My first budgeting attempt was frustrating because I thought I was doing well. Then, one expense would pop up that would completely rewrite my monthly budget.
Sometimes, it was unexpected car repairs and other times, and it was a medical bill that I did not plan for. Sometimes it was unexpected car repairs or a medical bill I didn’t anticipate, such as my vehicle registration or Amazon Prime Subscription.
It continued for many years until I finally found two simple tools that helped me avoid budget disasters: emergency funds and sinking funds.
This article will explain what sinking and emergency funds are and when they can be used. It also explains how to build them. These tools will completely change how you budget.
What is an emergency fund?
An Emergency Fund is exactly what it sounds like: money that’s set aside for emergencies. An emergency fund can be used to pay large, unexpected bills. It can also replace income temporarily if your job is suddenly lost.
Experts recommend that you have at least three months’ worth of expenses saved in an emergency fund. This will give you enough money to cover your expenses in a job loss.
An emergency fund is essential in light of the pandemic. If you can save more than 3 months of expenses, I highly recommend it.
HOW TO CONSTRUCT AN EMERGENCY FUND
Start by determining how much money you want to put aside for your emergency fund. Remember that saving 3-6 months’ expenses does not necessarily mean saving 3-6 monthly income. Assume that you will reduce your discretionary spending if you lose your job. You only need to have 3-6 months’ worth of necessities.
Once you have determined how much money you want to save each month, you can begin transferring money into your account each month. This money should be kept separate from your checking account, preferably with a high yield, to ensure you aren’t tempted to spend it.
It can feel impossible to save if you don’t have any savings. I set up an automatic transfer of my checking account to my savings. Start small; my first transfer was $50. Once you start to save money, your budget will become more flexible.
What are sinking funds?
You can save for unexpected expenses all year with a sinking fund. Let’s take, for example, Christmas spending of $600 annually. Instead of spending $600 in December and most likely going over budget for the month, you will save $50 throughout the year.
HOW TO BUILD SINKING FUNDS
Start by determining how much money you want to save each year to build your sinking fund. This will be easier for some categories. It’s easy to calculate how much you will need for your vehicle registration or annual subscriptions.
It might be harder to determine how much you should save for unexpected expenses like car repairs or medical bills. Looking through your bank statements to get an idea of what you spent last year. Divide the amount you want to save for the year by 12, and you will know how much to save each month.
Do not be overwhelmed by the number of possible sinking funds. You can start with the most important ones in your life and then build from them. I started with only a few sinking funds. Now I have almost a dozen!
I love the app you Need a Budget to track your sinking funds. It has a system that tracks these savings categories. Ally Bank also offers a high-yield savings account that allows you to allocate a portion of your savings to specific categories.
