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Question 4

As you move from basic survival budgeting into deliberate savings planning, concepts like sinking funds and targeted savings buckets become important. A sinking fund is money set aside over time for a known, upcoming expense — for instance, setting aside a bit each month for annual insurance, holiday gifts, or a planned car repair. This technique smooths cash flow: instead of facing a large, painful one-time bill, you accumulate the necessary amount gradually. Sinking funds contrast with emergency funds (which are for unknown, urgent needs) and with long-term investments (which are for growth and come with market risk). Behavioral benefits of sinking funds include reducing the friction when the known expense arrives and avoiding high-interest borrowing; operationally, people often maintain sinking funds in separate subaccounts or use labeled envelopes so the money is psychologically reserved. The following question tests your understanding of why someone might adopt sinking funds as part of a working budget.

What is the primary advantage of using sinking funds (separate sub-savings for known future expenses) within a household budget?

Did You Also Know...

By Wise Wallet

SEP IRAs let small-business owners make sizable employer contributions and are simpler to administer than some alternative plans.