Dave Ramsey Baby Steps Step 1: $1000 Emergency Fund
By glblguy
Photo by: peretzpup
The M-Network is currently doing a series highlighting the Dave Ramsey Baby Steps for getting out of debt and getting your life on the right track financially. You can read about all of the steps over on Cash Money Life who kicked things off with a great introduction. As other members of the network add their articles, I’ll add them to the end of this article.
The first in the Dave Ramsey baby steps is establishing a $1000.00 emergency fund (there is an unwritten step 0 which you can read about on Debt Free Revolution and Single Guy Money).
Why have an emergency fund
An emergency fund is established to help you deal with unexpected or unplanned events that can and will occur in your life. These are things like:
- Car repairs
- Home repairs
- Medical bills
- Unplanned travel expenses (i.e. illness or death of a far away relative)
Of course these are just a few examples. Without an emergency fund, these expenses typically land on a credit card in hopes that you can pay them off quickly, but in reality just add to the already large pile of debt many of us have. These types of expenses will happen to you and they are difficult to plan for. The emergency fund allows you to handle these unexpected events without debt and without stress.
Dave Ramsey quotes Money magazine as stating that “78 percent of us will have a major negative event in a given 10-year period of time.” 78% is a pretty high number, so chances are it will happen to you. An emergency fund will help you be prepared.
Avoiding Murphy while following the Dave Ramsey baby steps
Later steps in the Dave Ramsey baby steps will tell you to establish a larger more permanent emergency fund that is 3 to 6 months of your salary. In the early steps, we’re focused on getting out of debt. The $1000.00 “baby” emergency fund will help you weather the various little events that occur as you go through the process of becoming debt free. Ramsey likes to call them “murphies” or often refers to “Murphy moving in”, or “Murphy coming to visit”. The $1000.00 emergency fund will help you weather these little “murphies” without relying on new debt.
Helping you budget
The baby emergency fund is also going to be a key strategy to help you stay on budget. A budget is really a plan and as I often tell my software developers at my “real job”, “A plan is only valid until something changes“. Like a plan, a budget works great, until something unexpected occurs. That is what your emergency fund is for: handling the unexpected.
These unexpected items can be as simple as making a mistake in your budget and accidentally overspending, to intentional overspending due to the budget process being new, or completely unexpected expenses such as your hot water heater bursting (this actually happened to us).
$1000 for everyone?
This is where I vary a little with what Dave Ramsey recommends. Dave is pretty firm on the $1000.00 amount for the initial emergency fund. I look at it as a target or guideline. For example, for a single person that is renting in a large city with no car, a $1000.00 emergency fund might be overkill, and say $500.00 might be more applicable. For me, I own a home, 2 cars, am married and have 6 kids. $1,000.00 often isn’t enough so I tend to lean closer to $2, 000.00.
The bottom line is it really doesn’t matter if it’s $500.00, $1,000.00 or $2,000.00. Just save an amount around $1,000.00 that you feel comfortable will support those unplanned an unexpected expenses. The whole idea is to avoid using debt to ride those events, but to use your emergency cash instead.
I started with $1,000.00, and quickly realized I was coming far to close to using that whole amount a few times so I bumped it up to $2,000.00. Decide on an amount that makes you feel comfortable and don’t go overboard. Remember, we’re targeting getting out of debt first, we will save later. If the amount is too small, save more. If the amount is too big, save less. To be successful in this journey you will need to be flexible.
Where do I keep my emergency fund
While I have a particular preference, the real answer is wherever you feel comfortable. I don’t recommend you keep it in with your normal spending money as it becomes hard to track what is budget money vs. emergency money. I also don’t recommend you keep it as cash under your mattress. There is nothing worse than working hard to save up your baby emergency fund only to have it stolen or misplaced.
I learned a very important lesson about my emergency fund, make it available when you need it. I now keep my emergency fund in an ING Direct savings account but I also have an ING Direct checking account and have an ING Direct debit card in my wallet. In the event I suddenly need my emergency fund money, I make a quick call to ING, transfer the money from my emergency savings account to the ING Checking account and the money is available. I considered just keeping it in the checking account, but I like the additional interest earned from the savings account.
We established our emergency fund quickly, as we started follow Dave’s baby steps the month we received our tax return in 2007. I found his book at our local Sam’s Club, and fortunately purchased and read it.
I initially put $1000.00 in an ING Direct savings account. We later slowly adjusted that amount up to $2000.00. We’ve had to tap it a few times since, once when our debit card was stolen, a few times due to budgeting “issues” where we overspent or just under allocated, and one other time when I had to get some unexpected car repairs. We haven’t used a credit card since. Given we were using credit cards constantly prior to starting the Ramsey process, I think this is a true testament to the effectiveness of the emergency fund.
Make sure you check out I’ve Paid For This Twice Already… where you can read about Step 2 in the Dave Ramsey Baby steps. Paid Twice will discuss the debt snowball and most likely will talk about snowflaking too, which is a strategy I highly recommend!
Here are all of the articles thus far from the M-Network series:
- Overview of the Dave Ramsey Baby Steps at Cash Money Life
- Step 0 – No More Debt at Debt Free Revolution and Single Guy Money
- Step 1 – $1000.00 Emergency Fund – (you just read it, but hey, read it again!)
- Step 2 – Baby Step 2: Pay Off Debt Using the Debt Snowball at I’ve Paid For This Twice Already…
- Step 3 – Fully Funded Emergency Fund at Being Frugal
- Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement at The Dough Roller
- Step 5 – Dave Ramsey Baby Step 5 at My Two Dollars
- Step 6 – Dave Ramsey’s Baby Step 6: Pay Off Home Early at Moolanomy
- Step 7 – step-7 live and grow rich invest in mutual funds and real estate/ at Plonkee Money
- Dave Ramsey’s Baby Steps: M-Network Style at I’ve Paid For This Twice Already
Do you have an emergency fund? How much do you keep in yours? Have you had to use it? Do you follow the Dave Ramsey Baby steps? Add a comment!
February 27th, 2008 at 8:58 am
Good write-up, Gibble! Although on his radio show, Dave Ramsey does suggest some flexibility with BS1: for instance people who make under $20k should only save up $500 before progressing to BS2, or self-employed folks and large families should save a little more.
My very first “Murphy visit” came 3 weeks after I established my BEF and cost $1140 when the heat broke in Jan 07 … which was a little more than what I had put away! Since then I have had a $1500 BEF because my heating unit is almost as old as my husband and tends to cost a bit to repair.
February 27th, 2008 at 10:43 am
We have an emergency fund for 3 months of expenses. My husband saved most of it before we got married. While he’s not a Dave Ramset follower, he believes in having an emergency fund. When he car was damaged at the shop, he to dip into the fund. The good news is we got it back when we won the court case with interest!
February 27th, 2008 at 11:46 am
My take is a little different and, although I agree that an easily accessible chunk of money is an absolute necessity, I don’t think $1,000 is enough.
I also do not think that credit card and other types of consumer debt should be one’s primary financial focus. IMO one’s financial security and viability is more important. I am a personal coach with an emphasis on helping my client’s develop the fundamental skills of personal financial management.
In every case I have encountered to date, people who come to me with debt issues also have very little savings, usually none. They are truly living paycheck to paycheck and lack both financial security and viability.
The first question I pose to prospective clients is this: How long could you pay the bills if your check stopped tomorrow? The correct answer is forever (financial independence) but any answer less than six months, IMO, and they are in a very precarious position.
For my clients with consumer debt issues, I have a two-part plan and Part One is to make the minimum monthly payment on those debts until they have the six months worth of living expenses saved. The plan changes a little at that point but the focus always remains the clients financial security.
I completely understand the general distaste for interest paid on consumer debt but addressing a past mistake (overspending leading to consumer debt) in a way that negatively affects your present (by paying more than the minimum when you lack sufficient savings) only keeps you in a tenuous financial position. Debt is not good but it is not as bad as being homeless if you hit a string of unfortunate events.
And, yes, you “save” money (interest charges avoided) by paying off consumer debt sooner rather than later, but those “savings” are not the equivalent of money actually in the bank.
Thanks/Ron
February 27th, 2008 at 12:13 pm
I’m not an actual fan of Dave Ramsey, but I do think that the mini emergency fund is a great way of changing your mindset about money, away from feeling perpetually indebted, and towards a more financially secure future.
February 27th, 2008 at 12:25 pm
We’ve got an emergency fund that we keep in a high yield savings account. We had to tap it recently when I got into a car accident. After the accident we had about $800 worth of repair work to be done – which we paid for in cash directly from the emergency fund. Thank goodness for the fund!
February 27th, 2008 at 12:58 pm
We have taught Dave Ramsey’s Financial Peace University and the Baby Steps for two years at our church. over 400 people ahve graduated from this life changing course. The interesting thing about this is that Dave Ramsey didn’t invent any of this; he found a good way to package it and to present it to people who need to hear it.
My BS 1 story: my wife and I always used Credit Cards for emergencies. After completing the course and cutting up our cards, we started on the emergency fund. About three months into it the transmission went out on our primary vehicle. The cost was $699 to fix – we had $700 in the EF. We now have a 4 months EF and it is truly amazing how few emergencies we have any more.
Great article!
February 27th, 2008 at 5:54 pm
Great article. We have just started working on our emergency fund. We also enjoy the ease the ING Orange accounts.
I will admit, it has been difficult for us to get into the mindset of “if something breaks we should pay cash to fix it” Verses “we can use the money now and borrow if we need to.”
We have been programmed from birth that debt is just a part of life, and the almighty credit score is to be envied more than money in your hand.
Thankfully, through your site and others we are learning to not rely on debt as the answer. I have just turned thirty, and I shudder to think of the mess that we would be in on down the road if we had not started reading GLBL and listening to Dave Ramsey…
February 27th, 2008 at 7:12 pm
I’ve always been a fan of a 6 month emergency fund split between three savings locations of varying liquidity. That way you have your money growing as much as you can while keeping only a little of it closely accessible.
February 27th, 2008 at 11:26 pm
Great article. I only just started reading these PF blogs this week after living in Obliviousville for eons. I am embarrassed at the precarious lifestyle I and my family have been “enjoying”. If I were to die tomorrow, I would leave behind a horrendous mess of high interest rates and zero savings. I have a lot of catching up to do.
March 9th, 2008 at 2:12 am
OK, I don’t get this, you list four things that are “emergencies” and I think that the first three are pretty weak:
1. Car repairs
2. Home repairs
3. Medical bills
Car repairs aren’t emergencies, they’re inevitabilities. Your car will eventually need repair or maintenance. If you’re not putting aside money every month to mitigate the expected repair bill then you’re just deluding yourself. If you don’t have money available to cover your car’s insurance deductible then you’re just gambling.
And that’s the whole point of the deductible, you pick a number that you can afford to sock away, so that you can leverage the small amount of money into full coverage.
The same deal goes for housing. Your water heater will need replacement. This isn’t unexpected or unplanned, something is going to go wrong with your home basically every other year (sometimes more). Don’t be surprised when the heater goes or the roof starts leaking, you knew it was going to happen eventually, just dip into the money that you’d put aside for that purpose.
Again, if you have medical coverage, you’ll still need to cover your deductibles. Of course, medical coverage in the US is so screwed up that you’ll have to take some form of calculated risk. But again, at some point, you will need to see a doctor, this is neither unexpected nor unplanned. In fact, planned ones are the best kind!
I understand that Ramsey is trying to pimp his diet plan for debtors. I know that if you’re already in debt saving for these expenses is just more weight to bear, being in debt sucks.
But the fundamental problem here is that you don’t have a “bank account” (or some slice of savings) allocated directly to mitigating outstanding deductibles and accumulated wear. If you keep tapping your emergency fund and raising the cap, then all you’re doing is reactively paying off these problems. You know your tires are going to need replacement, shouldn’t you be proactively saving for that day?
Cars and homes accumulate large burdens of wear over the course of months and years, so pretending that these are “emergencies” is just foolish. Not being able to make your car insurance deductible is just poor planning and nothing else.
March 9th, 2008 at 8:14 am
@GatesVP – You’re splitting hairs. An emergency fund is a fund used to cover any unplanned expenses (i.e. not budgeted). You can call it whatever you like, but in the PF world, it’s generally referred to as an emergency fund.
A really good example of a car emergency is the engine going out. It’s a fairly new car, you set aside money for maintenance but it doesn’t cover the $3000 to replace the engine. You don’t have the cash to cover it, thus an emergency.
I think you and I are saying the same thing, you’re just questioning whether it should be called an emergency fund or not. The point is, have some savings to cover these “out of the ordinary” expenses so you don’t have to turn to credit cards for them.
July 31st, 2008 at 7:57 pm
Thanks for the great overview of the Dave Ramsey baby steps. I haven’t read his book and have only seen bits and pieces. Great that your network did the overview like it did!
Off to start that $1000.00 emergency fund and finish the rest of the Dave Ramsey baby steps.