Emergency Fund

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.

20 thoughts on “Dissecting Dave Ramsey’s Baby Steps: Baby Step 1

  1. How can this work if you make minimum wage and have student loan debt? Dave’s budget guidelines don’t even work for many low earners: where I live, an estimated 20 percent of renters are paying at least 50% of their income for rent (not including utilities); the proportion must be much higher among low earners.

    Great stuff if you have something approaching an average income to work with, on minimum wage, not so great.

  2. Minimum Wage,
    I’d do the following:
    I’d work multiple jobs, I’d move, I’d find a new job, I’d learn a new skill, I’d eBay stuff, I’d work harder than I’ve ever worked before. “Average incomes” don’t just appear out of nowhere. Neither do “below average incomes” or “above average incomes”. The reality is, if you want change, you make change. I’d stop looking at the people around me and start looking at the person in the mirror. Take the example that you gave. If I lived in an area where I could not afford rent, I’d move, simple as that. I’d apply for a hundred jobs a week. I’d rake lawns, clean gutters, flip burgers… (btw, I’ve DONE ALL OF THESE THINGS!!!) In other words, I’d fight for my future instead of focusing on my past.
    Good luck,

  3. NCN,

    Great post, I too used Dave’s baby steps to get out of debt. My wife and I choose to bump Dave’s recomendation to $1500.00.

    We only had one ’emergency’ during our climb out of debt. A branch fell on the windshield of my truck and cracked it in half. Thanks to our emergency fund, the $250.00 we spent to get it replaced was not borrowed!

    I also like the way Dave puts it… this is ‘personal’ finance. Everyone will take the same information and apply it in a different way. I look forward to your post on BS #2.

    Red Dawg

  4. I haven’t had that much success in extra jobs, though I have a family of 5 total and a better than minimum wage income.

    The important thing that I think Ramsey is trying to stress is a change in how we look at debt– that it is not a tool, not something that we want to be in, and that it’s better to do things with cash.

  5. I’d like to add two “Dave Said’s”

    First, Dave said that at first he used to tell people to spend everything they had on getting out of debt, but he found that if people had no money when a disaster struck, they had to go BACK into debt to handle the disaster. This was incredibly discouraging, so he started to suggest the emergency fund as the place to start.

    Second, Dave also says that if you know a storm is coming, you’d better have an umbrella. In other words, a thousand dollar emergency fund is not sufficient if you know that you’re about to lose your job, have a baby, undergo surgery, etc. For this reason, our current emergency fund goal is 2500 dollars. After the baby is born and we’ve seen how the medical bills fall out, we’ll take it back down to the recommended 1000.

  6. My husband and I started the Baby Steps plan one year ago, when we got married. We were both making just at $7 an hour, and with our wedding, car, and and nearly $25,000 in student loan and school related costs, it did seem like a hard road. We discussed it and went with $500 in the emergency fund instead of $1000, since we were making so little. I’m going to try to keep this focused on just Baby Step 1, so all I’m going to say is that the emergency fund is good for emergencies, but it can also open up opportunities for you. We were offered jobs 2 months ago as assistant apartment managers (after dozens of applications), which was going to be a nice bump in pay. However, it required moving immediately and breaking our current lease. If we hadn’t had the emergency fund (at around $800 by this time), we wouldn’t have been able to take that opportunity.

    To Minimum Wage: I was there. Just over minimum wage, student loans, car, owing family members, rent, crazy high utilities. It is hard. It is unbelieveably, “I don’t know what to do so I cry at night” hard. For me, it is still not over. But, it is NOT impossible. And it feels awesome to know that it won’t be like this forever. I promise, it is sooooo worth it.

  7. Great post! I’m actually still on the 1st step. I’m at the $800 mark and working my way up. Just 2 more pay checks and it will be fully funded.

    I’m looking foward to you dissecting Step 2 of Dave’s Baby Steps.

  8. Last August my wife and I made our first every budget and completed our emergency fund. There was one occasion when we agreed to tap into it, but in the end it wasn’t necessary. It wouldn’t have been possible if we didn’t make a plan for how to spend August’s money, and follow that plan. It required change for us: breaking long established habits and creating new ones, but it was worth it.

  9. I went through all of DR baby steps. Except for paying off the house early b/c we plan to move soon

    You do not have to go through the steps perfectly the way DR says it.

    But the main concept is to avoid debt.

  10. I believe the emergency fund to be purely emotional and psychological and not the best way.

    Here’s why: Instead of sending $1,000 to a MMA/savings, why not send the $1,000 to a credit card? Instead of earning 4.5%-5.05% interest, you save 14%, 18%, etc. by paying down the card. If an emergency situation does not happen, then you just keep on keeping on. If it does, you use up to $1,000 on the credit card. Even if you use ALL of the $1,000 you will still be no worse off than if you had the money in a savings account and used it all, plus you would have saved paying interest on the card.

    In Dave’s plan, if you use your emergency fund, you stop the snowball and rebuild the EF. That is time lost. In the above scenario, you just keep right on snowballing because your EF is the card. If you don’t have an EF situation, you’ve started sooner and finished faster than if you had taken time to build the EF. If you do have an EF situation, you are still ok.

    The reason this would not work for everyone is: a) It won’t work if the credit card is closed (which Dave wants you to do at the start) b) It won’t work if everything is an emergency to you c) It won’t work if you get discouraged because you had to use it (though that could be the case with the EF too) and finally d) It won’t work if you use more than $1,000. (Of course, if you NEEDED (as in true emergency) more than $1,000 and you only had $1,000 in the EF, you’re in trouble anyway.)

    Dave, and DR devotees, would slam this idea by saying “play with snakes” blah blah, but the fact is, you have the card account until you pay it off. Keep it open (to avoid the big hit on your credit score) until its paid, and, if you have an emergency, utilize a portion of a mentally set-aside $1,000.

    Of course, this is a disaster for some people. My parents, for instance, whom I introduced to TMMO a couple of years ago DO NOT NEED a credit card of ANY kind for ANY purpose. Believe it!

    Otherwise, it has served me well.

  11. As I see it, Dave’s biggest push is to get us to change the way we look at money. Both the ‘baby efund’ and ‘debt snowball’ can be argued against in term of pure interest and compounding. BUT they are both techniques that change the fundament ways that people relate to their money.

    Getting into a more healthy relationship with your money can’t be a bad thing. (and ye gods and little fishes, I think I just channeled Suze Orman!)

  12. What happens if you have to spend, say, $200 out of the $1000 baby-emergency fund. Should you then immediately concentrate on replenishing this fund before resuming your debt snowball at full strength?

  13. Michael..
    When I dipped into my e-fund,
    I would then stop sending extra payments and
    focus on rebuilding the e-fund.

  14. Wow, Ive never seen so many people claim to follow ‘Dave’s Plan’ while earning minimum wage AND paying student loans. Are you srious? What type of degree did you get? I am on 6 months or so from completing BS #2, but probably wouldn’t have done so as quickly without first having my starter emergency fund. My wife and I have been on ‘The Plan’ for 6 months and nearly paid 13,000 (1/2) of my student loans. We were blessed to suffice with 1000. My wife is a full time mommy, we have a 10 month old son. I am looking forward to BS #5 ( and, of course 7). Those of you earning 14,000 and paying student loans, find a job in your field of education!! Engineering and Accounting are the most seeked by employers at thhis time (also the highest paying from 45-55k average, respective)

  15. In order to keep a saving account free of monthly service fees, I must transfer a minimum of $25 into the savings account every month. (no transfer fees) I have just completed my $1000 Emergency Fund. If I stop the transfers, the bank will charge $5 per month. Should I allow the transfers to continue and add to the Fund? …or transfer $25 out every month, to maintain the Fund at $1K?

  16. Kirsten,

    You might be better off getting another account where there are no fees. I have online accounts with both Emigrant Direct (emigrantdirect.com) and E*Trade (etrade.com), and there is no miminum balance to maintain nor transfer requirements, and I earn a pretty decent (by decent I mean better than a regular bank savings) interest rate. You link the accounts to your regular bank checking account and can do online transfers in and out within 2 business days. I’ve had these accounts for over 3 years, and never any problems. I hope this helps.

  17. How can I start saving. My car is paid off, we have a house payment and some doctor bills, my husaband doesnt work Im the only one working.Please give me some tips.

  18. We have 5 little girls under age 10 and expecting again in Oct. Any suggestions for how much e-fund we should have? We don’t have any credit card debt…just students loans totaling over $100k and a mortgage. Plus with this new addition we will outgrow our current vehicle (that we own outright) and need to acquire something larger. I’m open to any ideas (and, not that it’s anyone’s biz, this is our LAST baby!! LOL)

  19. Kristy, as Dave would say Sell the Car
    I say sell the Baby(ies) and it’s a good start you are closing down the baby factory.

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