Dissecting Dave Ramsey’s Baby Steps: Baby Step 1
I’ve been listening to Dave Ramsey’s radio program for more than five years. I’ve attended his Total Money Makeover Live Event. I’ve read all of his books, including The Total Money Makeover: A Proven Plan for Financial Fitness and Financial Peace Revisited. I’ve watched his DVDs and I’ve listened to his CD’s. In other words, I’m a huge Dave Ramsey fan! In fact, I used his Baby Steps to get out of debt, build an emergency fund, and begin to invest for college and retirement. So, I thought I’d take a stab at Dissecting Dave Ramsy’s Baby Steps.
The idea behind the Baby Steps is pretty simple. Just like a child who is learning to walk, you must begin with baby steps. Each baby step leads to another baby step, which then leads to another baby steps. The free pdf from Dave Ramsey lists all 7 baby steps. Today, I’ll focus on baby Step 1: $1000 To Start An Emergency Fund. (By the way, I am in no way affiliated with Dave Ramsey or the Dave Ramsey Show. I’m just a huge fan!)
Baby Step 1: $1000 To Start An Emergency Fund
After creating a budget, Dave suggests that you create a mini-emergency fund of $1000. While many people who call into Dave’s show or read Dave’s books are ready to get out of debt, very few of them have any cash in savings. Dave suggests that creating an emergency fund will free people from their dependence upon credit cards. If the stove stops working, you have to get it fixed. If you do not have any money available in savings, an inconvenience becomes an emergency. You must borrow money (or use a credit card) to repair the stove. But, if you have sufficient cash reserves in your emergency fund, then you simply pay cash for a newer stove (or for a repair) and you get on with your life. In other words, a mini-emergency fund provides “insurance” against having to use your credit card.
After fully funding your mini-emergency fund, you are ready to move to Baby Step 2. Following Dave’s plan, you will not add any additional funds to your savings account until you have paid off all of your debts. This mini-emergency fund is intended to be a temporary solution to a problem that will soon go away. After getting out of debt, you will increase the emergency fund from $1000 to 3 to 6 months worth of expenses. You will drop the mini- and you will now have a fully-funded emergency fund.
Dissecting Baby Step 1:
Question 1: Is $1000 enough? Is it too much? Over the years, Dave has been consistent about recommending $1000 dollars as an adequate amount. I have heard him, from time to time, suggest a slightly smaller amount for a single person or a couple without children. Conversely, I’ve also heard him suggest a slightly larger amount for those with larger families, health conditions, or unstable job conditions.
My opinion: While getting out of debt, I had to use the money in our emergency fund on two separate occasions. Both of those “emergencies” cost less than $1000. So, for my situation, $1000 was the correct amount. Had we had an emergency that cost more than $1000, I suppose we would have had to bite-the-bullet and borrow money. Personally, I think that $1000 is a good “ballpark” figure and works well in most situations. If I was a single-guy, I’d probably shoot for $500. If I had 3 or more kids, I’d only be comfortable with $2000 or more.
Question 2: Where should I keep my mini-emergency fund? I’ve heard Dave suggest a checking account, money market account, or savings account. Personally, I keep my emergency fund in an online ING Direct savings account. Remember, you should be able access your emergency fund rather quickly, so CD’s or Savings Bond do not work, unless you are willing to pay penalties associated with cashing them in early.
My opinion: It really doesn’t matter where you keep your emergency fund, as long as you can get to it, it is secure, and you feel comfortable with where the money is at. Personally, I think that a money market account with your local bank, a secondary checking account, or an online savings account are all great places to keep you emergency fund.
Question 3: What if I’m ready to start paying of my debts? Do I really need an emergency fund? Dave always suggests that, before paying extra towards your debt, you create an emergency fund. Why? If you do not have an emergency fund, you will be forced to borrow money, when / if, you are faced with an unforeseen expense.
My opinion: I believe that having an emergency fund is crucial. Remember, even though it took a month or two to fully-fund my mini-emergency fund, those savings came in handy while I was getting out of debt. While I am sure that there are plenty of people who get out of debt without using an emergency fund, I find that most people, when confronted by a minor emergency, get side-tracked, borrow money to pay for the emergency, and then never get back to the business of debt reduction. An emergency fund turns an emergency into an inconvenience.
Question 4: What about a rate of return? How much money should I make on my savings inside my emergency fund? Dave rarely mentions rate-of-return while talking about the mini-emergency fund.
My opinion: While it would be nice to get “mutual fund” type returns on your emergency savings, I felt that the security of a money market fund or a savings account far outweighed the limited benefits of investing the money in mutual funds or stocks. Remember, the purpose of the emergency fund is to provide security should you face an unplanned for expense. You do not want to “gamble” with the money inside your emergency fund. Trust me, once you get out of debt, you’ll have plenty of time to learn about investing and growing your money.
I welcome your questions and comments. Have you used Dave’s Baby Steps? Do you have a question that you’d like me to answer? Do you disagree with Dave? Do you agree with him? How about me? Let me know. One thing: Please keep comments and questions focused on Baby Step 1.