Dave Ramsey Baby Step 1: Build An Emergency Fund

Dave Ramsey, Jean Chatzky and many others call it an Emergency Fund, which of course makes sense. Mary Hunt calls her version a Freedom Fund and I like the way she thinks too. Who ever's theories you like, the important thing is to get one going--just start. That's what I'm doing!

It was slow going getting started, but once I got going...WATCH OUT, it got easier and easier! I kept finding more ways to save, too.

I started out just saving our change from our pockets. Then, I started saving "extra" income we didn't expect, so we wouldn't count on it. Jury duty payments, refunds from any source, rebates, etc.

As of June 2009, with our income tax refund - we completed Step 1, Our Emergency Fund, PLUS had enough to pay off a credit card. WOO HOOOOO! Are we going to stop there? No way! We're going to follow the rest of Dave's Baby Steps. I'll be filling you in on our progress too, so don't miss it!

Over and over again, I've referred to the value of an emergency fund without really explaining what it is and how you can get one. To put it simply, an emergency fund is the most valuable thing you can have because it protects you from the unforeseen things that can demolish all of your financial planning and throw you into debt.

What exactly is an emergency fund?
An emergency fund is a cash reserve that you keep in a safe place and use only for emergencies. This cash reserve should be as liquid as possible (a high-yield online savings account is just about perfect) and should contain at least $1,000 (at first) and eventually six to twelve months of your household's take-home salary (eventually).

The only reason you ever tap into your emergency fund is if a situation arises that causes your monthly budget to not balance. Ideally, your monthly budget should have enough flex in it to handle things like a blown tire, but sometimes things happen like a dead transmission or a blown hot water heater and we simply need more cash than our budget can afford. This is when we turn to the emergency fund; it should have enough cash there to fix the emergency and then be replenished during the calmer times.

Sounds great, but I can't afford one!
Can you spare $1 a day? Then you can get started with an emergency fund. With just $1 a day, you can have an emergency fund of almost $400 by the end of the year and thus reach the $1,000 mark in about two and a half years.

Most of us can skip a take-out meal or two, or maybe skip out on dining out or not go on a weekend spending spree, and come up with $10 a day. If you can do that, you can hit $1,000 by the middle of April and have almost four grand in the emergency fund by the end of the year. $4,000 can help out with many financial crises.

How I used an emergency fund: an example
I used to think this was overkill, but I started an emergency fund anyway at the insistence of many, many personal finance writers. I started slowly, putting roughly $7.50 a day into it. In three months, I had about $800 stored away.

What happened? The brakes died in my truck. It turned out that the brake pads on my truck were actually crumbling - it was not something I had expected to happen. The bill? $700. Normally, this would have made me utterly sick and kept me up at night, but since I'd cut down on my latte and sandwich intake (not even eliminating it, just cutting down), I was able to calmly write a check to cover the whole thing.

That night, I bumped my daily emergency fund input up to about $20 a day, and it's gone up from there. It's a lot easier to give up your daily take-out and your silly shopping trips if you know you're making yourself safe from such disasters - and you've actually seen it at work.

One other note: I also use my own emergency fund as the starting-off point for my investments. I contribute heavily to my emergency fund on a weekly basis and make sure that it stays above a certain level that I'm comfortable with. What do I do with the excess? I deposit it into other investments, such as my non-retirement mutual fund (which my wife and I are starting to call the "dream fund").

Written by Trent Hamm
The Simple Dollar

Building up an emergency fund, if you haven't already, is one of the most important things you can do to help your finances.

But you knew that.

It's common financial advice, actually, but what's not so common is how to actually do it. Obviously those who haven't saved up an emergency fund have a difficult time saving money, even if they know they should.

So today we'll look at some strategies for building up an emergency fund, for those of us who don't have it so easy.

Why It's So Critical
I don't like to use the word "critical" often, because it's often an exaggeration. But in this case, when we're talking about the health of your finances, an emergency fund is definitely critical.

If you are having financial problems, the most important steps you can take immediately are 1) reduce your spending by being more frugal; 2) stop getting into debt; and 3) build an emergency fund of $1,000 (and later you can increase that to the standard 3-6 months of income).

Here are a few reasons an emergency fund is critical to your financial health:

1. Stop getting into debt. When an emergency comes up, if you don't have an emergency fund, the first thing that will be cut from your budget is your debt repayment. You'll use your credit card to pay for the emergency, and then you're deeper in the hole. An emergency fund stops the need to use credit to pay for emergency expenses.

2. Smooth out your budget. If unexpected things come up, you don't have to continually re-factor your budget to pay for these things. With an emergency fund, it makes budgeting much easier.

3. Prevent late fees. If you are living paycheck-to-paycheck, you will come up with times when you have to pay a bill late, or overdraw your bank account. With an emergency cushion, you avoid these financial hits.

4. Get ahead. If you can get a month ahead, your financial stress will drop way down. Instead of always playing catch-up, you can pay your bills ahead of time and sit back and relax.

21 Strategies for Creating an Emergency Fund
If you have trouble saving, it's not enough to tell you how important it is to have an emergency fund. You need some strategies for doing it.

Please note that you should choose the strategies that work best for you, and perhaps combine some of them if that works better.

1. Start small. If you don't have much to save, it doesn't matter - the important thing is just to start. Even if it's only $25 per paycheck, just start. It will slowly grow each paycheck, and you will be glad to see at least a little in your savings, and will soon be motivate to try to save more.

2. Automatic deduction. This is common advice, but that's because it works. Set up an online savings account (such as ING Direct or Emigrant Direct) and have it automatically deduct an amount each payday. If you don't have to think about it, saving will be much easier.

3. Payroll deduction. If you have discipline problems, there are accounts where you can have the amount deducted directly from your paycheck, before it's deposited into your checking account (or before your employer cuts the paycheck).

4. Treat it as a bill. Every payday, you have a list of bills to pay before you can spend any of your money on variable expenses such as gas, groceries or eating out. Well, add your emergency fund contribution to your list of bills, and pay it at the same time. This makes it non-negotiable, and then what's left over is what you can spend on other stuff.

5. Reduce an expense, save it. Take a look at how you're spending money now, and find some things that can be cut back. Magazine purchases, gourmet coffee, comic books, cable TV, gizmos and gadgets. Whatever you decide to cut back on, take that same amount and put it directly into savings each paycheck. Don't spend it.

6. Round up. I got this tip from J.D. Roth of Get Rich Slowly and actually, it's a strategy used by his wife, who will log every purchase or check she writes into her checkbook or finance software - but rounds up to the nearest dollar. So if she spends $26.01, she enters it as $27. Over the course of a month, this can add up to decent savings.

7. Double purpose account. This tip is from Trent of The Simple Dollar, who wanted to pay down his debts but still have the financial security of an emergency fund at the same time. So Trent brilliantly used a double-purpose account: he would save money in an account, and after he reached a certain minimum, anything above that amount was being saved to pay off a specific debt. So let's say the minimum amount is $500. After you pass $500, the money being saved is for a $200 debt (for example). Once you reach $700 in your savings account, you can pay off the $200 debt completely. Repeat the process for each debt.

8. Tip yourself. If you go to a restaurant and tip a waiter 15 or 20 percent, for example, match that tip for yourself. So if your tip is $10, tip yourself $10 as well %u2026 and put that directly in savings.

9. Keep paying debt, but to yourself. If you finish making a car payment, or paying off a credit card or smaller debt, take the amount you were paying to that debt and put it directly in savings each month. You won't feel a difference in your budget.

10. Budget big for groceries, then save the difference. Let's say you normally spend between $320 and $375 on groceries. Budget $400 for groceries, and whatever you don't spend of that $400, put it in savings.

Read the rest at Zen Habits