Now that you’ve completed the necessary steps before the steps, it is time to start your emergency fund. You are at the beginning of a long journey that might take you several years, but is well worth the effort. The first step is to save up $1,000 in a beginner emergency fund.
Dave Ramsey’s 7 Baby Steps
- Step 1: Save up $1,000 to start your emergency fund.
- Step 2: Pay off all non-mortgage debt using the debt snowball.
- Step 3: Save up 3 to 6 months of expenses to complete your emergency fund.
- Step 4: Invest 15% of household income into Roth IRAs and pre-tax retirement accounts.
- Step 5: Work on college funding for children.
- Step 6: Pay off your mortgage early.
- Step 7: Build wealth and give!
Why an emergency fund?
It’s going to rain. Your dishwasher breaks, your vehicle’s engine blows up, your pet gets sick and needs emergency surgery. Who knows what might happen! The point is, you will have an emergency, it is just a matter of time. Think about the past few years. I’m sure you can name a few emergencies that required extra money you weren’t intending to spend.
Emergency funds are crucial to financial wellbeing. They provide a buffer between you and life. Sometimes when you least expect it an emergency can come creeping up to your doorstep. Take a look at some emergencies that hit us in the past year. You’ll clearly see that emergencies DO happen and WILL happen with time.
According to Dave, $1,000 seems to be just the right amount to keep the little emergencies out of your life while you work on Baby Step 2 (The Debt Snowball). It’s enough to temporarily keep disaster from your wallet while you eliminate your non-mortgage debt. He makes the case that most emergencies don’t result over $1,000 in financial loss, so a grand is perfect for your beginner emergency fund. Later, after you have your non-mortgage debt paid off, you can build your emergency fund up greater than $1,000 in Baby Step 3.
If you feel your circumstances warrant more than $1,000, feel free to do so. Just don’t go to high on this starter emergency fund! You’ll need the money to throw at your debt.
Personally, I can tell you that having only $1,000 in the bank makes me feel very financially insecure. I knew logically that it would be enough to get us through Baby Step 2, but it just didn’t feel right. This anxiety, as it turned out, was exactly what I needed in Baby Step 2 obliterate our debt faster. We took all excess money and threw it at our debt. $1,000 for your starter emergency fund works as long as you are gazelle intense. We’ll get to that later . . . .
Where to keep your starter emergency fund
Dave recommends keeping your starter emergency fund in cash at your home or in the bank. This is by no means an investment. Think of it as insurance against the little storms that might come your way.
We kept our initial $1,000 in cash in our safe. We put it in a small box and labeled it: In Case Of Emergency Only. The reason we chose cash was because it is the most liquid form of money. If something were to happen, we’d have immediate access. At the same time, we didn’t want to justify pizza or movies with this money, so we made sure it was properly labeled!
When to use your emergency fund
It is important to point out that you should have already done a budget, which accounts for any expenses that might occur within a given year. Therefore, your emergency fund should NOT be used for Christmas gifts, birthdays, or other known expenditures. I must note that when you first start your budget, you may not think of an annual expense (ex: property tax). It is okay to use your emergency fund when you’ve overlooked a mandatory – as opposed to discretionary – expense. Modify your budget, and don’t make the same mistake again.
If you can, make it a rule to wait a day before you dip into your emergency fund. Sometimes sleep will bring you back to your senses and make it clear whether or not you should use your emergency fund.
Once you have your starter emergency fund firmly in place, your budget is running smoothly (current on all your bills), and you’ve stood firm on the no-debt pledge, you’re ready for the next baby step . . . .
Previous In Series: Dave Ramsey’s 7 Baby Steps: Getting Started