexible

Discipline

Requires systematic saving

Can be used any time


If your savings are sitting idle in a low-interest account, consider moving a portion into mutual fund SIPs for better long-term growth tailored to your financial goals. Explore top-performing mutual funds

Sinking fund vs emergency fund

Though both sinking funds and emergency funds help you prepare financially, they’re designed for completely different situations.

A sinking fund is for something you know is coming—like a vacation, home renovation, or replacing your car. You plan it. You save for it. You’re ready when the time comes.

An emergency fund, by contrast, is for the unexpected. Think of job loss, a medical emergency, or sudden home repairs. You don’t know when or if these things will happen, but you keep the fund ready just in case.

Let’s break it down:

Feature

Sinking Fund

Emergency Fund

Purpose

Planned goals or purchases

Unpredictable events

Timeline

Fixed, based on the goal

Indefinite

Contribution

Pre-determined and goal-based

Flexible

Accessibility

Used only when goal is due

Immediate

Risk

Minimal, low-risk investments

None, prioritises liquidity


In short, both are essential. Sinking funds help you avoid debt for things you know are coming, while emergency funds protect you from life’s surprises.

Should you use sinking funds?

 

Yes, sinking funds can be highly beneficial for both individuals and organisations. They provide a disciplined way to set aside money gradually, making large expenses or debt repayments more manageable. For individuals, sinking funds reduce financial stress by preparing in advance for predictable costs like loan EMIs, insurance premiums, or major purchases. For businesses, they ensure debt obligations and asset replacements are met without sudden cash flow disruptions. By planning ahead, sinking funds promote financial stability, reduce reliance on borrowing, and create peace of mind when big expenses arise.

Key takeaways

If you are still unsure whether a sinking fund is worth the effort, let’s make it simple. Here are some key things to remember:

  • A sinking fund helps you save in advance for specific future expenses—planned ones, not surprises.
  • It encourages regular saving habits and keeps your larger financial goals on track without derailing your day-to-day budget.
  • You can use it for anything: paying off a loan, buying a car, funding a vacation, or replacing an old appliance.
  • The goal is to reduce or eliminate debt by preparing for major expenses ahead of time.
  • You can park your sinking fund in a savings account, fixed deposit, or low-risk mutual fund based on your timeline and needs.
  • It’s different from an emergency fund. One is for expected costs, the other for life’s curveballs.

Conclusion

A sinking fund may sound like something only accountants or big corporations deal with but it is one of the most practical financial tools you can use.

Whether you're an individual saving for a dream vacation or a business planning to repay a loan, a sinking fund helps you stay prepared, avoid debt, and manage large expenses with confidence.

Even modest savings set aside regularly can turn into a reliable buffer for large expenses. Explore mutual fund SIPs designed for structured, long-term saving. Explore top-performing mutual funds!

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Frequently asked questions

Is sinking fund a cash fund?
Yes, a sinking fund is a cash fund. It is a designated pool of money set aside by a company to repay debt or replace assets, ensuring financial stability and adequate funds are available for future payments.

Is sinking fund compulsory?
No, a sinking fund is not compulsory. However, it is a prudent financial practice for businesses managing long-term debt or asset replacement. It ensures that funds are available for large expenditures without the need to secure new financing.
What is sinking fund formula?
The sinking fund formula is typically calculated as S= (P * i) / (1 - (1 + i)^-n). This formula helps businesses determine the amount of money they need to set aside periodically to cover the total amount due at the maturity of their debt.

Why do they call it a sinking fund?
The term "sinking fund" comes from the idea that the fund helps to "sink" (reduce) debt. Over time, regular contributions to the fund decrease the outstanding principal amount, effectively "sinking" the debt until it is fully paid off.
What is a sinking fund example?
A sinking fund example could be a company setting aside Rs. 20,000 each year into a fund to replace a piece of machinery valued at Rs. 100,000 in five years. This proactive approach allows the company to manage its asset replacements smoothly without financial strain.
What does sinking mean in finance?
In finance, "sinking" typically refers to the gradual reduction of debt. It involves periodic payments into a sinking fund, which are used to repay or buy back bonds or other forms of debt before their maturity, thereby "sinking" the total amount of outstanding debt over time.
What is the difference between a sinking fund and a savings account?

A sinking fund is a targeted savings pool for a specific purpose, such as debt repayment or asset replacement, with systematic contributions over time. A savings account, however, is a general-purpose account used for various financial needs, offering flexibility but without a predetermined goal.

Why are sinking funds good?

Sinking funds are beneficial because they encourage financial discipline, reduce dependency on loans, and prepare for future expenses without financial strain. They ensure that funds are readily available for specific goals, preventing last-minute borrowing or budget disruptions.

Is sinking fund refundable?

Sinking funds are typically non-refundable as they are allocated for specific financial obligations or purposes, such as repaying debt or replacing assets. However, unused sinking funds after fulfilling the intended goal may be redirected or withdrawn depending on the entity's discretion.

How is sinking fund collected?

Sinking funds are collected through regular contributions over a set period. These contributions may come from an individual’s income, a company’s revenue, or periodic payments from stakeholders, depending on the purpose, such as debt repayment or planned purchases.

What is a sinking fund example?

An individual saving Rs. 2 lakh annually in a sinking fund to buy a Rs. 10 lakh car in five years is an example. Similarly, a company setting aside funds yearly to repay bonds upon maturity is another illustration

What is another term for sinking fund?

The sinking fund (also known as a capital works fund) and the administrative fund serve different purposes. The sinking fund collects contributions from property owners and is specifically set aside to cover long-term maintenance or major repair costs. In contrast, the administrative fund is generally used for day-to-day expenses and regular upkeep.

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