Baby Step Three
Currently we are in step three of Dave Ramsey’s Baby Steps. In step three you build up your emergency fund from $1,000 into a full “3 to 6 months of expenses in savings”. This blog post goes into detail on how we chose to build our emergency fund.
1 month of Expenses
In order to get started with baby step three, the first thing you have to do is figure out how much money is one month of expenses for your family. If you already have a budget, then this is easy. I am going to log into EveryDollar right now and take a look. Here is the breakdown:
In going through the budget, you can see that I did not include everything that could be considered an expense. For example, I did not include taxes. One expense that I struggled with a little bit, was should I include tithing in the above list of expenses? After thinking on it, I decided that the main purpose of the emergency fund is to replace my income if I were to lose my job for whatever reason. In that case, if I do not have an income, then I would not be paying tithing, so I have chosen not to include it. Do whatever makes sense for your situation.
Three, Four, Five, or Six Months?
Why does Dave have say 3 “to” 6 months!? Doesn’t Dave know that we are all mindless drones, and he should give us an exact number? Well guess what, he does this on purpose. Again, you have to decide what makes sense for your situation.
I feel as though my line of work (Software Engineering) is quite stable. I have never gone a day without being employed. However, in planning for the emergency fund, one thing to keep in mind is whether or not you are in a single income or a dual income household. Since my wife is a stay at home mother, if I were to lose my job, we would have no other income to fall back on. Similarly, my family is one of those families that is prone to medical issues. With that in mind, for our situation, it makes sense to have a full six month emergency fund.
As you can see, the way to really decide if you need a three month fund, or a much larger fund is how much risk does your family carry? You can think of the emergency fund as insurance against the storms of life.
Now that we know that one month worth of expenses for our family is $3,227 and that we need six months of expenses, the rest is easy. Our total emergency fund should be:
Full Emergency Fund = ($3,227 expenses / month) * (6 months) = $19,362
Dang gina. That is a lot! But, Math don’t lie.
How long will it take us to get there?
Currently, we have $3,271 in our emergency fund (~1 month worth of expenses). We have a long way to go! We are 17% of the way there and have $16,135 left to be fully funded. In looking over the budget, I think we can realistically save about $3,400 per month, which puts us at:
Months to be Fully Funded = $16,135 / $3,400 = 5 months
Given that we have already budgeted out September, that means we will be building up the emergency fund for all of October, November, December, January, and February. So, on February 1st, 2017 we will have a fully funded emergency fund! It feels like that is forever away, but I am sure it will come before we know it.
Where to put the emergency fund?
It needs to be in a place that is easily accessible. Dave suggests a money market account or a checking account that comes with a debit card or check-writing capabilities. We happen to already have a USAA savings account that has both a debit card and checks. Perfect! The Annual Percentage Yield on this type of savings account is 0.15%. Low, right!? But remember this is not an “investment” account in the traditional sense. This is insurance.
What counts as an emergency?
Lastly, how do you know if you should spend the money in your emergency account. Dave suggests asking yourself three questions: Is it unexpected, Is it necessary, Is it urgent? The more of these that you answer yes to, the more likely it is an emergency.
We are glad to be building up a fully funded emergency fund at this time in our lives. We can build it up faster now that we do not have any student loan debt. I sm sure it will bring even more peace into our lives. I just wish we could get through this step faster so that we could be putting more into retirement! Maybe I will try to earn some side money somehow by getting back into mobile app development. If you have an idea let me know!