Dave Ramsey’s Baby Step 1: Baby Emergency Fund

by Joe Plemon on September 29, 2009

This little piggy
Creative Commons License photo credit: hill.josh

Jim and Doris were highly motivated about getting out of debt. They listed all of their debts, worked out a budget and agreed that they could pay an extra $300 every month above the minimum payments. During the first month, their air conditioner compressor quit working. A month later, Jim’s fuel pump went out of his car. Then, during a driving rainstorm, their roof started leaking. Because Jim and Doris had depleted all available cash in their zeal to reduce debt, they were not prepared for life to happen. How did they pay for these emergencies? By using their credit cards.

“Jim,” Doris moaned, “we are worse off than before we started. I feel like giving up.”

The Need for Step One

When Dave Ramsey began counseling others, he was so driven to help them get rid of their debt that he challenged them to throw every penny toward debt reduction. The problem, he soon discovered, is that when the unexpected happens, there are no resources to deal with it and when people go deeper in debt to handle these emergencies, they start to lose hope. Dave Ramsey’s Baby Step One, therefore, is to save $1,000 before trying to pay off debt.

This $1,000 provides a small buffer between their plan and life. While saving this $1,000, people learn how to budget and live on less than they make. They are preparing for the time when they will have no debt and can save a sizable emergency fund (Step Three). I have witnessed scores of people, many which have never saved for anything in their lives, experience this victory of saving a target amount. Achieving this first step builds confidence and prepares for future victories.

With Jim and Doris, the emergency fund would have been there to help them with these unexpected expenses. Of course the $300 a month they had earmarked for debt reduction would need to be used to rebuild the emergency fund, but they would have the peace of mind in knowing they had planned and not been “forced” to use their plastic.

Where Should I Keep This Money?

Good question. It needs to be kept where it is accessible but not mingled with other funds. A simple idea is to open a Money Market account with check writing privileges, then don’t use that account for anything other than emergencies.

Should Everyone Always Use the $1,000 Amount?

No. The key is to understand the purpose of this fund and make it the appropriate amount for your situation. Here are some exceptions to the $1,000:

  1. Dave recommends that those with household incomes of $20,000 or less should try for $500. Why? Remembering the principles of behavioral finance, we don’t want them to get so discouraged by the process of saving the $1,000 that they give up before getting to Step Two.
  2. A possible emergency is pending. For example, if the wife is pregnant, the couple should make minimum payments on all debts and use the debt payment cash flow to build up their emergency fund just in case it is needed. If, after the baby is born, the extra money is not needed, use everything above the $1,000 to pay off debt at that time.
  3. Job situation is highly unstable. As in point 2, stop the debt snowball and use all extra cash to build as big an emergency fund as possible. Once the crisis passes, go back to paying off debt again.

Closing Thoughts on Step One

Get focused and get it done. The faster you complete Step One, the more momentum you will have built to carry you through the next steps. Have yard sales, work overtime and make sacrifices in your budget, such as no eating out or vacation. When your broke friends and relatives start thinking you are weird, you are on track.

Next post in this series is Baby Step Two: Debt Snowball

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{ 4 comments… read them below or add one }

Arthur @ FinancialBondage.org April 24, 2010 at 3:56 pm

Saving money is tough for me, despite working two jobs. I can’t seem to get past the $1000…. Now that my truck is paid for, hopefully saving beyond the $1000 will be possible.

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joeplemon April 24, 2010 at 4:16 pm

Arthur,
Congratulations on getting the truck paid off! I bet it drives better now. Does this complete your Baby Step 2? If not, you can snowball that truck payment into paying off other debt. If so, you can use that former truck payment to start building up your emergency fund (Baby Step 3). Either way, congratulations. You are taking control of your finances.

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Tina June 8, 2010 at 5:43 pm

I finished FPU in December, ’09 and I find myself still on baby step one. Whenever I start to save up money and feel really good about it, life steps in. I am a single mother raising two children alone with no child support from their father. I cannot get a second job due to caring for my children, I cannot draw overtime as I am salaried, and I’ve had yard sales which have helped me break even during some months but they never yield enough to help me get ahead. FPU has helped me gain control over my money and avoid overages at the bank, but I’m wondering if that is all it’ll be able to do for someone like me?

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joeplemon June 9, 2010 at 8:42 am

Tina,
Congrats for finishing FPU. You said that FPU has helped you gain control of your money and avoid overages at the bank, but you are having trouble getting traction on your Baby Step 1. Based on what you told me about your life, I can see why. But I urge you to not despair. Even if gaining control and avoiding overages at the bank is all you can do right now, then I say you are doing all right. I can’t give any specific advise because I don’t know any more about your situation, but I can say that many people who have persevered through tough times and learned how to manage very little money have done extremely well once they started getting more money to manage.

This link http://www.singlemomrichmom.com/will take you to a blog written by a woman who has been through much of what you are going through. I don’t know if she has ever been to FPU, but she has struggled and is now doing much better. I hope it will help you.

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