Step 3 in Dave Ramsey’s Baby Steps is to save three to six months of expenses for emergencies. This step is to be tackled after you’ve completed Baby Steps 1 and 2:
By this time, you’ve experienced several emotional victories, especially if you’ve paid off a considerable amount of debt. Use this time to reflect on your progress and focus on your financial goals. The fun part of building wealth (Baby Step 4) needs the foundation laid by Baby Step 3 to provide a much-needed safety net.
What do you need to know about Baby Step 3?
3 months or 6 months?
It’s been debated whether one should save three or six months of expenses. At Stewardship, we consider whether one or both spouses work, the stability of the job, and what number provides the most peace of mind.
If both spouses work, we think three months of expenses will do (if one spouse loses his/her job, they will still have one income source). If only one spouse works, it may be better to save closer to six months of expenses. Job stability also plays a part. Unstable job prospects or variable income may necessitate more savings.
Finally, how much provides you peace of mind? Be careful—even though a certain dollar amount might provide you the most amount of peace, carrying too much cash can be harmful long-term.
Expenses, not income.
Look at your budget and add up all the necessary expenses to keep your household running. Then, multiply this by the number of months you are targeting. This way, if you lose your job you know you can pay your mortgage, put food on the table, and pay basic bills until you get back on your feet. If you’re saving three to six months of income, this number will also include things like taxes and planned savings, which are things you won’t need to account for if you lost your job.
Baby Step 3 isn’t meant to build wealth—that part is next! Baby Step 3 is meant to provide a foundation and safety net before you start building wealth. Think of it as a type of insurance. If you are building wealth in retirement accounts and have a large emergency or loss of income, Baby Step 3 provides a way for you not to have to tap into these (or rely on high-interest credit cards). Premature withdrawals from these accounts can mean hefty taxes and penalties.
Don’t minimize the importance of Baby Step 3! Not only does it protect you from falling back into the credit card trap, it provides a safety net and peace of mind so you can begin building wealth in Baby Step 4!
The key to continued success is to stick to your budget! If you’re stuck on Baby Step 3, our Dave Ramsey certified financial coach can help you build and maintain a budget, and look for ways to free up cash flow.
Jake is a co-founder and Director of Investing at Stewardship Financial. In his role he gets to help people make smarter decisions on how to invest in the capital markets.