Baby step #3 of Dave Ramsey's Financial Peace University might just save you from falling back into the debt trap
The idea of saving for a rainy day is nothing new. What I learned from Dave Ramsey and his Financial Peace University is that until you have a fully funded emergency fund, financial peace is a breath away from disintegrating.
The concept of having an emergency fund is having money set aside for a rainy day. Many governmental entities have what is considered a contingency fund or a rainy day fund. The idea for governments is to set aside some cash in case money becomes an issue.
It is important for families to do this, too, because it is not a question of if you will have an emergency but when will you have an emergency. Having money set aside will help you weather a financial storm.
This post is the third of eight sharing the real-life experiences of two readers as they work through the Dave Ramsey Baby Steps and Total Money Makeover. I’ve met so many people that have seen their finances saved by the Baby Steps, I wanted to share this series and some great ideas to put your personal finances back on track.
Get Started with Baby Step #1 and 5 Steps to Start Your Emergency Fund
Check out last week's article how to Use the Debt Snowball Method and Baby Step #2
How Much Should You Save for an Emergency Fund?
Having a fully funded emergency fund is different for everyone — at least the amount may be different for everyone, but the concept is the same. A fully funded emergency fund is equal to three to six months of expenses. That’s right — the amount of money that would meet your monthly needs for three to six months.
My husband, Bobby, and I have been utilizing the information from Financial Peace University (FPU) for almost 10 years. We started by putting $1,000 into our emergency fund. And then made huge strides in the debt snowball — all we have left is my student loan and a mortgage.
I have to admit, that number of three to six months can be quite staggering to me. As we are still on Baby Step 2 (the Debt Snowball), we haven’t gotten to this point. But we have had glimmers of what it is like, and it was great.
Saving for Your Emergency Fund
At one time, we had as much as $5,000 in the emergency fund. We did this after we had gotten all of our credit cards paid off as well as our car loans. We stopped our debt snowball for about a year because we knew our cars were getting older and so was our home.
We ended up using several thousand dollars over the course of the year or so to pay a large down payment on a used car. This allowed us to have a much smaller loan that we paid off two years early.
We built the emergency fund up again just in time for the replacement of our heating and cooling system in our home. This was a $5,000 expense that we were able to use $3,000 from our emergency fund to cover a portion of it. The man who put our system in gave us time to pay him the remaining amount, which we did in a matter of weeks, thanks to the budgeting process we learned from FPU.
Still I dream about the day when we can start Baby Step 3. A fully funded emergency fund for us would be right around $20,000 so it might take us a while but we're committed to seeing it through.
In the meantime, though, life still goes on and emergencies still happen. Our emergency fund has been sitting at around $2,000 for several months. I like having $2,000 because technically if we had a $1,000 emergency, we would still have $1,000 in our emergency fund.
Freedom Account and the Emergency Fund
We have also created what Mary Hunt (another financial wizard) calls the freedom account. Here is a savings account that we can set aside money for recurring expenses. We move money from our general fund into the freedom account to keep it from being absorbed by day-to-day living.
Our freedom account is where we put money for car and house repairs. We use it a lot to squirrel away money for vacations. While Dave Ramsey would probably advocate that we stop traveling, we will always make sure we can visit Bobby’s family in Boston.
When I think about it, there are three distinct differences between an freedom account and an emergency fund.
- The emergency fund is a money market account, where it earns some interest. The freedom account is a simple savings account.
As a money market account, it works like a checking account that earns interest. Right now, it isn’t much interest. But as we build it up that will change.
- The freedom account is more easily accessible to us than the emergency fund. We do not have a debit card for the emergency fund. This has been a challenge at times, but it has also been a blessing.
We have to come home for the checkbook if we are going to pull money out of the emergency fund. The freedom account is with the same bank as our general fund checking account. If we need to pull money from the freedom account to pay for a car repair or airline tickets, it is a click of a mouse to do so.
Want to see how far your savings will go? Use this savings account calculator to reach your goals.
- The freedom account’s balance ebbs and flows. There have been times when our freedom account had quite a bit of money (by our standards) in it as we were preparing for a major vacation.
We have also had times when there was maybe a few hundred dollars sitting in it, which usually occurs right after we come back from vacation! But all this ebbing and flowing is O.K. because this freedom account actually does offer us a lot of freedom.
Getting a taste of financial freedom, and peace of mind
Due to the existence of our freedom account, we had a place to set aside money as we prepared for Bobby to move from his job at a local newspaper to starting his own business. We used the last three months of 2017 to prepare.
We tried living just on what I earned, to see if we could make it while his business got up and going. The freedom account gave us a buffer that we wouldn’t have had otherwise.
When Bobby started his business January 2018, I didn’t stress out wondering how we would make it without his steady bi-weekly paycheck. I knew that if worse came to worse, if he didn’t have any money coming in, we could pull money into our general fund from the freedom account.
Incidentally, the business has done and continues to do well. Therefore, we have only actually dipped into the freedom account a couple of times for the household budget and that was early on in the year.
So, when I sit back and think about it, I like having our two separate accounts. The emergency fund gives me some comfort in knowing we can handle a small emergency should it arise. It also gives me a place to dream about the day it will hold much more than what it currently has.
Advantage in Times of Crisis
The updated statistics on personal savings as a percentage of disposable personal income have changed dramatically since last year. The COVID-19 pandemic not only had people stay at home but most of them were also left broke and unemployed. Other financial experts say Ramsey’s approach of saving more for a rainy day is silly when, for instance, you could be investing the money into other hyped streams of income that could be unreliable in due time.
You’ll have to decide what feels right and best-fitting to you. If someone in the family gets sick or if any untoward incident happens or you lose your job, you will have the financial support to stay afloat without having to resort to loans or credit cards again. Also, the most important thing that can be imparted to you as you start your journey to financial freedom is to the value of patience. Completing the 7 Baby Steps does not promise overnight success. As a matter of fact, it’s something that you’re going to consistently practice and apply your entire life and better pass on to your children. The great part is that the more you do it, the easier it will become until eventually, it’s just a regular part of your everyday routine.
The freedom account gives us the freedom to go about our lives knowing that if we needed money in a pinch, we have quick access to it … and we don’t have to touch the emergency fund I guess there is peace of mind in that small comfort. Just reliving our path through the Dave Ramsey Baby Steps, it seems like a very long journey already. I know we still have a ways to go but we feel great about how far we've come and where we're going!
Read the Entire Guide to Saving Series
- Can I Afford a House? [Dave Ramsey Secret to Saving More]
- Saving Tips for Teenagers: How to Teach Your Teen Child to Save
- 5 Best Ways to Manage your Investment and Savings
- 20 Money Saving Tips to Save $7,500 a Year
- 6 Budgeting Hacks to Beat Your Savings Goals
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.