The three types of savings funds

Sketchnote explaining the three types of savings funds you need to build your wealth and become financially independent. Full text explanation below.

You must know the story of the three little piggies? The one where each pig moves into a new neighbourhood and builds their dream home, only to find there’s a local undesirable, the big bad wolf, who wants to eat them. In the end all three piggies retreat into the house made of bricks and the wolf gets a boiled backside (my kids love that bit!).

Well here are three more little piggies and unlike the two who built their homes from sticks and straw, these piggies know how to keep the wolf from the door! So let’s say hello to the three types of savings funds….

Piggy number one – the emergency fund

First up we have the favourite of financial experts the world over – the emergency fund. This is a pot of money you build up to use if times get tough. The experts reckon you should hold the equivalent of three to six months living expenses to cover everything from a broken down car through to prolonged periods of unemployment. Having instant access to this cash is another important factor.

Piggy number two – the sinking fund

Next up is the sinking fund. In a personal finance sense this fund is a savings account kept separate from the emergency fund and is used to save for planned expenses like a holiday, your kid’s preschool fees or a new bathroom.

It’s an alternative to the more common approach of buying on credit and paying the money back afterwards.

The name might seem a bit odd (it’s derived from a common business practice of saving money for a future expense) and if it’s easier you could just call it your ‘fun fund’. Unlike the other two funds which are used to build and protect wealth, the sinking fund is for money you intend to spend in the future.

Piggy number three – the investment fund

Last, but by no means least, is the investment fund. This is money invested in shares and other assets with the aim of building long-term wealth. This fund is less ‘liquid’ than the other two, which means you need to sell the shares (or other assets) you’ve invested in first, before you can get hold of the money.

Generally speaking, you’d expect to leave an investment for a number of years before cashing it in and you also need to time the market right to ensure you don’t sell at a loss.

This is why it’s important to have an emergency fund in place first, before you start to invest – just in case you need the dough…

Where to keep your savings

I keep my emergency and sinking funds in separate accounts from each other and from my current account, purely because it provides a kind of psychological separation between the different pots of money and what they are used for.

If you a setting up new accounts for your funds, make sure:

  • you can get instant access (and don’t need to wait weeks to withdraw your cash)
  • the account pays you some interest (no matter how paltry)
  • you protect yourself from the tax man / tax lady (i.e. look at the option of cash ISAs)

One alternative to a bank account are NS&I premium bonds. These provide instant access to your money if you need it and while you don’t earn any interest, there’s always a chance of winning the monthly prize draw.

For me, the investment fund needs to live in a stocks and shares ISA. I prefer low cost index trackers such as Vanguard. Others I’m sure will prefer racier investments like peer-to-peer loans, crypto and stock picking, but I’m happy with the slow and steady approach.

Again, everyone has their own pathway and you should choose the one that fits your needs best.

So that’s the story of the three little piggies – three great ways to build your wealth as you bring home the bacon (oh dear… sorry)!

Thanks for reading 🙂