We discussed baby step 1 here, and then followed it up with baby step 2 here. In step 1, remember the intent is to save up enough to keep minor unplanned expenses from becoming emergencies. After that, we started cash flowing every extra dollar into the debt snowball in step 2, with the goal of ultimately paying off everything but the house. Once you reach that stage, you have no payments. In Dave Ramsey’s coaching, you don’t have credit cards either, and now you have likely freed up massive portions of your income to save. So now the goal is to take that minor emergency fund, and grow it into a much larger fund.
The stated goal is to save 3-6 months of expenses. Now that you have no debt outside of the mortgage, Dave teaches that now it is time to start making yourself comfortable so you can really start to build wealth. By this stage you have already learned how to plan for normal expenses. He teaches you methods of ensuring you are adequately insured for other emergencies and expenses, which you can pay deductibles for out of your small emergency fund. There are still, sometimes, unplanned expenses that sneak up on you. Life lessons that are learned the hard way. While slogging through steps 1 and 2, if those types of emergencies arise, his instructions are not to push through. He isn’t cold or uncaring towards his audience or his tribe of followers.
He very clearly tells them to pause. They can use the freed up cashflow to cover that emergency expense, and they may sometimes have to take out a line of credit or use an existing line that they haven’t closed yet, but once the storm has passed, the train gets back on track and the snowball begins rolling again.
Once you have reached that stage, though, he focuses on making even those types of emergencies into mere unplanned expenses. A family with 3-6 months of expenses doesn’t really have many emergencies. They may have life-altering circumstances, but they aren’t emergencies. Someone who loses their job, but has saved 6 months of mortgage payments, grocery costs, utility bills and more, can even stretch that into 7 or 8 months by cutting back on other unnecessary costs. This provides them a freedom to be able to find other employment without the fear and the stress of wondering how they are going to make it. That comfort also allows them to make the most out of the opportunity potentially seeking even better opportunity or more income.
Conveniently, this safety net is conspicuously absent prior to step 3. Emotionally, step 1 provided a tiny safety blanket, but not enough to let the new student feel complacent. That gives them the foundation to start paying off debt while keeping them just uncomfortable enough to make progress through step 2.
Most people have freed up at least 40-50% of their income at this point, and getting to 3-6 months of expenses saved up can take 6-12 months, perhaps a little longer if they loosen up the budget constraints and have a little more fun. It needs to be emphasized at this point, that it is an EMERGENCY fund. This isn’t for unplanned expenses that you were supposed to plan for. By this point, you should already be saving money to pay for car repairs, tire replacements, and other normal maintenance costs. So the emergency fund isn’t to be used for upgrading to a slightly better vehicle. You can save up and pay for that separately, in a later step. At this point, you pay for what is necessary to keep it driving. If it becomes more costly to repair it than to replace it, you find an inexpensive vehicle for very little money that you can keep running until you can afford to upgrade in cash.
The principle here is solid. I’m not sure it is necessary, but I agree with the idea of having a nice sum of cash stored up for larger expenses that are unplanned…or that unfortunate series of events in which many small, unplanned emergency expenses rise up. In a short period of time, you could have hail damage to your house, find yourself in a car accident, the kids could get sick and require hospitalization and the dog escapes the backyard and has to go to the veterinarian for an emergency surgery to save it. You can’t plan for stuff like that. That is why you get insurance when you are making the budget, but some things are less expensive to pay out of pocket for, and deductibles can add up.
So here you are really giving yourself a huge safety blanket. It is time to get comfortable and let the hard work you have done to reach this point start to pay off.
Dave Ramsey is more flexible in terms of where you put those emergency funds. The point is to be able to access that money in a very short time. The easiest way to do that is to just use a savings account, but he talks about using other vehicles, such as credit union accounts where you can access the money within a couple weeks if you had to take out a large withdraw, but in which it could grow in interest while deposited. Once again, I find myself agreeing with Dave, because he is still pushing people like myself when I applied his teaching, who have never had any sense of financial security or freedom. There are better long term alternatives, but we have to remember where these people started.
When I started his process I had student loans from my failed first attempt at a college education, a mortgage payment and 3 lines of credit which were consistently maxed out. I had gone to get a consumer loan from a military loan shark because I had decided I just needed this beautiful and expensive alto saxophone so I could relive my glory days from high school jazz band. Not exactly a ringing endorsement of financial wisdom. Remember that Dave Ramsey is talking to fools like me. I was fortunate that I learned these lessons well before my 30’s, but some of his audience are still making boneheaded budget decisions like those I highlighted above well into their 50’s. These people live in homes much bigger than they can use, and stock every room with stuff they purchase on store credit and will rarely if ever use. They have two people who can legally drive, and have 3 or 4 car payments, because they have their work vehicles, a fun vehicle, and a practical vehicle like a truck they can use for hauling their boat and jet skis, which are also on credit. They travel every year, sometimes multiple times a year, and always do so on credit.
Financial fools. Not because they can’t afford the payments. Right now, they certainly can and they are enjoying it. They are forgetting that risk is inherent in this and it could take a fairly small emergency to have all of this come tumbling down around them.
Not after baby step 3. Now these folks are comfortable. They are safe and relatively stress free. They can now afford to save up for expenses and plan new vehicle purchases, ATVs, toy cars or other luxuries without the risk of ruining their family’s financial future for their fun. They have now provided a fairly robust financial security for the needs of their family and are now ready to financially secure their futures.
The next several steps happen as needed, and simultaneously. I will discuss them together in a later post.
In the meantime, we should remember that Dave Ramsey’s coaching is intended to be emotional. There is a basic logic to it, which is also irrefutable, but the primary driving factor of his popularity is because he is a tremendous communicator who has figured out how to create a sense of community and passion. He does this while avoiding complicated financial discussions mired in math and micro-economic principles. His detractors need to learn those lessons if they hope to have anywhere near his impact.
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