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The world of savings is complicated. Between rainy-day, emergency, and sinking funds, there’s a lot you don’t know — but not for long. Check out this quick and simple guide on the different kinds of savings accounts, so you know what your budget needs.
The Rainy-Day Fund
The rainy-day fund (RDF) is often used interchangeably with the emergency fund, but they play unique roles in your finances. While they both help you handle unplanned spending, they differ in scope.
The RDF’s name suggests one grey and wet day for a reason. It’s there to help you out in those mildly inconvenient or annoying days when things go wrong, like when you get a minor parking ticket or need to buy new shoes for work.
An established RDF contains just enough to cover these small, unexpected shortfalls. For most people, $1,000 is more than enough to help them out on a rainy day.
You might notice that at this size, an RDF is the equivalent of a small-dollar emergency loan. By establishing your RDF, you can trade emergency loans as your usual safety net.
Until you build these savings, make sure you understand when and how to use emergency loans for unexpected expenses. These tips can help you manage your emergency loan with confidence.
The Emergency Fund
Moving up the chain of financial setbacks, we move onto the emergency fund. These savings are for bigger or ongoing unexpected expenses that cost more than $1,000. That’s why financial advisors recommend setting aside three to six months of living expenses in this fund. At this size, the emergency fund is substantial enough to handle considerable issues.
- You can rely on an automotive repair that never quite gets fixed. After your mechanic’s third attempt at repairing your car, you may spend thousands to keep your vehicle roadworthy.
- A bad fall leads you to the clinic, where you get an x-ray for your wrist. The x-ray confirms you experienced a break, and now you can expect to pay the additional cost of a plaster, physiotherapy, and prescription medication.
- Your employer lays you off suddenly. While you might get a small amount in severance, you can rely on your emergency fund to pay your bills until you find a replacement job.
No doubt, having an emergency fund can be life-saving in times of financial distress, but its size can be daunting. The average household spends two years saving just one month’s worth of living expenses. Check-in with your budget to see how you can accelerate this savings timeline.
If these savings fall short of what you need, some emergency loans may be available. Sometimes, lenders provide larger borrowing amounts. However, you should never use them as a form of income during times of unemployment; they’re designed to help you handle urgent unexpected expenses.
The Sinking Fund
Finally, let’s move off the topic of unexpected disasters and onto planned fun. The sinking fund is the savings account that helps you afford big purchases like a new gaming console or a summer vacation. It also covers practical financial goals, like moving costs to a new state, buying a new vehicle, or saving for a down payment on a new home.
The idea is that you “sink” your money into this savings account whenever you get a chance. Over time, these savings will grow until you can splurge on these purchases.
Each fund has a unique name and purpose in your finances. However, they all share one thing in common: being prepared. Squirreling away some cash is all about anticipating your needs early, so you don’t find yourself cash-strapped when it comes time to repair your car or buy a home.