14: Bonds and Sinking Funds

14: Bonds and Sinking Funds

Sinking Fund Call

A sinking fund call is a provision that allows a bond issuer to buy back its outstanding bonds before their maturity date at a pre-set price.

The money that is used for the buyback comes from a sinking fund, an amount that is set aside from the issuer's earnings specifically for use in security buybacks.

A sinking fund provision in a bond adds an element of doubt over whether the bond will continue to pay a return until its maturity date. That is seen as an additional risk for investors.

  • A sinking fund call allows a bond issuer to recall a portion of its bonds, or all of them, before the maturity date.
  • The bond investor receives the principal and the accrued interest but not the future interest payments.
  • Bonds that have this provision pay a higher return because this element of uncertainty is added to the investment.

What Is a Sinking Fund?

A sinking fund is a strategic way to save money by setting aside a little bit each month.

Sinking funds work like this: Every month, you&rsquoll set money aside in one or multiple categories to be used at a later date. With a sinking fund, you save up a small amount each month for a certain block of time before you spend.

Sinking funds work great for things you don&rsquot want to pay for in a single month&rsquos budget, like:

  • New tires for your car
  • Christmas gifts
  • Vet bills
  • Wedding expenses
  • Plane tickets
  • Birthday parties
  • School books and supplies
  • Clothes for a special occasion
  • Vacation
  • Home remodels

You can create a sinking fund for any financial goal, dream or expense you have!

Sinking Fund vs. Savings Account

A sinking fund is usually more specific than a savings account since you know exactly how much you&rsquoll put in and when you&rsquoll use it.

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It all comes down to being intentional. If you&rsquore saving for a new car, next year&rsquos vacation, your anniversary gifts, your son&rsquos braces and your Christmas presents all in the same savings account, chances are, sooner or later, the lines will start to blur. So, instead of lumping everything together in your savings account, be deliberate and specific by having multiple sinking funds.

Sinking Fund vs. Emergency Fund

A sinking fund is also different from an emergency fund. Much different. An emergency fund is money set aside for the unknown.

With a fully funded emergency fund, you should have 3&ndash6 months of expenses saved for any and all possible emergencies. When your air conditioner burns out and you have to replace it, your emergency fund will step in, and it won&rsquot even feel like an emergency&mdashonly an inconvenience. Why? Because it&rsquos the safety net between you and life. You have no way of knowing if these things are coming or when they&rsquoll happen, but you do know that life happens, so you have the money set aside and ready.

With a sinking fund, on the other hand, you know exactly what that money&rsquos for, and you know when you&rsquoll use it.

The sinking fund is for the known. The emergency fund is for the unknown.

Classification of a Bond Sinking Fund

The bond sinking fund is categorized as a long-term asset within the Investments classification on the balance sheet, since it is to be used to retire a liability that is also classified as long term. It should not be classified as a current asset, since doing so would skew a company's current ratio to make it look far more capable of paying off current liabilities than is really the case. Also, a bond sinking fund introduces a potentially large amount of cash to the balance sheet, which can be misconstrued by investors as being available for other uses hence the need to clearly identify the use of its funds specifically to retire bonds.

Understanding a Sinker

A sinking fund is a means of repaying funds borrowed through a bond issue through periodic payments to a trustee who retires part of the issue by purchasing the bonds in the open market. A sinking fund has regular money deposits—mainly as a way to boost investor confidence in the fund. Putting money into the fund on a regular basis helps the investor have faith that the promised payments will be timely, and that the sinking fund can be utilized to redeem debt securities or preferred stock issues.

A sinker's payment comes from a pool of money that the issuer has set aside to repurchase a portion of the bonds it has issued each year. By repurchasing some bonds before they mature, the company reduces the one-time significant expense of repaying the entire principal of the bond when it reaches its maturity date. Portions of the outstanding bond issue which are paid off are referred to as sunk.

A sinker theoretically has a lower default risk at maturity, since the issuer intends to retire a portion of the bond issue early. However, the sinker bond also has reinvestment risks similar to those of a callable bond. If interest rates decline, the investor could see the bond repurchased by the issuer at either the sinking fund price or the current market price.

There are sinker bonds, and then there are super sinker bonds. Super sinker bonds are generally home financing bonds, where there is a greater risk of bond prepayment. The term also applies to any bond with long-term coupons and short maturity. If a super sinker bond is connecting to a home mortgage, it might be a pre-paid mortgage which allows the mortgage holder to get a long-term yield after a short period. Super sinker bonds attract investors who want a brief maturity but also want longer-term interest rates.


To start using sinking funds, determine how much you can realistically save every month, and decide what you want to save for.

Next, put your plan into action. Every month, save money for all of your sinking fund categories so you can use the cash at a later date.

Let's say you have $800 every month that you can apply towards saving. If you were using a regular savings account to put your money into, after a year you would have $9,600.

After a year, you and your spouse decide you need to replace one of your vehicles. You go down to the dealership and purchase a car using the $9,600 that you saved.

It feels fantastic to use cash for such a huge purchase, right?

The problem is, what happens when after buying your new car, your dishwasher breaks, you discover a broken A/C unit, and you have an unexpected medical bill.

What do you do? Do you use some of your emergency fund? Do you wait it out and hope the problems disappear? Do you swipe your credit card and figure out how to pay it off later?

Here's how the example would change if you used sinking funds instead.

If you have the same $800 every month to put towards saving, divide the $800 into four sinking fund categories:

  • $100 for vacation
  • $200 for home repairs
  • $100 for medical expenses
  • $400 for a new car or car repairs

At the end of the year, your sinking fund totals would equal:

  • $1,200 for vacation
  • $2,400 for home repairs
  • $1,200 for medical expenses
  • $4,800 for a new car or car repairs

When you and your spouse decide to buy a new car, just like in the scenario above, you now have two different options. You can spend some of your car sinking fund to make some minor repairs and continue to save until your car sinking fund reaches the amount you need to buy the car you want, or you can find another reliable transportation that you like for $4,800.

Meanwhile, you will still be able to replace the dishwasher, fix your A/C unit, and cover your unexpected medical expenses. This is all accomplished without touching your emergency savings, and you still get what you need and want without losing your sanity or feeling stressed.

Should I Move the Money in My 401(k) to Bonds?

An employer-sponsored 401(k) plan may be an important part of your financial plan for retirement. Between tax-deferred growth, tax-deductible contributions and the opportunity to take advantage of employer matching contributions, a 401(k) can be a useful tool for investing long term. Managing those investments wisely means keeping an eye on market movements. When a bear market sets in, you may be tempted to make a flight to safety with bonds or other conservative investments. If you’re asking yourself, “Should I move my 401(k) to bonds?” consider the potential pros and cons of making such a move. Also, consider talking with a financial advisor about what the wisest move in your portfolio would be.

Bonds and the Bear Market

Bear markets are characterized by a 20% or more decline in stock prices. There are different factors that can trigger a bear market, but generally they’re typically preceded by economic uncertainty or a slowdown in economic activity. For example, the most recent sustained bear market lasted from 2007 to 2009 as the U.S. economy experienced a financial crisis and subsequent recession.

During a bear market environment, bonds are typically viewed as safe investments. That’s because when stock prices fall, bond prices tend to rise. When a bear market goes hand in hand with a recession, it’s typical to see bond prices increasing and yields falling just before the recession reaches its deepest point. Bond prices also move in relation to interest rates, so if rates fall as they often do in a recession, then bond prices rise.

While bonds and bond funds are not 100% risk-free investments, they can generally offer more stability to investors during periods of market volatility. Shifting more of a portfolio’s allocation to bonds and cash investments may offer a sense of security for investors who are heavily invested in stocks when a period of extended volatility sets in.

Should I Move My 401(k) to Bonds?

Whether it makes sense to move assets in your 401(k) away from mutual funds, target-date funds or exchange-traded funds (ETF) and toward bonds can depend on several factors. Specifically, those include:

Years left to retirement (time horizon)

Where else you’ve invested money

How long you expect a stock market downturn to last

First, consider your age. Generally, the younger you are, the more risk you can afford to take with your 401(k) or other investments. That’s because you have a longer window of time to recover from downturns, including bear markets, recessions or even market corrections.

If you’re still in your 20s, 30s or even 40s, a shift toward bonds and away from stocks may be premature. The more time you keep your money in growth investments, such as stocks, the more wealth you may be able to build leading up to retirement. Given that the average bear market since World War II has lasted 14 months, moving assets in your 401(k) to bonds could actually cost you money if stock prices rebound relatively quickly.

On the other hand, if you’re in your 50s or early 60s then you may already have begun the move to bonds in your 401(k). That might be natural as you lean more toward income-producing investments, such as bonds, versus growth-focused ones.

It’s also important to look at the bigger financial picture in terms of where else you have money invested. Diversification matters for managing risk in your portfolio and before switching to bonds in your 401(k), it’s helpful to review what you’ve invested in your IRA or a taxable brokerage account. It’s possible that you may already have bond holdings elsewhere that could help to balance out any losses triggered by a bear market.

There are various rules of thumb you can use to determine your ideal asset allocation. The 60/40 rule, for example, dictates having 60% of your portfolio in stocks and 40% dedicated to bonds. Or you may use the rule of 100 or 120 instead, which advocate subtracting your age from 100 or 120. So, if you’re 30 years old and use the rule of 120, you’d keep 90% of your portfolio in stocks and the rest in bonds or other safer investments.

Bond mutual funds and bond ETFs could be a more attractive option than traditional bond investments if you’re worried about bear market impacts on your portfolio. With bond ETFs, for example, you can own a collection of bonds in a single basket that trades on an exchange just like a stock. This could allow you to buy in low during periods of volatility and benefit from price appreciation as you ride the market back up. Sinking money into individual bonds during a bear market or recession, on the other hand, can lock you in when it comes to bond prices and yields.

If you’re weighing individual bonds, remember that they aren’t all alike and the way one bond reacts to a bear market may be different than another. Treasury-Inflation Protected Securities or TIPS, for example, might sound good in a bear market since they offer some protection against inflationary impacts but they may not perform as well as U.S. Treasurys. And shorter-term bonds may fare better than long-term bonds.

How to Manage Your 401(k) in a Bear Market

When a bear market sets in, the worst thing you can do is hit the panic button on your 401(k). While it may be disheartening to see your account value decreasing as stock prices drop, that’s not necessarily a reason to overhaul your asset allocation.

Instead, look at which investments are continuing to perform well, if any. And consider how much of a decline you’re seeing in your investments overall. Look closely at how much of your 401(k) you have invested in your own company’s stock, as this could be a potential trouble spot if your company takes a financial hit as the result of a downturn.

Continue making contributions to your 401(k), at least at the minimum level to receive your employer’s full company match. If you can afford to do so, you may also consider increasing your contribution rate. This could allow you to max out your annual contribution limit while purchasing new investments at a discount when the market is down. Rebalance your investments in your 401(k) as needed to stay aligned with your financial goals, risk tolerance and timeline for retiring.

The Bottom Line

Moving 401(k) assets into bonds could make sense if you’re closer to retirement age or you’re generally a more conservative investor overall. But doing so could potentially cost you growth in your portfolio over time. Talking to your 401(k) plan administrator or your financial advisor can help you decide the best way to weather a bear market or economic slowdown while preserving retirement assets.

Tips for Investing

It’s helpful to review your 401(k) at least once per year to see how your investments are performing and whether you’re still on track to reach your retirement goals. If you notice that you’re getting overweighted in a particular asset class or stock market sector, for example, you may need to rebalance to get back on track. You should also review the fees you’re paying for your 401(k), including individual expense ratios for each mutual fund or ETF you own.

Consider talking to a professional financial advisor about the best strategies to implement when investing in bear markets and bull markets as well. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to connect with professional advisors online. It takes just a few minutes to get your personalized advisor recommendations. If you’re ready, get started now.

Path to the ballot

Process in California

In California, the number of signatures required for an initiated state statute is equal to 5 percent of the votes cast in the preceding gubernatorial election. Petitions are allowed to circulate for 180 days from the date the attorney general prepares the petition language. Signatures need to be certified at least 131 days before the general election. As the verification process can take multiple months, the secretary of state provides suggested deadlines for ballot initiatives.

The requirements to get initiated state statutes certified for the 2020 ballot:

  • Signatures: 623,212 valid signatures were required.
  • Deadline: The deadline for signature verification was June 25, 2020. However, the process of verifying signatures can take multiple months. The recommended deadlines were March 3, 2020, for an initiative requiring a full check of signatures and April 21, 2020, for an initiative requiring a random sample of signatures.

Signatures are first filed with local election officials, who determine the total number of signatures submitted. If the total number is equal to at least 100 percent of the required signatures, then local election officials perform a random check of signatures submitted in their counties. If the random sample estimates that more than 110 percent of the required number of signatures are valid, the initiative is eligible for the ballot. If the random sample estimates that between 95 and 110 percent of the required number of signatures are valid, a full check of signatures is done to determine the total number of valid signatures. If less than 95 percent are estimated to be valid, the initiative does not make the ballot.

Stages of this initiative

On October 10, 2019, Robert N. Klein filed the ballot initiative. Ώ] Attorney General Xavier Becerra (D) released ballot language for the initiative on December 17, 2019, which allowed proponents to begin collecting signatures. The deadline to file signatures was June 15, 2020.

On February 13, 2020, proponents announced that the number of collected signatures surpassed the 25-percent threshold (155,803 signatures) to require legislative hearings on the ballot initiative. ⎜] In 2014, Senate Bill 1253 was enacted into law, which required the legislature to assign ballot initiatives that meet the 25-percent threshold to committees to hold joint public hearings on the initiatives not later than 131 days before the election.

On March 21, 2020, Sarah Melbostad, a spokeswoman for Californians for Stem Cell Research, Treatments, and Cures, reported that the campaign's signature drive was suspended due to the coronavirus pandemic. Melbostad said, "In keeping with the governor’s statewide order for non-essential businesses to close and residents to remain at home, we’ve suspended all signature gathering for the time being. . We’re confident that we still have time to qualify and plan to proceed accordingly." ⎝]

On May 5, 2020, the campaign submitted 924,216 signatures for the ballot initiative. ⎞] At least 623,212 (67.43 percent) of the signatures needed to be valid. On June 22, 2020, the office of Secretary of State Alex Padilla announced that a random sample of signatures projected that 78.14 percent were valid. Therefore, the ballot initiative qualified to appear on the ballot at the general election. ⎟]

Cost of signature collection:
Sponsors of the measure received in-kind contributions from Robert N. Klein II to collect signatures for the petition to qualify this measure for the ballot. A total of $4,145,719.73 was spent to collect the 623,212 valid signatures required to put this measure before voters, resulting in a total cost per required signature (CPRS) of $6.65.

By setting up a sinking fund, the financial burden associated with a repayment or asset purchase is greatly reduced. The existence of a sinking fund also reduces the risk for investors, who have an improved chance of being repaid when the associated debt becomes due. Also, when a sinking fund is a required part of an investing agreement, investors are more likely to allow a reduced rate of interest on the associated debt or preferred stock.

A sinking fund reduces the availability of cash for the borrower, which narrows the range of its investment choices. This occurs because available cash is constantly being funneled into the sinking fund, rather than being deployed to earn a return.

Sinking Funds vs. Emergency Funds

Sinking funds are designed specifically for planned expenses. For example, you would use it to replace your roof, since it's likely a known expense. Another planned expense is a vacation. Another expense is a new pair of glasses, if you know that you get a new pair every year, you can plan for them.

However, an unexpected car repair would be covered by your emergency fund, whereas you would use a sinking fund to replace the tires since that is an expected expense.

You may be a pro at padding your emergency fund or sticking to a monthly budget. But adding sinking funds to your financial skill set can help you better manage your money and focus on your financial goals.

Watch the video: Who Called My Bond? (November 2021).