Baby Step 3: Save 3-6 Months Of Expenses. Dave Ramsey’s third Baby Step is to create a fully-funded emergency fund equal to three to six times your average monthly expenses. Why?
Emergencies come in many shapes and sizes
- Car troubles (repairs, accidents, and what I call “beater replacement”)
- House repairs (roof, HV/AC, fence damage)
- Medical & Health issues
You need to be ready for the big financial storms.
Emergency savings is also Common Sense
Living paycheck-to-paycheck is dangerous – even if you don’t have any debt. One major financial event can easily put you back into debt, taking your attention away from building wealth. A rains day fund is just common sense.
Emergency savings is Biblical
New International Version of Proverbs [21:20] is: In the house of the wise are stores of choice food and oil, but a foolish man devours all he has.
The New Living Translation is: The wise have wealth and luxury, but fools spend whatever they get.
We need to have savings. 3-6 months worth of expenses is smart, wise, and being a good steward with our finances.
Include these necessities when calculating Emergency Funds
In Episode 108 I talked about how to calculate 3-6 months of expenses
- Shelter (rent or mortgage)
- Utilities (heat and lights)
- Food (like groceries, not eating out)
- Transportation (gasoline and maintenance)
- Insurance (car, health, life)
You want to calculate necessities in this number, not luxuries. Finishing Baby Step 3 quickly will allow you to start building real wealth and, if you have children, prepare for their futures.
Where to put 3-6 months of emergency savings
- Local bank savings account
- Online Money Market Account
Emergency Funds are not investments, they are insurance. Putting savings into long-term investments of any type is missing the point. You want to keep your emergency savings liquid, even if they don’t grow much.
I recommend having your beginner emergency fund of $1,000 (Baby Step 1) at your local bank and the remaining 3-6 months of expenses in an online Money Market account. The reason your first $1,000 is at your local bank is because it becomes extremely accessible without being too accessible. The reason I wouldn’t keep the rest there is because you can get better interest rates in online Money Market accounts, even though it’s not that great right now.
Celebrate finishing Baby Step 3
You’ve been working hard and sacrificing for a long time. Now is the time to celebrate
- Buy your spouse a nice, reasonable gift
- Take a trip. That is what Jen McDonough did!
- Let mom stay home with the babies if you can live on one income
Don’t go crazy but enjoy your new found freedom!
What is Baby Step 3B?
There is an invisible side-step in the seven Baby Steps called Baby Step 3B. It’s not necessarily a detour but it does take your discretionary income in a different direction for a short period of time. Without all the debt payments you used to have and using your new-found talent for living on less than you make, you can choose to postpone moving on to Baby Step 4 if you find yourself in one of the following situations:
- Want to build up a downpayment for a house
- Are moving to a new location
- Need to save up for a paid-for baby delivery (gives you a nice discount when insurance doesn’t cover it)
- Replace a hooptie with a nice, more reliable used vehicle
- Pay off house early if a very small balance remains
Many of the Baby Step 3B items can be saved up for in your normal budgeting process or will be addressed in a later Baby Step.
Bonus: Jen McDonough screams “We’re Debt Free” at Financial Peace Plaza. I joined her in the first Iron Jen Show after returning from their pilgrimage to see Dave Ramsey.