Whew! This is the point where you are really getting a handle on this whole personal finance thing. You have paid off all debt except your house, so you should have some significant wiggle room between your income and your expenses. You are starting to see yourself as a winner in the money game, and it’s true! Now it’s time for the final step of your financial foundation: 3-6 months worth of expenses in a safe savings account.
Why do you need that much in savings?
Now that you have extra money every month, isn’t it enough to just avoid debt and pay cash for your splurges? Well, having 0 debt does put you miles ahead of the average American, you’re right. But you’re still a few hundred yards away from the short-term financial stability finish-line. So don’t stop running quite yet.
The next and final step for short-term stability is having 3-6 months of expenses in an easily accessible savings account. This is your emergency savings in case life suddenly gets a little too real. I hope that this step is a complete waste of your time. And for a lot of you, it will be. But the truth is that some of us will face an unexpected job loss, a short-term disability, a seriously ill child, or any of a hundred other things that can turn your life upside down. And for those, this will be one of the most important things you can do to make the hardest time of your life a tiny bit easier.
Three to six months’ savings won’t protect you from every tragedy that exists, but it will cover the vast majority of them. And even more important, if the tragedy is even worse, it will give you some time to get your sanity back after the initial shock. It gives you breathing space while you grieve. It allows you to concentrate on the people who need you, instead of “How on earth am I going to pay the bills next week?” Having that buffer savings is a favor that you will NEVER regret doing for yourself if the unthinkable happens.
How do I get my savings to that level?
This should be pretty easy. You have been paying off debt at a rapid rate by really throwing every extra penny at the debt you have. Well, now you can splurge a little to celebrate that accomplishment. (And by splurge, I mean a weekend get-away or a special but smallish new shiny thing – NOT a cruise around the world or a Ferrari!) And after the splurge, that extra money in your budget that you used to send to the credit card company or whatever creditor you were paying off should immediately head toward the nearest savings account. Just take the money that you were already putting toward debt repayment and send it to savings.
Where do I keep my savings?
The big thing here is that this is an EMERGENCY fund. In case of emergency, you don’t want to have to do something super complicated to get your money. So just put it in a money market account or a savings account. “But Jill,” you say, “This is gonna be a chunk of cash. Wouldn’t it be better to earn a little something on it?”
NO. No it wouldn’t.
And this is why. That’s not its purpose This is not money that is intended to earn interest. It’s money that is going to save your butt if something bad happens. You will invest in the next step. You will invest for the rest of your life. The money you invest will make you rich. But this emergency savings is not investment money. It’s “in case of emergency” money.
Don’t be penny wise and pound foolish with this money. Just put it somewhere safe!
What if I’m a spender and don’t trust myself to keep it?
Ahhh, great question. If you are afraid that you will lack discpline to keep that money sacrosanct for a true emergency, then put it at a separate bank from where you keep your checking account. Maybe a bank where you don’t have your electronic login info memorized, so it’s a hassle to use it for an impulse buy. You just want to be able to get to it without TOO much trouble if you you should really need it.
How much savings?
Three months’ expenses? Six months’? Or somewhere in between?
And the answer: it depends. This is based on several parts of your personal situation.
The first issue to get an actual number for your monthly expenses. How much do you realistically spend on non-negotiable in a month? Include housing, utilities, gas, car maintenance, food, and other essentials. However, you can probably skip any frills like lunches out. Just add up what it would cost you to stay afloat for one month, bare bones. Once you have that number, we’ll figure where in the 3-6 month range you should aim.
How much stability do you need?
When I was single and childless, I was a risk-taker. I figured the worst that would happen is that I would move back in with family for a few months. Now that I have a family and live in a different city, I need more stability. It would be a tremendous disruption to pull my kids out of school. That not only means we couldn’t relocate on a whim. It also means I wouldn’t want them to know that we were having financial trouble. My kids are worriers, and it would be important for them to see our lifestyle going on more or less as they were used to before. So stability is a huge need for us at this point in our lives. We wouldn’t even want to cut too far into the extras unless it got pretty bad. This points us to the upper end of the range.
Next question: How stable is your income?
If your income is strongly commission based, or your company has a history of layoffs, you will want to shoot for six months of savings, maybe even more if you have a family. On the other hand, my husband and I are both in incredibly stable jobs. I’m a teacher with great evaluations and many years experience in this district. My husband is a lawyer for the state in which we live. Plus, we could live on either one of our incomes if we absolutely had to. This points us to a lower savings amount.
Last (and most important) question: What is your comfort level?
Don’t discount your own emotions. If having six months’ worth of expenses in savings just makes you feel better, then by all means do it. If the other two questions indicate that you could go with less, and you don’t lie awake at night worrying about it, cut it down to three.
For us, even though our jobs are so stable and we have extra in the budget, I grew up on a farm in the 1980’s. And even though we made it through, losing the only home I had ever known was a very realistic fear for me. So we stick with the 6 months plan.
Ok, so now you’ve got the final step in your foundation. Next week: building on that foundation to create financial independence.
If you were trying to swim across a lake with an anchor, and you weren’t sure you’d make it, what’s the first thing you would do? Drop the anchor, right?
Yet in personal finance, we often carry around a huge anchor for not just years, but decades. Sometimes we don’t even realize we’re carrying it because everyone else in our lives has always carried anchors, too. What’s that anchor?
Debt.
Yes. For many people, debt is an anchor that will absolutely prevent them from getting to where they want to go financially. Why? Because we spend a ton of money making payments. Think of every payment you have now or have had in your life. How much money would you have to work with every month if you didn’t have those payments to make?
“OK, Jill,” you say. “Sounds great. But if I knew how to do it, I probably would have already done it.” Yes, it’s easy to say, but not easy to do. But then again, teaching isn’t easy either, is it? And you’re KILLIN’ that! So I know you can do things that are tough. I know you’re not a quitter. And I know this is worth the effort.
Again, these are not my ideas, they were formulated by Dave Ramsey. But this is my personal take on the system he used.
Kill debt with emotion, not logic
In getting rid of debt, like most things in life, your emotion matters more than logic. So we’re going to put your debts in an order that will give you some quick wins and really allow you to see some fast progress. Make a list of your debts – credit cards, car loans, student loans, medical bills, loans from family and friends, payday loans, EVERYTHING except the house. Include the name of the debt, the total amount, and the minimum payment you have to make each month. Then put them in order from the smallest amount owed to the largest amount owed.
Dumping the Debt – smallest to largest
Once you have your $1000 emergency fund (for more on saving $1000, click here) and your list of debts, you continue paying minimum payments on all of your debts. But stop EVERYTHING else. Stop the money that goes into your retirement. Stop buying new clothes. And stop eating out. Get rid of everything that is not absolutely essential.
At the end of the pay period or month, you scrape up all that extra money you have and put it toward the first (smallest) debt on the list. With any luck, you’ll knock this one out right away. When you’ve paid off your first debt, you take that monthly payment and you put it toward the second debt on your list, along with ANY extra money you can find. (Check the couch cushions one more time. Raid the cup holder in your car!) Now you are making a bigger payment on that second debt each month, and it should disappear pretty quickly. You repeat this process until you have worked your way through every debt.
That “until” could be a big one. Like 2-3 years big. Two to three years that might feel like 2-3 decades. But what would it mean to you to have NO payments? NO car payment. NO credit card bills. NO student loan. What would your life look like if you paid your mortgage, utilities bills and were DONE? I’ll bet for most of us, it would be a lot different. A lot more joyful. A lot less stressful.
Would it be worth it to sacrifice – REALLY sacrifice for a while to give yourself options? To give yourself freedom?
Again, for those in the back – It’s emotion, not logic!
If you are a math geek, you are saying to yourself, “Lowest payoff to highest? NO WAY! If you put it in the order of lowest interest to highest,you’re going to save all that money you’re paying on high interest loans and you’ll pay it off so much faster.” Well, that’s a great theory, but it’s kind of like all those theories your education professors taught you that just flat don’t work in actual life.
Remember, paying off debt is not about the numbers. It is not about the logic. If it were, no one would ever get into debt. It’s totally against all logic to spend money you don’t have to buy things you almost never actually need! This is about emotion. And whatever extra interest you pay will be more than offset by your intensity as you start paying off debt and really feeling like this thing could actually happen.
In this case, the interest isn’t your problem. The principle is. Bad spending habits and spending more than you earn are. The interest is just a symptom.
So I’m going to ask you one more time, would it be worth it to sacrifice – REALLY sacrifice for a while to give yourself the option to continue teaching or do something else, like stay home with the kids or start a business. To give yourself the peace of mind that comes with knowing you have money in the bank to pay all of your bills? To sleep soundly without worrying that one small emergency will bring your entire financial house of cards tumbling down around you? If so, get that $1000 saved, and get your list made, and get on your way.
In the last post, I gave you an overview of Dave Ramsey’s 7 baby steps to financial success. Over the next several weeks, I’m going to break each one of those steps in more detail. Remember, this is not my stuff, it’s Dave’s. This is just my take on it. Step 1 is save $1000, but it should really be divided into step 1A and step 1B.
Step 1 A: STOP using credit cards
Stop borrowing money at all. If you have debt, it is because at some point in your life, you were spending more than you were earning, and that led to trouble. It might not be your fault, but the result is the same. And we’ve got to deal with it. Maybe you are still doing it. If so, nothing else can help you. Before you do anything else, you’ve got to stop spending money you don’t have.
There are a lot of ways to do this. Most people can get their spending in line by doing a budget. Yeah, it’s about as fun as a pap smear (well, not quite THAT bad), but it works. You’d be amazed by the number of people who swear that doing a budget is as good as getting a raise. They suddenly have to pay attention to where their money is going.
Online apps
And there are tools that make it a lot more appealing. Ramsey solutions developed “Every Dollar” and online budgeting app. I’m old, so I’ve always just done mine in excel, but I’ve tried Every Dollar and it’s super user-friendly. There are a lot of other ones out there, but Every Dollar is the only one I have personally tried. If you’d like to know other options, check out this list.
The ugly truth
With all that said, I have never been successful doing a budget. I hate it, and I generally end up ignoring it. However actually sitting down and figuring out guidelines is essential. So even if you make it and then ignore it (like I do) I still recommed giving it a go. The big thing is that you need to know how much you’re spending and keep it under control. If you cut up your credit cards and don’t have a realistid idea of how much money you need at the end of the pay period for food and gas, you’re going to be in a world of hurt.
Step 1B: Put $1000 in savings as fast as you possibly can
DO NOT TOUCH that money unless there is a serious emergency. And no, a great sale isn’t an emergency! If you already have $1000 or more saved up for emergencies, you can go ahead a skip on down a bit. If not, this is important stuff. Now, if you don’t have even $1000 you could use for an emergency, DO NOT beat yourself up. According to a CNBC article from January, 2018, you are not alone. Only 39% of families could cover a $1000 emergency. So this is normal in America. But normal isn’t always fun. If worrying about money keeps you up at night, this is an indispensible step in your journey.
Why does Dave recommend saving before putting a single dollar (beyond minimum payments) toward debt? Because if you want to get your finances in real order, this ain’t no sprint. It’s a marathon. And if you don’t warm up and stretch out before a marathon, you gonna hurt something. Well, this is that warm up to help you keep from getting messed up on the way.
But I want to pay off debt, why delay?
Nothing is going to make it harder to actually get out of debt than, well, life. You know how it works, right? You’re chugging along toward a goal and then something comes along and stops your progress. You have to take 3 steps back and it’s so discouraging that you never get that momentum back.
Here’s how it works with money: You swear to yourself you are going to stop using the credit cards and pay the off. “NO. MORE. DEBT.” You say to yourself. And everything is just fine until (dramatic music – dun, dun, dun!) – a child gets sick and there’s an unexpected trip to urgent care. OR the water heater goes out. OR gas prices spike and you’re paying twice as much for gas as you thought you were. OR grandma dies and you have travel expenses for her funeral. OR _________________ (fill in any of a godzillion possible emergencies here).
You’re paying off debt and every penny is going to extra payments. There is nothing in the bank, so you whip out the credit card. STOP RIGHT THERE. I thought you weren’t going to use the credit card any more. I thought you said “NO. MORE. DEBT.”
Well, $1000 in the bank will take care of about 85% of those emergencies. (That’s a statistic I totally made up, but it’s based on personal experience.)
How fast do you think you could save $1000? Could you sell something? Have a yard sale? Do a little tutoring or teach summer school? Totally give up eating out until you have $1K in the bank?
This might seem impossible, but it creates the base for absolutely everything that happens to you financially. This is the reason. Our goal is to get you out of debt, right? If you have absolutely no savings you’re going to keep going further into debt every time an emergency happens. And THAT is going to do a huge number on your belief that you can actually do this.
So just save the $1K and be done with it. Then move on to step 2: Eliminating ALL debt.
