Introduction to Emergency Fund & Sinking Fund
Have you heard of these terms; emergency fund & sinking fund? Maybe you wonder what they signify?
Well, these are concepts of sound financial planning. The idea behind these distinct concepts is to ensure that your plans run as smooth as you visualise them. The main reason – avoid dipping into a single planned fund or resorting to borrowing to pay bills. Understanding the process of financial planning and the different types of funds help you avoid common financial mistakes and keep you on track toward achieving financial success.
Emergency Fund
You establish this to cover unexpected (unplanned) expenses.
◉ The idea is to avoid borrowing or even withdraw your retirement savings accounts.
◉ Another bad idea would be to sell a valuable asset to meet emergencies!
◉ The size of your fund is determined by your regular living expenses.
◉ Experts recommend that you keep at least 6 times your monthly expenses and a maximum of up to 12 months of the same. (see image)
Consider keeping these funds in an easy to liquidate account (separate from your regular account), and also to replace any used funds as soon as possible.
How to Set Up an Emergency Fund
You establish this to save money for upcoming definite expenses. For example; buy a car, plot, home improvement, holidays, etc. Simply put, it is used to cover planned expenses. Sinking fund savings are goal/ dream oriented.
The heart of the matter is to also to ensure that are not be tempted to cancel long-term savings account (retirement), sell a valuable asset, or in the worst case scenario turn to debt as a quick solution.
The size of the fund is determined by cost of the expense (item) you intend to cover. Since it’s a definite purpose account, once used up there’s no need to replenish it.
Sinking (Definite Purpose) Fund
Example of Sinking Fund
An Education Insurance Policy is for a definite purpose, definite term and definite maturity. Once it matures, it ceases – that’s the end of the goal.
Here’s the clarity:
Purpose – School fees (partial maturities) and protection
Term – a duration that aligns with your child’s age and grade levels
Maturity – the end date & final payment of the policy
“Beware of little expenses; a small leak will sink a great ship.”
— Benjamin Franklin
Comparing Emergency Fund & Sinking Fund
Take Away…
Maintaining an Emergency fund & a Sinking Fund(s) simplifies your financial planning process. It also makes your relationship with your money very clear as you tread the road to financial freedom. The more persistent you are with your budgeting – the clearer the picture. You get to know what to categorize under emergencies and what goes into a definite purpose (sinking) fund. Therefore, you set up an emergency fund for the unknown and a sinking fund for the known.
