Emergency Funds vs Sinking Funds

When I first started budgeting, I built a small emergency fund of $1000. This is the first of seven baby steps recommended by Dave Ramsey. Over 6 years, we built up the emergency fund to cover 6 months of expenses. At the same time, we also have sinking funds. So what’s the difference between emergency and sinking funds? And do we need to have both?

Emergency fund and where to put it

Am emergency fund is typically used to cover a few months worth of necessary expenses in case of a job loss. For us, our emergency fund covers 6 months worth of necessary expenses, in case I lost my job. The necessary expenses include rent, groceries, insurance, utilities, and expenses for our dog. It doesn’t include things like Spotify, Netflix, or any unnecessary wants such as dining out.

We save most of our emergency fund in a high-yield savings account at Ally bank. Recently, I also put a small part of it in I-bonds due to the variable interest rate of 7%. The issue is that the I-bond needs to be held for a year. But, most emergency situations don’t necessarily require you to have instant access to cash (unless it’s to pay ransom money…).

So, a part of our emergency fund strategy is to use our credit cards and pay the statement balance when it’s due. We’re already doing this for most of our bills, and we always pay the statement balance to not carry any balance that could incur interest.

Another way to pad the emergency fund is to include our brokerage account and Roth contributions, since those can be taken out without any penalty. However, taking money out of the brokerage and retirement account is our last resort, since we don’t want to sell the assets we’ve invested in unless absolutely necessary.

Sinking Funds

Contrasted with emergency funds, sinking funds are for future true expenses. Things like saving to replace a car or laptop, a home downpayment, your biannual car insurance bill. You figure out how much money you need for the sinking fund, and when you need it by. Then, you divide up the total amount by the number of months left. This is what you need to save each month towards the sinking fund in order to reach your funding goal.

For example, I need to pay my car insurance of $305 every six months. This is about $51 per month. I put $51 every single month in my budgeting software towards this goal, so by the sixth month, I can pay for car insurance in full. Some of our sinking funds don’t really have a due date, but a more general funding amount we like to reach.

We have tons of sinking funds, because we try to anticipate what we will be paying for eventually. Example of sinking funds we have are:

  • Health – we have our annual deductible saved up in this goal. We use the health sinking fund for things like vitamins, fitness-related expenses, or prescriptions once our FSA and HRA are tapped out.
  • Dental cleaning – our dog, Oskar, had a dental cleaning and extraction surgery last year. This was a shock to our emergency fund, and we anticipate that he might need regular dental cleaning, so we saved up the amount we spent for his last cleaning/extraction session.
  • Driver license renewal – it’s a small amount, but it’s nice to already have that money set aside.
  • Passport renewal – we need to renew our passports every 5 years for immigration reasons, so we have this amount saved up.
  • Taxes – I started this to set aside 12% of the bank bonuses we get, so we don’t have a surprise bill come tax season.
  • Home downpayment – recently started this and we have a 3.5% downpayment goal without a real end date in sight.
  • laptop – I try to keep my laptop for more than 5 years, so I have a funding goal that’s 5 years out from when I purchased my current laptop.
  • Trips – a sinking fund for near-future trips.
  • Car replacement – a downpayment fund for future car purchases. I put this in our brokerage since I don’t anticipate needing to buy a new car for 10 years or more.

If you own a home, you might have more sinking funds than we do to replace things like your boiler or AC. If you have kids, you may have additional categories such as sinking funds for future braces, or to buy them a used car when they turn 16. Whatever you can anticipate you need to pay for, use a sinking fund to save up for it. It prevents you from liquidating your emergency fund, so you have that emergency fund for ACTUAL emergencies. Needing to replace a TV or laptop is not an emergency.

Final words

Emergency funds and sinking funds are tools we use to save for our future. Our emergency fund helps to alleviate the stress of potential job loss, since we are able to cover 6 months worth of expenses. And our sinking funds help us from liquidating our emergency fund and retirement savings. If you have trouble figuring out your financial goals, think of what you want in the future. And think of adding an emergency fund as one of your top financial priorities.

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