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  • Sinking Fund vs. Emergency Fund: What’s the Difference?

    Sinking Fund vs. Emergency Fund: What’s the Difference?

     

    When I started budgeting for the first time, I would get so frustrated because I felt like I was doing really well. But then one big expense would come up and throw off my entire budget for the month.

    Sometimes it was unexpected car repairs or a medical bill I didn’t plan for. But other times it was expenses I knew about and just didn’t plan for, like my vehicle registration or my Amazon Prime subscription.

    This went on for years until I found two simple tools to help me avoid these budget mishaps: sinking funds and emergency funds.

    In this article, I’m explaining what a sinking fund and emergency fund are, when to use each one, and how to start building them. I promise these tools will totally change the way you budget!

     

    What is an emergency fund?

    An emergency fund is just what it sounds like — it’s a chunk of money set aside for emergencies. First, an emergency fund can be used for large unexpected bills. But more importantly, it can replace your income for a short time if you unexpectedly lose your job.

    Experts generally recommend having at least 3-6 months of expenses set aside in your emergency fund. That’s enough to give you some breathing room in case you lose your job.

    In light of the pandemic, it’s more important than ever to have an emergency fund. And if it’s feasible for you to save more than 3-6 months of expenses, I definitely recommend it.

     

    How to build an emergency fund

    To build your emergency fund, start by figuring out just how much you want to save. And remember that saving 3-6 months of expenses doesn’t necessarily mean saving 3-6 months of income. If you lose your job, assume that you’ll cut out some of your discretionary spending. It really only needs to be 3-6 months of necessities.

    Once you know how much you want to save, you can start transferring money into the account each month. I do recommend keeping this money in a separate savings account — preferably a high-yield savings account — so you’re never tempted to spend it.

    When you aren’t currently saving, it feels impossible to get started. I started by setting up an automatic transfer from my checking account to my savings account. Start small – my initial transfers were only $50! But once you get into the habit and see the benefits of having a savings, you’ll start making more room in your budget.

     

    What is a sinking fund?

    A sinking fund is a saving strategy you can use to save all year long for expenses that come up only occasionally. For example, let’s say you spend $600 per year on Christmas. Instead of spending $600 out of your December budget and likely going way over budget for the month, you would save $50 per month throughout the entire year.

    Sinking funds can be used for three types of expenses:

    • Planned expenses like your vehicle registration or Amazon Prime subscription
    • Unplanned expenses like car repairs
    • Savings goals like a vacation or the down payment on a new car

     

    Sinking fund categories

    There are so many categories you can make sinking funds for. And honestly, once you get the hang of it, you’ll be excited to set up more sinking funds. It’s kind of addicting! Here are some examples of sinking funds you might have:

    • Vehicle registration
    • Car repairs
    • Car insurance
    • Home repairs
    • Christmas
    • Medical bills
    • Pet expenses
    • Vacation
    • House downpayment
    • Association dues
    • Clothing
    • Car replacement
    • Weddings
    • Kid-related expenses
    • Tuition
    • Annual subscriptions
    • New appliances

     

    How to build sinking funds

    To build your sinking funds, start by figuring out how much you want to save for the entire year. For some categories, this will be easy. You can easily figure out how much you’ll need for your annual subscriptions or vehicle registration.

    But it might be more challenging to figure out how much to save for unplanned unexpected like medical bills and car repairs. For those, you can page through your old bank statements to get a good idea of how much you spent last year. Once you know how much you want to save throughout the entire year, simply divide that by 12, and you know how much you’ll want to save each month.

    Don’t feel overwhelmed by the sheer number of sinking funds you could start. Choose those that are most important to your life and come up most often, and you can build on them from there. I started with just a couple of sinking funds, and now I have nearly a dozen!

    As for tracking your sinking funds, I love to use the app You Need a Budget (YNAB), which has a system designed to track these savings categories. Another tool you can use is Ally Bank, which has a high-yield savings account with “buckets” where you can allocate parts of your savings to certain savings categories.

     

    Final Thoughts

    Both your emergency fund and your sinking funds are an important part of your financial plan, but they have very different purposes. To make the most of your savings, I recommend using both! Your sinking funds will help you budget for expenses both planned and unplanned that come up only occasionally, while your emergency fund is there to protect you in case of a job loss.

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  • How to Pay Yourself First and Finally Start Saving Money

    How to Pay Yourself First and Finally Start Saving Money

     

    Here’s how most people approach saving money:

    They tell themselves that they’ll save whatever is left at the end of the month. But someone there never seems to be anything left when the end of the month rolls around.

    I was stuck in this pattern for years, and I know how frustrating it can be.

    I finally learned the “pay yourself first” strategy, which has completely changed the way I budget and has helped me to save money consistently each month.

    In this article, I’m sharing how you can pay yourself first to pay off debt, build your emergency fund, and save for your biggest financial goals.

     

    How to Pay Yourself First and Finally Start Saving Money

     

    What does it mean to pay yourself first? 

    The concept of paying yourself first means that you set aside money in your budget for savings and financial goals before budgeting for anything else.

    The entire purpose of the “pay yourself first” strategy is to avoid the problem I talked about earlier, where you run out of money each month before you have a chance to save any. 

    When you pay yourself first, you transfer money out of your checking account as soon as you get paid each month before spending any. Then, you can only spend what’s left.

    Paying yourself first is an effective way to build your emergency fund or save for a financial goal. You can also use it to pay off debt by making extra debt payments as soon as you get paid.

     

    How to pay yourself first

    Follow these steps to implement pay yourself first in your own budget.

     

    Step 1: Calculate your income and expenses

    First things first, write down your monthly income and expenses.

    If you’re a salaried employee, calculating your monthly income will be easy. If you have an irregular income because you’re self-employed or are an hourly employee, this will take a little more work. I recommend checking what your income has been for the past 3-6 months and taking the average amount.

    It should also be easy to figure out your fixed expenses. These are the non-negotiable expenses you have to pay each month like rent, insurance, and your student loan payment.

    Once you’ve calculated your fixed expenses, try to determine how much you spend on other expenses throughout the month. Your variable expenses will include things like groceries, transportation, clothing, etc. These change each month, but you can probably look back a few months and find the average.

     

    Read: Creating a Monthly Budget: A Step by Step Guide

     

    Step 2: Set financial goals for yourself

    One of the most important steps in paying yourself first (at least in my opinion) is setting financial goals.

    It’s easy to tell yourself that you’ll save money. But unless you really have a why behind your savings, it can be hard to stick with it. If you set a specific goal, you’ll have something to motivate you to follow through. 

    Financial goals you might save for include:

    • Building your emergency fund
    • Start saving for retirement
    • Saving for a new car
    • Saving for the downpayment on a home
    • Saving for a vacation
    • Renovate your home
    • Start a business
    • Reach financial independence

     

    Read: How to Set Financial Goals You Can Achieve

     

    Step 3: Decide how much you want to save each month

    Once you’ve calculated your income and expenses and figured out what you want to save for, decide how much you’ll save each month. You want to make sure you’re saving enough to make a real difference, but not so much that you don’t have enough money for your monthly spending.

    An easy way to figure out how much to save is to divide the amount you want to save by the number of months before you want to have it saved.

    Let’s say you’re planning a vacation next summer and you expect to spend around $2,000. If the trip is 12 months away, just divide $2,000 by 12. You’ll find that you need to save roughly $167 per month for the next year.

    If you’re new to pay yourself first, you might worry about overspending and running out of money. If you’re just getting started, begin with a small automatic transfer.

    When I first started using this strategy, I did an automatic transfer of $50 the first week of the month. As I adjusted to my new spending limitations, I increased my monthly savings.

     

    Step 4: Automate it

    The best way to ensure you pay yourself first every month is to automate it. Set up an automatic transfer to go through a day or two after payday each month. That way, you’re saving regularly and you don’t have to think about it.

    I can almost guarantee that if you don’t automatic it, you’ll often come up with an excuse for why you can’t save as much this month.

    And if you’re using the pay yourself first method to pay off debt, just set up an automatic payment each month for the amount you want to pay.

     

    Benefits of paying yourself first

    Paying yourself first is one of the best strategies to help you build your savings or pay off debt every month.

    Many individuals and families struggle to make progress on their savings. The most recent data shows that only about 39% of Americans would be able to cover a $1,000 emergency.

    Not only can paying yourself first help to prepare you for a financial emergency, but it can also help you make progress on your financial goals.

    The pay yourself first method is especially well-suited for people who struggle with spending. Think of it as a reverse budget. Rather than having to stick to your spending plan to save, you’ll be limited to spending what’s left after saving.

     

    Final Thoughts

    I know how frustrating it can feel to be so determined to save, and yet you somehow never manage to. Paying yourself first is one of the best ways to reach your financial goals, even if you’ve struggled to do so in the past. 

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