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The Purpose of an Emergency Fund. Hint: It's Not What You Think

by Shawanda Greene

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I was talking to a friend today about the difference between an emergency fund and a sinking fund.  She heard the term “sinking fund” on The Dave Ramsey Show so she called me up to ask if I’ve ever heard of one.  Well, I listen to The Dave Ramsey Show too, and if I remember correctly, Ramsey describes a sinking fund as cash reserved for necessary, expected, but nonetheless, potentially burdensome expenses.

Investopedia disagrees with Ramsey’s definition.  Actually, a sinking fund is a pool of money set aside by a company to help repay a bond issue. It does seem as if Investopedia and Ramsey agree on the spirit of a sinking fund, so let’s go with Ramsey’s definition since it’s sexier.

An emergency fund is for – well – an emergency: a sudden, urgent, unexpected event that requires immediate action.  As far as I can tell, an emergency fund and a sinking fund serve the same purpose except one is built in anticipation of the unexpected knocking you off your feet while the other is not.

Here’s a list of some of my personal emergencies:

  • I locked my keys in a gym locker. Since I used an ultra hardened lock, I had to hire a locksmith to saw it off the locker. That cost about $90.
  • A family member passed away, and I had to fly home for the funeral. The last minute flight set me back roughly $400.
  • My car failed it’s safety inspection due to worn brake pads.  The replacements were $180.

I didn’t think any of these things would happen when they did.  If the cash in my checking account was insufficient, then theses expenses could’ve been paid with money from my emergency fund.

Contrast the events listed above with the following:

  • Your 25 year old roof begins to leak. That’ll be $14,ooo.
  • Betsy, your 1995 Geo Prizm who can’t pass a safety inspection to save your life, has to be put down.  A realiable set of wheels is running around $8,000.
  • The refrigerator you happened upon while dumpster diving and have been using for the last five years dies.  You don’t want to push your luck so you pick up an imperfect substitute for $500 at the Sears scratch and dent warehouse.

Use your sinking fund to pay for these.  You know roofs don’t last forever and neither do cars and neither do refrigerators.  You get my point.

You’re probably saying to yourself, “what difference does it make as long as I have the money to pay for this stuff when I need to?”

So what happens if the cost of the roof wipes out your emergency fund, then you need to pay for expensive dental surgery? Dental insurance stinks.

Don’t let something you could’ve planned for leave you financially vulnerable to circumstances you have no way of predicting. I know it’s a lot of cash to have on hand, but that cushion will help you sleep better at night if either the expected or the unexpected come calling for your immediate attention.

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{ 4 comments… read them below or add one }

FFB July 8, 2009 at 11:41 PM

So if I get this correctly, an emergency fund is for things that hit you out of the blue that need money. A sinking fund is for things you know are wearing away and will have to be replaced eventually.

Is that about right?

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Shawanda Greene July 9, 2009 at 11:17 PM

@FFB – Yep. I manage to destroy a cellphone about once a year. It doesn’t help that I handle my phone so much and that I’m a klutz. If I don’t have the money in my checking account, I know I’ll tap my emergency fund to replace it. It’s not a huge expense and many would say it’s not even a necessity. I’d agree, but I know me. I’d hate to compromise the integrity of my emergency fund by tapping into it for something I pretty much expect.

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iheartbudgets May 24, 2012 at 8:14 PM

Agreed! I actually just posted about these, haha! I used the term "savings buckets" because when I tell people about Sinking Funds, they get a puzzled look on their faces. I love the idea of savings up for something BEFORE it becomes a problem. Not planning ahead makes it easy to call everything an emergency. Soon enough, that new pair of shoes or lawnmower or car becomes an emergency that you "need". Good call Shawanda!
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