Even The Best Plan Has Snags
Having a baby emergency fund is an essential part of starting a healthy financial plan. It gives you some wiggle room in order to handle what life throws at you (mainly the little things), while paying off your debt with gazelle intensity. If you have no debt, then you should have 3/6 months of savings in your fully funded emergency fund. Life happens at the most inconvenient time, but if you have an emergency fund, it’s not so stressful. Needless to say, when that time comes you will need to know what to do to adjust your financial plan in order to recover.
I often get contacted about what to do when someone has to use their emergency fund, or by no fault of their own incurs new debt unexpectedly. I will answer this question assuming that you are working The Total Money Makeover by Dave Ramsey, which I endorse and highly recommend. The Total Money Makeover consists of 7 baby steps, located below, as well as in the right sidebar of this blog.
Dave Ramsey’s Baby Steps
(I have provided a few links in Dave’s baby steps. Those links are my method to give you more options depending on your ability or motivation, while allowing you to still follow Dave’s core plan.)
Baby Step 1 – Save $1,000 for baby emergency fund. ($500 if you make less than $20,000)
Baby Step 2 – Pay off all debt except for your mortgage using the debt snowball.
Baby Step 3 – Fully fund your emergency fund by saving 3/6 months of expenses.
Baby Step 4 – Invest 15% of your income for retirement.
Baby Step 5 – Save for college.
Baby Step 6 – Pay off mortgage.
Baby Step 7 – Build wealth and GIVE!
The basic rule of thumb is that if you are working the baby steps and find that you have a setback, you would stop what you are doing in the current baby step and replenish the baby step that was affected. Then you would return to the baby step you were on before the interruption.
For instance, if you:
–Are on baby step 2, but have an unexpected emergency that uses $500 of your emergency fund, you would STOP paying down your debt to get it back to $1,000.
–Are on baby step 3, and end up with an unexpected debt that you can’t pay in full, you would STOP funding your fully funded emergency fund, and pay off that debt until it is gone.
–Are on baby step 4 and up, and end up needing to use some of your 3/6 months of savings, you stop what you are doing, and go back to get that fully funded again.
Avoid Using Your Emergency Fund IF Possible
It is important to know that your emergency fund should only be used for emergencies. Sounds easy enough right? You would be surprised at how many people admit that sometimes Christmas Day is used as justification to dip into savings. Dave Ramsey points out that Christmas actually falls on the same day each year, so it shouldn’t be an emergency since you know it is coming. I must say we too, have been guilty of not saving for Christmas, which can definitely cramp your December budget. Try to plan for irregular expenses to help cut down on budget fatigue.
Start a separate type of savings, usually called a sinking fund, to plan for other items such as car insurance renewal, Christmas gifts, birthdays, vacation, etc. We use a local savings account for sinking funds, and have our emergency fund in an ING Online Savings Account. You would budget for each sinking fund expense by figuring out how much you need to come up with, and divide it by how many months you have until it is due. Create a category in your monthly budget to fund each irregular expense. I have created a worksheet on the EOD Deluxe Budget 2.0 that allows you to keep up with your sinking funds. Budgeting for irregular expenses will save you stress and many headaches!