Friday, July 20, 2007

"The Total Money Makeover" (chapter 8)

Much of what is said in chapter 8 is similar to chapter 6, and for good reason. The eighth chapter of The Total Money Makeover discusses the third baby step.

Remember, if you are going to follow Dave Ramsey's baby step system exactly, you must have steps one ($1000 emergency fund) and two (out of debt except the mortgage) completely finished. Ramsey is a firm believer in total focus, so you must have these two steps completely finished before moving on to step 3.

Step 3 is "Finish the Emergency Fund."

Now, what is meant by "finish"? For most people, especially with families, Ramsey recommends having 3 to 6 months of essential expenses in that emergency fund. If you are single, or if you don't own your home, you might only need 2-3 months, but, personally, I like the idea of having at least 3 months no matter what your life situation.

A couple of points about this baby step:

1. As we said in baby step 1, put your money in a place where you can get to it in an emergency, but only in an emergency. Obviously, if you are pleased with where your $1000 starter fund is, you can just build that account.

2. To get an idea of how much money you will need, you need to go through your budget and figure out what you have to pay each month in essential payments. Obviously, the house payment or rent is essential. You will also need to eat in an emergency, but you won't need to eat out! You'll need enough for the electric bill, but not the cable bill--you'll turn off your cable in an emergency (won't you?).

3. Finally, why is this such a big part of a financial plan? It is simply because emergencies are what, many times, wreck the financial plans of those who are really trying to "get ahead." They pay off their debt, but then they start spending the extra money they have. Then a child has to go to the hospital. Or dad is laid off. Or mom finds out she has to have some serious medical tests run. Or the car absolutely falls apart. And what do we pay those expenses with? If there is no emergency fund, we go back into debt. With a fully-funded emergency fund, we can handle even large emergencies without going back into debt.

For many people, this baby step is as important as any other. With several thousand dollars lying around for emergencies, we can sleep at night. Even if Murphy's Law comes into effect in our house, we can pay her to leave!