Yesterday we gave a brief overview of Dave Ramsey’s 7 Baby Steps, and talked about why it is so important to prepare yourself for the whole experience. You need to be ready to change your lifestyle, be ready to commit to no more consumer debt, and know that people are going to think you’re a little bit strange. But that’s OK because being normal means you’re broke!
Dave Ramsey’s 7 Baby Steps
- Step 1 – $1,000 to start an Emergency Fund
- Step 2 – Pay off all debt using the Debt Snowball
- Step 3 – 3 to 6 months of expenses in savings
- Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
- Step 5 - College funding for children
- Step 6 – Pay off home early
- Step 7 – Build wealth and give!
Baby Step 1: $1,000 To Start An Emergency Fund
Once you’re current with your creditors, the first of the baby steps that Ramsey talks about is to save a $1000 emergency fund. What’s an emergency fund you ask? An emergency fund is your umbrella for when those rainy days come. Rainy days could include a good number of things:
- Car repair
- Emergency room visit or other unplanned medical incidents
- Unplanned travel expenses (funerals, weddings, etc)
- Job loss
- When you don’t have enough for occasional expenses (like car insurance, property taxes)
You WILL Have Unplanned Expenses
Murphy’s law says that “anything that can go wrong, will go wrong“. Dave Ramsey likes to say that an emergency fund will help keep those “little murphies” from turning into new debt, especially while you’re trying to get rid of old debt.
Ramsey quotes a statistic about unplanned expenses on his site:
Money magazine says that 78% of us will have a major negative event happen in any given 10-year period of time.
Ok, let’s look at that figure again. 78%! A majority of us will have a major negative event in any given ten year period! Even if you haven’t had that major negative event, I’m sure probably 100% of us have had those minor negative events pop up from time to time.
My wife and I had one of those major negative events last year when my wife went into the hospital for 3 weeks. We incurred upwards of 250,000 dollars in medical bills. Luckily we had good health insurance and most of the costs were covered. We had also already started Dave Ramsey’s program, so our total out of pocket cost was covered by our emergency fund that we had already saved up! Our situation last year is a great reason why emergency funds are such a good idea.
Why $1,000 For The Emergency Fund?
When it comes time to save up the emergency fund a lot of people wonder if $1000 will really be enough. My opinion is that it is. Most small emergencies will be covered by $1000, and only some major life events or other problems won’t be covered. Some people will still opt to save up a bit more.
My wife and I saved $2000 in our emergency fund because we felt a little safer having just a bit more in the bank. It turns out it was a good thing we did because our out of pocket medical expenses for my wife’s hospital stay were $1800. Granted, our situation was a major one, most unplanned expenses won’t be that big.
Figure out for your family if you think $1000 will be enough. Look at your circumstances, how many children you have, job circumstances, etc and decide on a number. Just make sure that you don’t set too large a number for the baby emergency fund because you can start short-circuiting your debt reduction plan if you try to save too much.
Make Sure To Keep Your Emergency Fund Available
When it comes to where you should put your emergency fund, I think it’s a good idea to make sure that you’re keeping it in a place where you’ll be able to access it quickly. Some good alternatives:
- High Yield Savings Account: Put it in a good high yield savings account like the ones at ING. ING even offers some very flexible sub-account options so that you can split money up into different categories. (like emergency fund, vacation fund, summer camp, etc). This is what we’ve done.
- Money Market Account
- Local bank branch
The key here is to keep your money accessible and liquid, in case you have one of those emergencies where you need to get the money quickly.
Places I would not suggest putting your emergency funds include CDs, stocks, real estate, or other investments. Keep it somewhere you can get to it in a short period of time. The purpose of this money isn’t to gain a ton of interest, but instead to insure you against unplanned events.
Do a Quickie Budget
After deciding to change, and starting on your emergency fund, it’s probably a good idea to do your first budget. John Maxwell said:
A budget is telling your money where to go, instead of wondering where it went.
That quote is so true. If you’re not telling your money where to go (into an emergency fund), it will just disappear. Do a quickie budget, figure out what your income and expenses are, and then assign every surplus dollar a job.
At this point in the baby steps you should be paying the minimums on all your debts, and then saving as much money as you can towards your $1000 emergency fund.
If you need to sell things on ebay, get a second job, or sell your sacred comic book collection, just do it! Crank it out and get that $1000 saved!
If you need a good template to do your first quick budget, try out the one at Dave Ramsey’s site:
Dave Ramsey Quickie Budget – Download Here
Baby Step 2: Pay off all debt using the Debt Snowball
After saving up your $1000 emergency fund, the next baby step is to pay off all your debts using the debt snowball. Check out our next post for the details about how the debt snowball works!
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Go Dave Go…I coordinate FPU at my church and we just finished our 2nd session tonight. He has a great product that can help lots of people. Emergency Fund is priority one for anyone who wants to succeed with money.
We just finished our 2nd to last session tonight! It’s been a good class, and lives have been changed. Good luck on your class!
I don’t always agree with every bit of investment and personal finance advice Dave gives on his show. But, I do listen to his show at least once a week, and no one has ever been able to design a plan that works for so many people the way Dave does.
Peter, good on your for leading a FPU course, the world thanks you for saving some financial lives.
the weakonomists last blog post..Weakon 120: Intro to Economics
Thanks for sharing these steps. I don’t always agree with Dave Ramsey, but he does have a lot of good ideas, and he does know how to break things down. I like the idea of getting the emergency fund going first; it keeps you from having to turn as much to credit cards when something comes up.
Mirandas last blog post..Forget Economic Stimulus: Get Your Own Financial House in Order
Dave is good. But I disagree with some of his stuff. His “baby steps” are good, however.
Great article and series, Pete! Thanks for mentioning my article.