Personal Finance 101 – the $1k Baby Emergency Fund
If you have not read the first article about this topic, make sure you read it first so you will not get confused or misunderstood about what Dave Ramsey means. He has a different idea about how to manage your money. It is good to understand it very well and it will be more if you start to do it.
Real Solid Money Management
This is the second part of my series of Dave Ramsey’s Baby Steps, a proven personal financial plan. My goal is to explain a really solid money management plan in plain ol’ English, for intelligent yet financially “average” home managers.
As I mentioned a few days ago, I’m going to tackle the topic of about Dave Ramsey’s Baby Steps over the next few weeks. The concept is still a bit new to me, so a big reason I’m writing is for my personal benefit – to clarify my thoughts and convictions, to succinctly hone our plan, and to reveal any fallacies.
That said, the Baby Steps were created for the regular Jane – the person without a BS in business or finance, the person who does their taxes online (without a CPA) and wants, more than anything, to just gain control over their personal finances. That’s me.
The essential thing to understand about this financial plan is that its purpose is for you to live debt-free. That means getting out of debt and staying out of debt, for the rest of your life. No longer using debt for anything. Ever. Not school, not braces, not weddings. The only debt Ramsey’s okay with is a fixed-rate 15-year mortgage with at least a 20% down payment (although he even advocates buying real estate with 100% cash down, if you’re able). This means cutting up your credit cards. You don’t need them anymore – even “for emergencies” – if you’re on this plan. Baby Step 1 is your new plan for emergencies. Toss the cards. I’ll discuss the evils of debt in more detail on Baby Step 2. If you can’t quite give up credit cards yet, you’re not ready to move on. Stop there.
Moving right along. Baby Step Numero Uno – quickly save $1,000. Quite a few people probably already have this and then some (I’ll explain in Baby Step 2 what to do with the “then some”), and for others, this might be the most they’ll have ever saved up in their life. But the important key here is to save it up quickly. This step is not supposed to take long because you’ll lose momentum. Ramsey recommends getting a little side job, selling something on ebay or craigslist, or seriously cutting back on a spending category of yours for a short while. Step 1 should take one to two months max. Start getting ready for that garage sale.
$1,000 should feel like a rather small emergency fund – that’s because it is. Ramsey says having a smallish safety net (although it is still a safety net) helps with the urgency needed to get out of debt. $1K should be enough to cover those basic emergencies that might come up – plumbing issues at home, air conditioning servicing, gasket and zip-zorp replacement on your car (I obviously know vehicles). But the sooner you get through Baby Step #2 – getting out of debt – the sooner you get to the third step, which is fully funding your emergency fund. That will get you through more serious, potentially longer-term emergencies (such as unemployment). You want to get there as soon as you can, so hurry up and get that baby emergency fund so you can plow your way out of debt and then really save.
A caveat – and this is important – this cash is for emergencies. A new dress for the company party, a weekend away, Christmas – none of those are emergencies (it’s on December 25 every year). Unless something serious comes up, it’s almost best to forget the money is even there. Leave it alone. It’s your safety net (since you’re not using credit cards, or any other form of debt, ever again).
At the same time, keep it liquid. You’re not investing here, so the goal is not the highest possible interest rate (in other words, no mutual funds or something with penalties for early withdrawl). A solid savings account with easy access is ideal. Many Ramsey-ites keep their emergency funds at Capital One 360 - their savings accounts currently yield 3.40%, and you can easily connect it to an Electric Orange checking account (which, coincidentally currently yields 2.25%). This is where we have our emergency fund.
So that’s Baby Step 1 in a nutshell. It’s the easiest one to understand, so it’s pretty basic. But it’s THE foundation to the rest of a well-tested debt-free financial plan that works, so you gotta have it. Put a thousand bucks in the bank as soon as you can, and don’t touch it once it’s there.