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Emergency Fund vs Sinking Fund: What’s The Difference?

What is an Emergency Fund?

An Emergency Fund is exactly that, it’s a fund set aside for an ‘emergency’, a fund that you DO NOT plan to use. It just sits in your bank account (gaining interest) waiting for the day when something unforeseen goes wrong. It’s a brilliant way to avoid using your credit card or dipping into savings when times get tough. Your Emergency Fund is your absolute best friend – it’s got your back when your washing machine explodes or you get a parking ticket (we’ve all been there).

How much should I save?

This is completely up to you however a good starting point is £1,000. Once you have reached £1,000 continue to save until you have reached 3-6 months’ worth of living expenses (this will vary depending on your personal circumstances). By this point you will be the Ultimate Saving Pro, but don’t stop saving! Plump-up that Emergency Fund to £10,000 or even £20,000. As we grow older and acquire more assets it only feels right to keep a large safety buffer to protect them.

Where should I keep it?

I keep my Emergency Fund in a high interest rate savings account (Natwest Digital Regular Saver 3% interest rate). I set up a monthly standing order (automated monthly deposit) to ensure I am putting money into my Emergency Fund regularly. Make sure you check the minimum deposit requirement to ensure you are eligible to receive interest.

What is a Sinking Fund?

A Sinking Fund is your Emergency Fund’s distant cousin. Unlike an Emergency Fund, when you have a Sinking Fund you DO plan to use it. Its purpose is to pay your large annual expenses so you aren’t rich some months of the year and broke during the others.

How much should I save?

Step 1: Write down all of your large annual payments. At the beginning I recommend you keep it simple e.g. car insurance, pet insurance, car tax, car MOT and car service. As time passes on you could include other annual payments such as Christmas, birthdays, anniversaries, dentist visits, hair appointments, holidays etc.

Step 2: Look back at old invoices and write down how much each annual expense costs per year e.g. your car insurance cost £548 last year. If the expense is the same cost every year write down that number. However, if the cost is likely to change then estimate how much it will be e.g. last year my car insurance cost £548 but the year before that it was £566. I’d estimate it will cost approximately £530 this year.

Step 3: Add all of the costs together and divide by 12 (the 12 months in the year).

Step 4: Take that amount and deposit it into a Sinking Fund each month to ensure you have the correct amount of money ready to pay off each annual expense (whenever it pops up).

 

TOP TIP: Keep a list of your annual expenses; what month they are due and how much they cost so you can refer to them later.

2020 Sinking funds

Month Expense

Total

January Car insurance £548
April Pet insurance £299
April Car service £200
September Car MOT £50
October Car tax £45

 

Where should I keep it?

I have seen several different methods of where to keep your Sinking Fund. A popular method is using Monzo online banking which lets you organise your money into ‘money savings pots’. It’s fab and very aesthetically pleasing. However, spreading your savings out and creating lots of little Sinking Funds means you aren’t earning any interest (and that’s free money you’re missing out on). I keep my Sinking Fund in one singular high interest account (Natwest, again). The minimum requirement to earn interest is £50 and last year I was depositing £94.17 each month into my Sinking Fund so ker-ching! Even my savings were saving!

Summary

Emergency Fund

Sinking Fund

Used to pay for unexpected emergencies Used to pay large annual expenses
You DO NOT plan to use it You DO plan to use it
Can earn interest Can earn interest
Keeps you from being broke some months of the year Keeps you from being broke some months of the year
Amount changes yearly Amount changes yearly

 

Implemented together these two saving funds will make your budget invincible! No more dipping into savings unexpectedly! No more staying awake at night wondering how you’re going to pay for your broken laptop! No more wondering how you’re going to pay for Christmas!

Doesn’t it sound great? You can do it!

Lottiebudgets

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