Why you need Sinking Funds and Emergency Fund?

The basic principle between sinking and emergency funds is that each is used for saving money but there are reasons why you need sinking funds and emergency funds. It is important to understand that sinking funds are often set-up to cover an ‘upcoming expense’ where as emergency funds are literally for emergencies. Often people confuse these two and consider them both to be ‘rainy day’ funds and in a way they are. They stop you from needing to borrow money or dipping into any long term savings you have set-up like retirement funds that you can withdraw from, thankfully in the UK you can’t withdraw from your NI contributions.

Saving money is not something that comes naturally to most of us and until a couple of years ago, I was no different. I used to go through periods where I would put money aside every single month for no reason and then 6 or so months later I would spend it all on meaningless things because I wasn’t saving money for a specific goal so I had no motivation or incentive to continue saving and stop myself from spending my hard earned cash. This is why most people need sinking funds and an emergency fund so they have a reason to save money and an incentive to save for something specific for for future.

*Disclaimer – I am not a financial advisor.

Why you need Sinking Funds and Emergency Fund?

Both sinking funds and an emergency fund are a type of saving that helps you cover future expenses whether big or small. When I started saving, I had no real goal as to why I was saving and what I was saving for. It is so important to to have a goal when saving money whether it is for small expenses like your car MOT or for larger expenses like buying a car or major car maintenance. This is one of the many reasons why you need sinking funds and emergency fund because sinking funds allow me to save for a specific goal and emergency fund covers me for all future emergencies.

There are many reasons why (one might) need sinking funds and (an) emergency fund for example, you might need sinking funds to cover wedding costs or even birthdays. With sinking funds you can set up as many as you need and personally I have about 9 sinking funds and I shared them all in this video and how I fund each one of them. Emergency funds on the other are mostly designed for future unexpected emergencies but there can be occasions when you might have saved for an expense using sinking funds and need to top up using your emergency fund for example a small car repair turns into a large unexpected expense.

When it comes to how much you should set aside every single month for emergency funds, it’s by calculating how much you need to cover 3-6 months of your expenses then divide by how many months you think it would take you to save up that 3-6 months of expenses. For emergency funds it pays to save a small percentage of your pay check , set up automatic deposits and only spend for emergencies. For sinking funds, you need to have a target amount and same whatever you can afford and as frequently as deemed necessary so you can spend it when you have reached you target.

Recently I read “the richest man in Babylon” and it spoke about always saving 1/10th of your monthly income. Then you needed to find a way to make that money grow and work for you in the future so it can bring more money. I think everyone would love to save money if we knew it could bring us more money in the future although today’s problem is we want instant gratification. Re-reading the book I realise the book was teaching us how to save money every single month, encouraging people to invest (either stock market or side hustles) so that it can start to work for you through stock dividend income or passive income.

When it comes to where to store your sinking funds and even the emergency fund, I recommend opening one account with a different bank from your everyday bank. For sinking funds specifically, you want one savings account that allows you an opportunity to create pots instead of multiple savings accounts, imagine having 9 sinking funds and opening 9 savings accounts. Store your money where it can grow like high yield savings accounts but don’t keep it in the stock market, the money needs to be easily accessible.

When it comes to deciding the types of spending categories for the sinking funds, you have a choice from three but can create more than one sub-category. You can set up sinking funds for one-time purchases, maybe you want to buy a laptop, recurring expenses like annual car service, you know it comes round every single year so you can save a year in advance and you can save for events like birthdays, anniversaries and the like.

Whilst an emergency fund it’s very important, sinking funds are just as important and I hope the reasons I shared as to why you need sinking funds and emergency fund were useful. Do you have any sinking funds or an emergency fund?