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Using different strategies for specific types of savings goals can help you stay organized and get ahead faster. Rather than putting all of your savings in one account and commingling funds, you might find it easier to reach your goals if you separate your savings into two categories: sinking funds and emergency funds.
Sinking funds help you save up for specific planned purchases, while emergency funds provide you with a safety net for unplanned expenses. Both help you avoid going into debt when you need to pay for a purchase or unexpected expense.
|Sinking Fund vs. Emergency Fund|
|Sinking Fund||Emergency Fund|
|Used for planned expenses||Used for unplanned expenses|
|Intended for a specific goal||General buffer, not for a single purpose|
|Goal amount is tied to the cost of the purchase||Goal amount is three to six months of living expenses|
What Is a Sinking Fund?
A sinking fund is money set aside for a specific, planned future expense, such as a vacation, a wedding, school tuition, home renovations or a new computer. The term comes from the investment world, where sinking funds are used for paying off debts or bonds.
Using a sinking fund increases your spending power without forcing you to rely on your emergency savings or use credit such as a loan or credit card. In this way, you can help ensure you'll have enough funds available if an urgent expense arises, and you'll avoid paying interest on a credit card or loan.
How to Create 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.
- Decide on a savings goal. To start, figure out how much you want to save. The amount you want to set aside will depend on your savings goal and can vary greatly depending on what you're saving for, whether it be a $1,000 new TV or a $30,000 wedding.
- Choose a time frame. If you want to reach your savings goal within a certain timeframe, calculate how much you'll need to set aside each month to hit that goal. Alternatively, if you're not in a time crunch, review your budget to estimate how much you can comfortably afford to contribute each month.
- Set up contributions. Plan to contribute in a way that works for you, such as by transferring money from your checking account weekly or monthly, or adding varying amounts if your income fluctuates. Setting up automatic transfers into your sinking fund ensures you'll stay on track toward your goal.
Where to Set Up Your Sinking Fund
A sinking fund isn't a certain type of financial account; it's simply a fund used for a specific purpose. As such, you have several options for what kind of accounts to use. Some examples include:
- High-yield savings account: These savings accounts carry a higher interest rate than traditional savings accounts and are just as easy to pull cash out of when you need the money. Find out whether you'll need to maintain a minimum balance to avoid fees, and keep in mind your bank may limit you to a maximum number of withdrawals per month.
- Money market account: Money market accounts also typically offer higher interest rates than traditional savings accounts. They may require a higher minimum starting balance than other types of savings accounts.
- 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.
If you'd rather use your existing savings account and put part of it toward your sinking fund, be sure to carefully keep track of the funds to avoid using that money for any other purposes.
What Is an Emergency Fund?
An emergency fund is money set aside to help you cover unexpected future expenses. By being able to cover unplanned purchases with cash, you can avoid racking up credit card debt, taking out loans, asking family for money or paying penalties to dip into your retirement account early.
The money you put into your emergency fund shouldn't be touched for discretionary expenses, but saved for true financial emergencies, such as:
- Job loss
- Unforeseen medical procedures
- Car repairs
- Costly vet bills
- Home repairs such as a leaking roof or broken HVAC
How to Create an Emergency Fund
Creating an emergency fund is similar to creating a sinking fund, though you'll focus more on determining how much you can afford to save each month rather than trying to reach a goal for a specific purchase.
- Determine how much you can afford to contribute. How much do you need in your emergency fund? Experts generally recommend having three to six months' worth of living expenses saved, including housing, food and other necessary costs. The idea is that if you lose your job or can't work for a few months, you'll have enough to get by without going into debt. That said, saving anything is better than nothing, and making regular contributions will help you over time. Even having $750 set aside could help you cover an emergency vet visit or car repair. Look at your budget and determine how much you can put toward your emergency fund each month.
- Choose the right type of account. An emergency fund isn't a specific type of account, but it's usually best to keep this money separate from other savings. Because the money in an emergency fund may need to be accessed quickly, you'll want to avoid keeping it in less liquid forms of savings or investments, such as CDs or stocks. As with your sinking fund, look for a savings account or other savings vehicle with a relatively high interest rate to make the most of your money, such as a high-yield savings account. Again, be aware of minimum balance requirements and fees.
- Set up automatic deposits. To establish your emergency fund, set up automatic payments so you can move money to your emergency account easily. The balance will slowly add up over time, and you can choose to stop adding to it once you've reached your goal amount or keep contributing over time.
If you deplete your emergency fund, aim to replenish it as quickly as you can. Keeping this stash of cash in the wings will help protect your finances the next time life throws you a curveball.
An Added Bonus: Preserving Your Credit
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 can raise your credit score by giving you credit for monthly bills you already pay, such as eligible phone, utilities and streaming services.