Wow. By this point, you will have paid off all your non-mortgage debt and are ready for Baby Step 3 . . . fully building up your emergency fund! As you transition from paying off debt to building up cash, you’ll be more financially secure than most. If you’re ready for Baby Step 3, you’re making great progress! Let’s take a look at where you are in the baby steps:
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 again?
In Baby Step 1, you gathered up $1,000 to start a beginner emergency fund. This was purposed to prevent life’s little emergencies from causing you to go back into debt. In Baby Step 3, you now need to go back to that emergency fund and build it up so you can prevent the larger emergencies from becoming an issue.
In Dave Ramsey’s The Total Money Makeover, Dave reminds us:
Don’t forget, Money magazine says that 78 percent of us will have a major unexpected event within the next ten years.
The odds are against us. We need to prepare for emergencies.
There are many different things that can happen:
- You get laid off from your job. No job is secure. Even if you are excellent at what you do, job stability is not always within reach. You’re going to need a pile of money to get you through while you seek another job.
- You have a medical emergency. Don’t always count on health insurance to save you. While health insurance essential, make sure you have some savings that can cover medical expenses when needed.
- Your home has severe damage that needs repair. A tree falls through your roof. The flood waters rise. Homeowners insurance is great, but you might need some cash to cover those events that might not be covered by your policy.
Don’t risk not having an emergency fund. You need one.
How much money should I save?
Dave recommends saving 3 to 6 months of expenses. Pull out that budget you wrote and add together all of your expenses for a month. Let’s suppose your expenses come to $3,000/month. That means you should save somewhere between $9,000 and $18,000.
But how do you know whether to save 3 month’s worth or 6 month’s worth of expenses? If you’re married, sit down with your spouse and discuss how much you think you should save. Whoever feels that you should save more, wins. But what if you’re both stuck and still not sure how much to save? Here are a few pointers:
When to save more:
- If you’re single. Couples usually have an advantage financially and can depend on each other in times of need.
- If you’re expecting an emergency. It’s best to pile up cash when you are expecting an emergency so that you don’t have to go into debt to survive it.
- If you’re primarily living of commission. Commission is more volatile than other forms of income. It is best to save for ups and downs in a “Hill and Valley Fund.”
Where should I keep the money?
Dave suggests you should put the money into a liquid savings account such as a Money Market account with no penalties and full check-writing privileges. Note that Money Market accounts do not provide the best interest rates, but this IS NOT an investment anyway.
Wherever you keep the money, you need to be able to get to it fast. You never know how quickly an emergency will sneak up on you!
If putting your money into an insured account (like an FDIC or NCUA) is important to you, here are a couple of ideas:
- ING Direct: A great online place to keep your money. You can pull out your money within 2 business days and it provides a much higher interest rate (1.1%) than Money Market accounts at the time of this writing. But remember, it’s not all about the interest rate. This fund is intended to be a safe place to put your money. Try linking it with an Electric Orange ING Direct Checking account for even faster access. Write me if you want a $25 bonus from ING Direct for starting up an ING Direct Orange Savings account (you must email me before opening an account, and click the link I’ll send you in an email).
- Brick and Mortar Savings: If you feel more comfortable, store up your emergency fund in your bank’s savings account. Money Market accounts usually have an advantage over this (check-writing privileges), but Money Market accounts are not insured.
Once you have 3 to 6 months of expenses in savings, you’ll have more financial security than you can imagine. You’ll breathe easier knowing that you have a solid buffer between you and life. Now that you’re completely out of non-mortgage debt and built your fully-funded emergency fund, you’re ready to start your retirement investing!