Emergency fund vs. sinking fund: What’s the difference?

You hear a lot about emergency funds and sinking funds as a way to shore up your personal finances, but often the important differences between the two mechanisms is overlooked.

An emergency fund and sinking fund may sound kind of similar, but they are actually very different tools both aimed at improving your financial security. Let’s look at the differences.

What is an emergency fund?

Good cash management means putting funds away for a rainy day in case you’re hit by a big cost that comes out of the blue—like an illness or a car breakdown.

This is where an emergency fund comes in. It delivers a financial safety net so you don’t have to get a loan if something untoward and unexpected happens to you or your family.

How much do I need?

There’s no strict rule here, but when it comes to an emergency fund, more is better. Even if you can only save a little at first, it’s a good idea to start, and to do it regularly.

For instance, if you put $40 a week into a savings account, you’ll have over $2,000 by the end of the calendar year, which will give you something to fall back on if a crisis hits.

Experts suggest that a good general target is to have enough money in your emergency fund to cover three months of expenses at a minimum.

How to save for an emergency fund

Sticking to making regular payments is often the hardest part when it comes to building an emergency fund.

When it comes to this part of the equation, some ideas to take the sting out of it include setting up a separate savings account, automating your savings, and maximising your offset account if you have a home loan.

How is a sinking fund different?

A sinking fund is completely separate from your savings account or your emergency fund, and can be used to save up for things like home repairs, a holiday, or a new car.

You can think of it as a strategic way to save money by regularly setting some aside.

Simply put, while your emergency fund should be reserved for something that comes at you unexpectedly, the idea of a sinking fund is to save for a specific and planned expense.

How to create a sinking fund

There are few simple steps here. First, dedicate a savings account to hold your sinking fund in, that you won’t access for other expenses. It can help to give the account a name in line with the expense or saving goal.

Next, you need to decide how much you’re going to store in your sinking fund as a starting point. This will likely depend on your individual financial circumstances and the goal you’re aiming at with the fund, such as whether it’s for a new car or a weekend getaway.

From there, you’ll need to decide how much you’ll put away in the sinking fund on a regular basis whether that’s weekly, monthly or quarterly.

How much should I have in a sinking fund?

Unlike with an emergency fund, the amount you need in a sinking fund account depends on the estimated cost of the expense. Once you’ve accumulated that amount, you’re able to spend it for the specified expense.

Another way to organise your sinking fund to guide your saving—if you want to get a bit fancier—is to split it into categories of expenses in line with your goals. You can deposit money for recurring expenses like taxes, subscriptions and insurance premiums, one-off purchases like a new computer or car, and then large events like anniversaries or birthdays.

Remember, the bottom line is that emergency funds and sinking funds are not mutually exclusive – both mechanisms are ways to take greater control over your finances and are ways to give you more financial freedom in the long term.

Information provided in this article is of a general nature only and we have not taken your personal financial objectives, situation or needs into account. We recommend you consider if you need to seek professional financial advice before making any financial decisions.

This article is issued by Simple Financial Choices Pty Ltd (ABN 58 629 890 900; AFS Representative No. 001269407), a Corporate Authorised Representative of True Oak Investments Ltd (ABN 81 002 558 956; AFS Licence No. 238184), as the Sub-Promoter of Simple Choice Super. Simple Choice Super is a sub-plan of the Grosvenor Pirie Master Superannuation Fund – Series 2 (ABN 32 367 272 075; RSE Registration R1001204), which is marketed under two brands – Simple Choice Super and Slate Super. Visit our website or call us on 02 8074 1772 or email us at [email protected] to discuss your superannuation.