Sinking funds and savings accounts are two financial tools that you can use to create financial peace and make personal finance as simple as possible. This post will walk you through the difference between the two accounts and how you can use them to create financial stability even on a relatively small income.
Savings accounts are set up for long-term savings. A savings account is intended to sit and receive deposits for long enough to amass a substantial amount of money. The main difference between a savings account and a sinking fund is that a savings account doesn’t necessarily have a specific purpose. It can be a fund that you build up for a variety of reasons that doesn’t have a time limit or it’s meant for a large purchase. A bonus of setting up a savings account is that many savings accounts allow you to accrue a small amount of interest each month.
- Long-term savings-Stashing money away towards a house down payment, car, boat, other large purchase is best done in a savings account where the money isn’t as easily accessible as it would be in a checking account.
- Emergency fund-Saving 3-6 months of expenses in a fund separate from your checking account and other savings accounts help to ensure that the money is only used in the event of an emergency.
- Large unexpected expenses-In the event of something unexpected–a costly car repair, leaky roof, etc.–money can be pulled from a savings account to cover the cost without breaking your monthly budget.
Sinking funds are essentially short-term savings accounts that are set up for a specific upcoming expense. Sinking funds can be funded either using cash or setting up categories in a savings account.
- Upcoming holidays, birthdays, anniversaries, etc.-This can be done either by putting a set amount away each month and using it as you need it or by setting an amount for each event and dividing the total by how many months until the event. These are events that happen every year, Christmas always comes on December 25th, birthdays fall on the same days every year, but somehow they always seem to come as a surprise. Sinking funds let you be ready when they show up!
- Smaller savings goals–If you’re saving up for something smaller, for example an inexpensive vehicle, back to school expenses, a vacation etc., a sinking fund works really well. Just divide the amount you want to save by the number of months you have until you need the money and save that amount each month.
- Bills-We pay most of our bills every 6 months, so I take the total amount of the bills and divide them by 6, and then save a little each month. When the bills come due, the money is sitting in our savings account.
- Home maintenance and auto repair-Household maintenance and auto repairs happen unexpectedly and can definitely bust the budget if they become necessary. Setting aside a certain amount each month means that a larger sum will eventually pile up and can be used to pay for these unexpected expenses.
Both savings accounts and sinking funds are great ways to plan for future expenses and ensure that you won’t be caught without money when unexpected expenses inevitably come up.