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Your definitive guide on the difference and importance of both an emergency fund and sinking fund.
Welcome back to the Master A Budget Series! Yesterday, we talked about Budget Categories and Percentages; today, you will learn about the Emergency fund vs Sinking Fund.
Let’s dive in.
I think you will agree with me when I say that life is full of surprises, both good and bad. I would not mind it if it is good all the time, however, what if it is bad?
Well, nothing we can do to prevent that. We can always whine and complain about it, which won’t do any good.
Or we can always do something to prepare for it.
As Murphy’s Law says, “Anything that can go wrong will go wrong,” therefore we always need to have a plan.
That’s where emergency fund and sinking fund come in.
What Is An Emergency Fund
Some may question the necessity of an emergency fund. After all, is it really necessary? How do you go about it? Does it need to be a huge amount?
Here are some ideas and suggestions that should help answer these questions.
Is an Emergency Fund Necessary?
Generally speaking, yes, an emergency fund is necessary. What form it takes can vary, but it is a good idea to have an emergency fund.
An emergency fund can help you avoid high-interest debt, and helps reduce your stress.
After all, as I have mentioned earlier, life is full of surprises and many of them are sudden and not good.
By having that “cushion” can help you feel ready and calm.
How Do You Go about Creating an Emergency Fund?
Total Your Expenses
First, determine your expenses. Look at three to six months’ worth of living costs and count on saving that much in a fund.
For example, if you normally spend $4,000 a month, multiply that by 3 and you would get $12,000. The $12,000 will be your target emergency fund.
The amount can help you keep your standard of living for a time if you lose your job, or it can cover a large expense such as car repairs or medical expenses.
My favorite way to keep track of our finances is by using Personal Capital. With Personal Capital, I can visualize our spending and savings, get insights into our cash flow, see the transactions we’re making, analyze our net worth, and more.
It is an absolutely FREE tool to use, and if you sign up through our link, you and I will get $20 each!
Determine Your Time Frame
Then determine how long it will take you to save that much and how much you have to take out of your paycheck each month to reach that goal.
Once you’ve determined the amount you need to save and how long it will take to save it, it’s a good idea to change your mentality and put payments into the emergency fund before you pay for anything else.
If you can do it by automatic deduction, go for it — see if you can have a portion of your paycheck taken out and put into a savings account.
Otherwise, make it a habit to put money in your savings first and foremost, and then take care of your other expenses after.
What If You Have Low Income?
Even if you have low income, you can set aside something each month. Try saving a percentage of your income, such as 5 or 10 percent.
It may take you longer, but it will accumulate.
Does Emergency Fund Have to Be Huge?
In short, no. An emergency fund does not have to be massive – but it certainly should cover unexpected expenses.
Learn more about the emergency fund by checking out How To Create An Emergency Fund?
An Emergency Fund is a saving that will cover unexpected expenses that need to be taken care of immediately.
But, how about those expenses that are expected?
This type of expenses will be taken care of by your Sinking Funds.
What Is A Sinking Fund
Another type of savings that you should have is the Sinking Fund. Sinking Fund is a saving strategy in which you set aside a little amount each month to prepare for larger purchases in the future.
Why Do I Need A Sinking Fund?
You might be questioning the need for a sinking fund if you are already saving. I totally get it, however, your savings might not last long if you don’t know what you’re saving for.
You might not even know if you have enough.
By having a Sinking Fund, you will be:
Your washer and dryer won’t last forever. Your furnace will have its hiccups. But it’s ok because you are prepared for it.
Your sinking fund is a collection of cash intended to pay for a specific future purchase. So when it’s time to use it, you will be able to pay cash.
No more swiping credit cards and be in debt. Although, I usually use my cards to earn rewards points and use the cash to pay off the balance.
Enjoy Your Purchase
When you have the fund to purchase an item or a vacation package, you will be able to enjoy it more because you know that you are not in debt by purchasing that item or package.
How Does Sinking Fund Work?
Starting a sinking fund is simple and easy.
Review Monthly Budget
Start by looking at your monthly budget and determine how much you can realistically save every single month.
Identify Annual Expenses
You will then evaluate your expenses and identify the expense that you pay annually, it can be an annual gym membership, car insurance, home insurance, etc.
Determine How Much To Save each Month
You will then take the annual amount and divide it into twelve months. And after knowing the amount you should be saving every month, you should work diligently on setting aside that amount every single month.
For example, we pay $900 on hour home insurance and we pay it annually. So, I would divide $900 by 12 which gives me $75.
I would then create a Home Insurance Sinking Fund and set aside $75 every month. When it comes due then I will have the full amount ready.
As for things that you would not know the amount, like home repair, vacation, children’s fund, etc, set aside any amount that you want as long as it will not mess up your monthly budget.
If you only have $500 extra for savings in your monthly budget, stick to the $500.
Join the MWP community to get access to free printables, including a sinking fund tracker.
What Can Be Included In A Sinking Fund?
You can basically include ANYTHING in your sinking fund categories. However, make sure you have the following:
- Home Repair Fund
- Vacation Fund
- Medical Expenses Fund
- Car Repair Fund
- Children’s Fund (if you have kids)
- Pet Fund (if you have pets)
You can also add the following sinking fund categories:
- Holiday Fund
- Gift Fund
- Gym Membership
- Home Insurance
- Car Insurance
- Christmas Fund
- Life Insurance
- Car Replacement
- House Downpayment
There you have it!
Final Thoughts On Emergency Fund And Sinking Fund
Although emergency fund and sinking fund are both savings, the main difference rests on their purpose.
An emergency fund is for purchases that are UNEXPECTED and NOT SPECIFIC while sinking fund is for purchases that are EXPECTED and SPECIFIC.
You can keep your emergency fund in an interest-bearing account that is easily accessible and watch it grow. We keep ours with CITBank, which gives us a reasonable interest rate.
As for the sinking funds, you can keep them in one account but you need to keep track of each sinking fund.
I keep ours with Capital One 360 Savings, which allows us to have multiple savings account in one account.
Now that you have learned about Emergency Fund vs Sinking Fund, next up on the series is about the Best Budgeting Apps and Cash Envelopes.
Do you have an emergency fund and sinking fund yet?
If you haven’t yet, download the Master A Budget Workbook to practice what you will learn from this series.
Articles Related To Emergency Fund and Sinking Funds:
- How To Start An Emergency Fund
- Sinking Fund Examples For Couples
- Advantages Of Budgeting
- Signs That You Need A Budget
- Components Of A Budget