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

You must be familiar with an emergency fund. It is a savings fund that you use to counter any critical cash need.  It requires you to save a particular amount each month for 6 months consistently. You cannot withdraw from that account for that period. It thus helps you build up savings that you can use under unemployment and serious financial issues.

Well, there is also something like a sinking fund. It is a small fund attached to achieving a goal. For example, if you need £7000 to add new furniture to your living room.  Thus, you save only towards that goal by setting a target.  However, almost similar usage confuses individuals. Read ahead to know the difference between a Sinking Fund and an Emergency Fund.

Sinking fund Vs. Emergency fund:  Meaning or Implications

A sinking fund is a savings fund that one uses to achieve a particular lifestyle goal. People often create this fund to save for a house deposit, wedding expenses, or to plan a holiday. It could be anything but a single goal to achieve. It also reduces the risk of aspects like loan defaults. It is because you have the required funds as sinking funds. You can withdraw from it to pay the instalments.

An emergency fund, on the other hand, works the same as the name suggests. It involves saving a fixed amount per month (usually for 6 months) consistently.  One usually uses it under unexpected cash requirements or under a financial crisis. For example, if you lose a job, you can use an emergency fund to pay for essential living needs. Alternatively,  you can tap one to fund a heavy surgery expense. Thus, unlike sinking funds, you can use it for any purpose or need.  However, it should be a cash-critical expense.

1. Sinking fund Vs. Emergency fund:  Examples

You can generally create a sinking fund for small and long-term life goals. It just requires you to analyse your finances, make necessary changes and start saving towards the goal. Here are some examples of sinking funds to consider:

• Short-term goals: Car repairs, holiday gifts, medical bills
• Medium-term goals: Vacations, major appliances and furniture
• Long-term goals: financing child education, down payments, or house renovation

As mentioned above, an emergency fund is not used for a particular aim or purpose. As a whole, you essentially use it to fund critical short-term needs. Here are some examples of an emergency fund:

• Paying for urgent medicines
• Structural home repair, like a leaking roof
• Paying utility and credit card bills
• Paying council tax or bridging one

2. Sinking fund Vs. Emergency fund: Amount to save

How much you should save on a sinking fund depends on your current goal and cash requirement. For example, if you wish to save for replacing the car seat covers with custom leather upholstery, you must save £1400. Thus, you can save towards this particular goal by setting direct debit.  Thus, there is no particular amount that you must save.  It entirely depends on the purpose.

Alternatively, emergency fund saving goals depend on your monthly income, monthly bills and savings. You can follow the 3-6-9 rule to save for an emergency fund. Here is how it works:

• Save for 3 months if you have a good and stable income
• Save for 6 months consistently if you have high financial obligations ( children, mortgage)
• Save for 9 months if you are self-employed with an irregular income

Thus, decide according to what best meets your circumstances the best.  Pick an amount you can comfortably save even if your income drops.  Accordingly, keep aside a fixed portion of your salary towards the emergency fund.

3. Sinking fund Vs. Emergency fund:  How does it work?

The functionality of sinking funds and emergency funds is almost similar. However, you use the sinking fund for a particular goal. Here are the basic steps involved in sinking an emergency fund:

• Step 1- Decide the amount to save and make a budget ( for example, £20000)
• Step 2- Determine the timeline up to which you must save ( saving £20000 in 5 months)
• Step 3- Determine how much you need to save monthly ( divide £20000 by 5 – £4000/month)
• Step 4- Automate your monthly savings ( use a bank account with a direct debit facility)
• Step 5- Use the savings after the deadline ( in sinking funds). However, you should use an emergency fund only under extreme cash needs.

4. fund Vs. Emergency fund:  Where to set up?

You have several options when it comes to setting up a sinking fund. You can consider any of the following options:

1. High-yielding savings account: High interest increases your final contributions
2. Money market account: These offer higher interest rates than savings accounts. However, you must save a particular balance or minimum balance to keep it active
3. Certificate of Deposit (CD): Certificates of Deposit offer better interest than savings accounts.

Alternatively, you can consider the best interest rate savings account to keep your emergency fund functional. However, what if you need £3000 urgently, but you have saved only £500? Don’t worry, if the emergency fund doesn’t work or falls short, check Same-day loans from a direct lender. It may help you get instant cash to fund your needs. It does not involve detailed documentation.

Bottom line

The article clearly defines the difference between a sinking fund and an emergency fund. A sinking fund is especially used to achieve a specific financial goal. Whereas you can use an emergency fund to counter any cash urgency. The methods of saving the amount are usually the same. However, the frequency of tapping each may differ.