Emergency, Rainy Day and Sinking Funds – What are They and Why do you Need Them?
Emergency, Rainy Day and
Sinking Funds – What are They and Why do you Need Them?
What do they mean, and do you need all of them?
Keep reading to find out how these funds work and who should consider them.
What is an Emergency Fund?
The name says it all. An emergency fund covers you in the face of an emergency. But what type of emergency?
There are many ways to view an emergency fund, but the most common way is a fund to protect you should you lose your job or be unable to work for any other reason.
Say, for example, your company closes unexpectedly. As a result, you suddenly lose your income; how will you cover your bills? A fully funded emergency fund could cover your expenses for three to six months. This gives you time to figure out your next steps without worrying about money. You could also use an emergency fund if you fell ill or were injured and unable to work for an extended period.
How Much Money Should an Emergency Fund Have?
Ideally, your emergency fund should have three to six months of monthly expenses. This includes your monthly bills and the money needed to buy necessities like groceries and household items.
For example, if you make $3,000 a month, you should have $9,000 - $18,000 saved for your expenses. Since that’s not going to happen overnight, start with a $1,000 emergency fund to get you through a basic emergency, but make it a point to save as much as possible as soon as you can.
Who Should Have an Emergency Fund?
Everyone should have an emergency fund. The younger you are, the more money you’ll need in your emergency fund. On the other hand, you may not need as much as you near retirement since you’re likely prepared for retirement and have money saved to cover your expenses.
What is a Rainy-Day Fund?
A rainy-day fund is like an emergency fund, but slightly different. An emergency fund is strictly meant for your bills should you be unable to work. A rainy-day fund, on the other hand, covers unexpected expenses.
Consider the rainy day fund your fund for mishaps. For example, if your furnace suddenly stopped working, you could dip into your rainy-day fund to pay for it. You could also use it if your car stopped working or you were in a car accident and had to cover your deductible.
The rainy-day fund covers smaller, one-time expenses. Its point is to stop you from going into debt to cover an expense you have to pay that doesn’t fit your budget.
How Much Should your Rainy-Day Fund Have?
Each person will need a different amount in their rainy-day fund. Think about why you’d need it. For example, if you know your children will need braces in the next few years, figure out the average cost and have at least that much saved by the time your kids need them.
Also, consider the average cost of common repairs for your car’s make and model and the replacement of any appliances in your home.
The average person needs at least a few thousand dollars in their rainy-day fund, give or take. The key is to replenish your rainy-day funds after you use them. For example, if you have to replace your refrigerator and spend $1,500, you should try replenishing those funds as quickly as possible to cover the next emergency.
Who Should Have a Rainy-Day Fund?
Rainy day funds are good for everyone. Whether you’re young and starting your family or you’re nearing retirement, things happen.
A rainy day prevents you from going into debt or choosing between paying your bills and taking care of the emergency. Your rainy-day fund might not need to be as large as you get older, but you should always have one.
What are Sinking Funds?
Sinking funds are an account set aside for a specific purchase. For example, if you want to buy a new car and know you want a $10,000 down payment, you’d put money in your car sinking fund for the down payment.
It’s a sinking fund because you put money toward it each month. In our example above, you probably couldn’t save $10,000 overnight, but you could put away a percentage of that amount each month until you reach your goal.
You could have as many sinking funds as you want, but don’t go overboard, or it becomes more difficult to reach any of your goals.
How Much Should your Sinking Fund Have?
How much you need in your sinking fund depends on your goals. If it’s a high-cost goal, you’ll need to save more in your fund than if you have a less expensive goal. Also, depending on your goals, your sinking funds will change throughout the years, and sometimes you might find you don’t even need one.
Who Should Have Sinking Funds?
You need sinking funds when you have things you want to save for, so you don’t have to go into credit card debt. Most people have more sinking funds in their younger years, but you’re never too old to have one.
Final Thoughts
Taking care of your finances and saving for emergencies and
financial goals is the best way to handle your money. When you stay out of
debt, you pay less money in interest and have an easier time getting approved
for things like a mortgage or car loan.
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