What’s the Difference Between a Sinking Fund and an Emergency Fund?

What Is a Sinking Fund?

A sinking fund is money you set aside for planned upcoming purchases, such as a vacation or home renovations. You can also use a sinking fund to save for irregular bills, like a semiannual insurance premium or tax payments.

With a sinking fund, you'll typically stash a certain amount in a savings account on a regular basis and withdraw the funds when you reach the goal and use the money as planned. This method allows you to take on a large purchase without having to take out a loan, put the purchase on a credit card or tap into your emergency savings.

How to Build a Sinking Fund

Creating a sinking fund can be as easy as setting a goal, opening an account and transferring a set amount of money to that account each month.

• Choose your savings goal. Identify any big purchases coming up, and research how much you'll need to save for each.
• Choose a time frame. Review your budget to estimate how much you can afford to contribute each month. From there you can determine how long it will take you to reach your goal.
• Set up contributions. Plan to contribute in a way that works for you, such as by transferring money into the account once a month or setting up automatic transfers.

What Is an Emergency Fund?

An emergency fund is money set aside to help you cover unexpected future expenses. This allows you to avoid taking on debt through a loan or credit card when there's an emergency. Ideally, you won't touch the money for discretionary expenses; you'll keep it in savings for true financial emergencies, such as:

• Job loss
• Medical procedures with high copays
• Car repairs
• Costly vet bills
• Urgent home repairs, such as a leaking roof

How to Build an Emergency Fund

The easiest way to build an emergency fund is to automatically direct a portion of each paycheck to your savings account. While that can be a challenge if you're on a tight budget or your income fluctuates, there are ways to grow your emergency savings no matter how much you earn.

Here are basic steps to follow to build your emergency fund:

• Set a savings goal. One popular rule of thumb says you should save three to six months' worth of essential living expenses, like rent, groceries and utilities. Or you could set an initial goal that feels more attainable, like $500 or $1,000.
• Go over your budget. Review your current income and expenses, and determine how much you can put toward your goal each month. You may need to reduce expenses or increase income to make room for this line item.
• Set up automatic transfers. Consider establishing a recurring automatic transfer from your checking account to your emergency fund. The "set it and forget it" approach ensures you won't miss contributions, and paying yourself first ensures you won't use the money elsewhere.
• Monitor your progress. Check your savings balance regularly, such as each payday, to ensure your deposits are accurate and to celebrate your progress.
• Replenish the funds. If you need to tap your savings during an emergency, make a plan for replenishing the funds once the crisis is behind you.

Learn more: Tips to Boost Your Emergency Fund

Where Should I Keep My Emergency Fund and Sinking Fund?

It's best to keep your savings in a safe place where you can easily contribute to the balance and access your money when needed. Try not to keep your money in a checking account, since you might be tempted to spend it. Here are some places to try:

• High-yield savings account (HYSA): These accounts offer an annual percentage yield (APY) that's much higher than the national average, which helps your funds grow quicker over time. Many of these accounts also allow you to deposit and withdraw money anytime.
• Money market account (MMA): MMAs also pay high interest rates and offer easy access to your funds. Compared to savings accounts, MMAs give you more options for accessing your money. They often come with checks or a debit card in addition to online transfer capabilities.
• Certificate of deposit (CD): CDs offer greater interest than a traditional savings account, but less liquidity. You can invest in a CD that will last a few months to many years. This might be a good option if you received a windfall, such as a large tax refund, and want to park your money in an interest-bearing account for a certain time period.

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Frequently Asked Questions

The Bottom Line

If a major expense arises and you have no savings, you'll likely turn to a credit card, loan or other means of borrowing. Beyond resulting in additional interest and potentially other fees, it could also damage your credit score. If you make any late payments, or miss a payment, you could put your credit score at further risk.

By deliberately saving up for both planned and unplanned future expenses, you're helping reduce your chances of going into debt while keeping your credit strong. If you want to make your credit score even stronger, try using Experian Boost^®ø, which could raise your FICO^® Score^Θ based on your Experian credit report by giving you credit for monthly bills you already pay, such as eligible phone, utilities, rent, insurance and streaming services.