THE BROKEN WALLET

*Disclosure: This page may contain affiliate links. We receive a small commission if you purchase something we recommend (at no cost to you). All opinions remain our own.

What is a sinking fund in simple terms, and what’s the difference between an emergency fund and a sinking fund account?

Most people know the importance of saving for the unexpected like a job loss, injury, or illness. In fact, many experts recommend a minimum of 3 to 6 month’s worth of living expenses in savings.

Even when you know the benefits of an emergency fund, you might make the mistake of keeping all of your savings in a single account, and then tapping this account for non-emergency expenses. 

Of course, there’s no rule that says you can’t manage your money this way. But before you deposit another cent in your emergency fund, here’s what you need to know about sinking funds in simple terms, including why they work for some people. 

What is an emergency fund?

An emergency fund is useful for unexpected expenses. These expenses can include any unforeseen sudden cost like medical bills, car repairs, and home repairs. It also comes in handy after unemployment. 

An emergency fund helps you stay on track, acting as a buffer to keep you afloat until your finances improve. This way, you don’t use a credit card. 

You can start small and aim for a “starter” emergency fund of $500 to $1,000, and then gradually increase this amount. The more money you have in your emergency fund, the better. 

Related: 7 Ways to Trick Yourself Into Saving Money

What is a sinking fund?

A sinking fund (in simple terms) is money you set aside for “a specific purpose.”

Some might ask, Why have a separate account? Why shouldn’t I keep my cash in one account?

While some people might use one account for “all their savings,” a sinking fund prevents touching your emergency fund for “non-emergency purposes.”  

Many people use their sinking fund for:

• family vacations
• gifts
• down payments
• large purchases
• home projects
• etc.

How to build an emergency and sinking fund?

Now that you know the perks of a sinking fund, how do you build one. The good news is that there are multiple ways to increase your account fast. To get started, it’s important to track what’s coming in and what’s going out, and from here create a realistic budget. 

A budget can identify spending leaks that need plugging. And once they’re plugged, you’re able to save more. It also helps to prioritize spending which creates more disposable cash. Strategies to build an emergency (or sinking fund) include:

• plan a no-spend challenge
• use cash back apps like Ibotta
• split your direct deposit (some into checking and some into savings)
• turn off autofill for credit cards
• meal prep
• use the 24-hour rule
• save windfalls (bonuses, gift money, tax refunds, etc.)
• plan and budget for splurges
• research “free things to do [in your city]”
• spend more time with your frugal friends

Related: 6 New Money Saving Challenges to Try in 2022

Related: 10 Creative Ways to Save Money on a Tight Budget

As a side note, one recommendation is opening an online high-yield savings account for both your emergency fund and sinking fund account. You’ll earn a higher interest rate and grow your money faster.

One option is to keep $1,000 in an emergency fund with your local bank for immediate access, and then keep the bulk of your emergency fund in an online high-yield savings. 

You can also set up recurring transfers from your bank account to your Acorns account weekly or monthly. Using a savings app is an excellent way to pay yourself before you pay bills.

– Guest post by Erica Williams