Life holds no shortage of surprises.
Some of them are good, but unplanned expenses accompany others. You never know when medical bills, car repairs, and other real emergencies are going to put the squeeze on your budget. The best you can do is set aside some money in case of an emergency.
But how much is enough for an emergency fund?
For the answer to that question, we turn to Dave Ramsey. Ramsey is a financial expert, the author of the best-selling book Total Money Makeover, and the creator of the money management course Financial Peace University.
Dave Ramsey on Emergency Funds
Dave Ramsey is a big proponent of emergency funds. In Total Money Makeover, he outlines seven baby steps to gain control over your financial life and build financial security. Baby Step 1, according to Ramsey, is saving $1,000 for an emergency fund.
$1,000 might not seem like a lot of money when dealing with actual emergencies. It’s not enough to cover every emergency situation. It won’t make up for a loss of income or go far when you’re facing significant medical expenses, which Ramsey acknowledges.
Is $1,000 Enough for an Emergency Fund?
According to Dave Ramsey, if you have any debt other than a mortgage, you should build a $1,000 starter emergency fund and then focus on a debt repayment plan. Once you pay off your debts, Ramsey suggests building an emergency fund consisting of three to six months of living expenses.
Ramsey believes $1,000 is an adequate amount for a starter emergency fund for a couple of reasons.
First, saving $1,000 is an emotional win when you’re broke, overwhelmed with debt, and unable to save money. Saving that first $1,000 is important when learning how to budget and take back control over your financial situation.
Second, it’s enough to cover minor things that could come and give you peace of mind knowing you have some money set aside while focusing on improving your finances and becoming debt-free. With $1,000 in your emergency reserve, you’re less likely to get knocked off track. You’ll have a small cushion to cover a one-time emergency or unexpected cost like a new set of tires while you work on Baby Step 2.
Where To Keep Your Emergency Fund
Liquidity and access are the essential factors in choosing where to park your emergency fund. You should keep your emergency savings in cash rather than investing it. You also need fast and easy access to your money.
Most personal finance experts consider these three types of accounts the best places for your emergency savings:
- Basic savings accounts at your bank or credit union
- Money market accounts with a debit card or paper checks
- High-yield savings accounts offered through an online bank
Separating your emergency money from the money you use to pay your monthly expenses is wise. The easiest way is to open a savings account where you already do your banking. You can simply fund it with an automatic transfer.
Money-market accounts pay variable interest based on current market rates. It’s a solid choice, as long as it comes with a debit card or paper checks and doesn’t have too high of a minimum balance requirement.
Online savings accounts pay higher interest rates than your local brick-and-mortar bank because online banks have less overhead. They’re worth considering as long as you will have fast access to your emergency savings when you need them.
Baby Step 2: Getting Out of Debt
After reaching the $1,000 minimum emergency fund savings goal, Ramsey suggests focusing on paying off all debt, except for your mortgage in Baby Step 2. To become debt-free, he suggests using the debt snowball method to pay off all your consumer debt, including credit cards, auto loans, and student loans.
If you’re unfamiliar with the debt snowball, it’s an aggressive debt payoff plan focusing on paying off your smallest debt first. You make minimum payments on your other debts.
Once you pay off the first debt, add the minimum payment you were making on that debt to the next debt payment. You repeat this pattern until all your debts are paid.
Building a Three to Six-Month Emergency Fund
Baby Step 3 requires building a fully-funded emergency fund. Ramsey defines a fully-funded emergency fund as three to six months of basic living expenses in a savings account you do not touch for anything other than true emergencies.
That is enough money to protect you against more significant emergencies like losing an income source or paying for emergency medical care. Having a three to six-month emergency fund should prevent you from relying on credit cards or a personal loan to see you through when an emergency hits.
While this might seem like a lot of money to leave untouched, almost every financial guru makes a similar recommendation. Three to six months of expenses is considered the rule of thumb for an emergency fund. It might not be enough in your situation, however.
Consider building a larger emergency fund if you have multiple dependents, a chronic medical condition, or an irregular income. For example, a self-employed person with two kids might create a 12-month emergency fund to cover unexpected expenses. Your emergency fund can be too big, though.
When you have too much money in a bank savings account paying a low interest rate, your money does not grow fast enough to keep pace with inflation. That means your money will have less buying power over time. You could also miss out on investment opportunities or lose out on tax savings that an IRA, 401(k), or 529 college savings account offer.
Should You Listen to Dave Ramsey’s Advice on Emergency Funds?
The popular finance guru does have a solid plan for being financially prepared for whatever curveballs life throws at you. His advice for saving a three to six-month emergency fund is standard and in line with other personal finance experts. That doesn’t mean it’s right for you.
You might need more money for emergencies set aside depending on your circumstances. Putting aside $1,000 and then putting all your extra cash toward debt payments before building up your emergency savings might not be suitable for you. Before you take Dave Ramsey’s advice or anyone else’s, review your budget and financial goals, then decide for yourself.
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