by Dave Ramsey
An Emergency Fund Can Turn Crises into Inconveniences
As you budget over the years and your Total Money Makeover completely changes your money habits, you will use the emergency fund less and less. We haven’t touched our emergency fund in over fifteen years. When we first started, everything was an emergency. But as you crawl off the bottom, and The Total Money Makeover begins to take effect, you have fewer things you can’t cover in your monthly budget. At the start, though, you’ll be like we were—everything will be an emergency. To show you what I mean, consider two different stories of people at two different places in the Baby Steps.
Kim was twenty-three, single, on her own, and at a job making $27,000 per year. She had recently started her Total Money Makeover. She was behind on credit cards, not on a budget, and barely making her rent because her spending was out of control. She let her car insurance drop because she “couldn’t afford it.” She did her first budget and two days later was in a car wreck. Since it wasn’t bad, the damage to the other guy’s car was only about $550. As Kim looked at me through panicked tears, that $550 might as well have been $55,000. She hadn’t even started Baby Step One. She was trying to get current, and now she had one more hurdle to clear before she even started. This was a huge emergency.
Seven years ago George and Sally were in the same place. They were broke with new babies, and George’s career was sputtering. George and Sally fought and scraped through a Total Money Makeover. Today they are debt-free, even their $85,000 home. They have a $12,000 emergency fund, retirement in Roth IRAs, and even the kids’ college is funded. George has grown personally, his career has blossomed, and he now makes $75,000 per year while Sally stays home with the kids. One day a piece of trash flew out of the back of George’s pickup and hit a car behind him on the interstate. The damage was about $550.
I think you can see that George and Sally probably adjusted one month’s budget and paid the repairs, while Kim dealt with her wreck for months. The point is that as you get in better shape, it takes a lot more to rock your world. When the accidents occurred, George’s heart rate didn’t even change, but Kim needed a Valium sandwich to calm down.
Those true stories illustrate the fact that as you progress through your Total Money Makeover, the definition of an emergency that is worthy to be covered by the emergency fund changes. As you have better health insurance, disability insurance, more room in your budget, and better cars, you will have fewer things that qualify as emergency-fund emergencies.
What used to be a huge, life-altering event will become a mere inconvenience. When you are debt-free and aggressively investing to become wealthy, taking a few months off from investing will put a new engine in a car. When I say the emergency fund is Murphy-repellent, that is only partially correct. The reality is that Murphy doesn’t visit as much, but when he does, we hardly notice his presence. When Sharon and I were broke, our heating-and-air system quit, and the repair cost $580. It was a huge, hairy deal. Recently I had a new $570 water heater installed because the old one started leaking, and I hardly noticed. I wonder if the stress relief that your Total Money Makeover provides will allow you to live longer?
Let Me Be Perfectly Clear
There are some Baby Step Three clarifications. Joe asked recently if he should stop his Snowball—Step Two—to get his emergency fund finished. Joe and his wife have twins due in six months. Brad’s plant is closing in four months, and he will lose his job. Mike got a huge severance check of $25,000 last week when his company downsized him. Should these people work on debt or finish the emergency fund? All three should temporarily stop Snowballing and concentrate on the emergency fund because we can see distant storm clouds that are real. Once the storm passes, they can resume the plan as before.
Resuming the plan for Joe means that once the babies are born healthy, are home, and everyone is fine, Joe will take the emergency fund back down to $1,000 by using the rest of the savings to pay the Debt Snowball. Resuming for Brad would mean that once he finds his new job, he’ll do the same. Mike should hold his instant emergency fund of $25,000 until he is reemployed. The sooner he can get a job, the more that severance is going to look like a bonus and have a huge impact on the Debt Snowball.
Sometimes people think they don’t need an emergency fund because their income is guaranteed. Richard was retired from the military and received over $2,000 per month, which he could live on if he lost his job. He didn’t think he needed an emergency fund because he thought all emergencies were job-related. Then he had a car wreck the same month he was laid off. His $2,000 kept coming, but now he faced car debt. Even if your income is guaranteed, you still might need to help a sick relative, replace your heating system in the middle of winter, or get a new transmission. Large, out-of-budget emergencies that aren’t job-related do come up and will require the emergency fund.
If You Don’t Own a Home
I keep saying that you are debt-free except for the house at this point and saving to finish the emergency fund. What if you don’t have a home yet? When do you save for the down payment? I am going to talk as many of you as possible into the 100 percent down plan, but I know some of you will take the fifteen-year fixed-rate mortgage that I said earlier is okay.
I love real estate, but do not buy a home until you finish this step. A home is a blessing, but if you move into home ownership with debt and no emergency fund, Murphy will set up residence in the spare bedroom. I believe in the financial and emotional advantages of home ownership, but I have known many stressed-out young couples who rushed to buy something before they were ready.
Saving for a down payment or cash purchase of a home should occur after becoming debt-free in Step Two and after finishing the emergency fund in Step Three. That makes saving for a down payment Baby Step Three (b). You should save for the home if you have the itch before moving on to the next step. Many people are worried about getting a home, but please let it be a blessing rather than a curse. It will be a curse if you buy something while you are still broke. There are all sorts of folks who are eager to “work with you” so you can make it happen sooner, but the definition of “Creative Financing” is “Too Broke to Buy a House.”
Next Stop: Serious Wealth Building
Well, you have made it. You are now debt-free except for the home mortgage, and you have three to six months of expenses saved. Getting to the end of this step if you are gazelle-intense takes the typical family twenty-four to thirty months. Two or two and a half years from the time you start your Total Money Makeover, you can sit at the kitchen table with no payments, other than for the house, and with around $10,000 in a Money Market account. Close your eyes one more time and let your emotions and your spirit visit that place. Wow, I know I see you smiling now.
I’m a single mom of two kids, I own my own company, and I have everything paid off but the house! But it didn’t start out that way.
When I was 20, I became pregnant with my first child and thought my life was over. I had completed two years of college, but I didn’t know how I was going to finish my degree and raise a baby, so I left school. Then the next year, I went through a horrible divorce. I didn’t know what I was going to do!
I was living off of $400 a month and using credit cards for everything. I went back to school and worked like crazy to graduate a year and a half later. Even though I had a degree in advertising, I couldn’t find a job I was excited about. So I decided to start my own cleaning business at age 23.
Word spread and my business grew. At my lowest, I was $100,000 in debt. Over the past six years, though, I’ve steadily worked my way into becoming debt-free! I worked long, hard hours in order to pay off all the debt that I owed, but it was completely worth it!
Now, I have no car payments and have $2 million in term life insurance and disability insurance. I am happy, I’m debt-free, my kids go to a private school, and my retirement plan is set up. Each month, I put away $3,000 for my children’s education, the emergency fund, and investments. My house is c
urrently on the market because I want to rent and save up for a huge down payment on my next home. My goal is to be completely debt-free, including the house, by age 35!
Autumn Key (age 29)
Owner of Southern Comfort Cleaning
I am very demanding and very passionate about following these principles and steps precisely because I have seen people (like the ones throughout this book) win doing The Total Money Makeover. I have heard every excuse, every whining reason, and every rationalization as to why you are different and you have a better way, but trust me: you don’t. The good thing about principles is that they make life easy. I have heard it said that when someone bases his life on principle, 99 percent of his decisions are already made.
Once we have covered these basic steps and laid a foundation, the time has come to build some wealth. Remember, that is why we started a Total Money Makeover. We wanted not just to be out of debt, but to become wealthy enough to give, retire with dignity, leave an inheritance, and have some expensive fun. Stay tuned for some big fun.
9
Maximize Retirement Investing: Be Financially Healthy for Life
I have a friend in his forties who has a bodybuilder physique. He is lean with well-defined muscle groups, but he is not some wild health nut. He watches what he eats and works out a couple of times a week. I have another friend in his thirties who diets fanatically, runs every day, lifts weights three times a week, but is still forty pounds overweight. The second guy started his health journey a couple of years ago and is losing weight and getting in shape. The first muscleman maintains what he worked hard years ago to get, but he isn’t working nearly as hard today.
The Total Money Makeover is the same way. Gazelle-intensity is required to get to the wealth steps, but simple maintenance will keep your money muscles maintained. Keep in mind that my muscleman friend never eats three plates of food at a sitting. He is still aware he can lose his fitness, but he can look good and feel good with a lot less effort, assuming he remembers the principles that got him his great body in the first place.
Gazelle intensity has allowed you to lose one hundred pounds of debt and get your cardio emergency fund ready. That foundation will allow you to become financially fit by toning your muscles. You have attacked your debt; it is gone. With the extra money after eliminating your debt, you attacked your emergency fund; it is funded. You are now at a crucial time. What do you do with the extra money that you poured into the emergency fund and debt payoffs? This is not the time to give yourself a raise! You have a plan, and you are winning. Keep it up! You are two quarters into a four-quarter game. It is time to begin with the end in mind! It is time to invest.
What Retirement Isn’t
Investing for retirement in the context of a Total Money Makeover doesn’t necessarily mean investing to quit your job. If you hate your career path, change it. You should do something with your life that lights your fire and lets you use your gifts. Retirement in America has come to mean “save enough money so I can quit the job I hate.” That is a bad life plan.
Harold Fisher was one hundred years old. He worked five days a week at the architectural firm he founded. Mr. Fisher didn’t work because he needed money, not by a long shot. He worked because he found joy in what he did. He was a designer of churches. His favorite saying was, “People who retire early, die early.” “If I retired, what would I do?” he asked. Harold Fisher was financially secure and able to do what he wanted, and that defines retirement the Total Money Makeover way.
When I speak of retirement, I think of security. Security means choices. (That’s why I think retirement means that work is an option.) You can choose to write a book, to design churches, or to spend time with your grandkids. You need to reach the point where your money works harder than you do. A Total Money Makeover retirement plan means investing with the goal of security. You already possess the ability to quit your job, and if you don’t like your work, you should consider doing that. If not today, develop a five-year game plan for transitioning into what God designed you to do; however, don’t wait till you’re sixty-five to do what you love.
That said, the money part does matter. You want to reach your golden years with financial dignity. That will happen only with a plan. According to a study by the Employee Benefit Research Institute, 70 percent of Americans say they are not where they need to be with retirement savings, and more than 40 percent have never even tried to calculate how much money they need to save in order to retire with dignity. Not only have we not done anything about retiring with dignity; we have lost hope that it is even possible. Consumer Federation of America found that of people making less than $35,000 per year, 40 percent said the best way for them to have $500,000 at retirement age is to win the Lotto. Wow! These people need a Total Money Makeover in a big way! If you want another peek at the warped view of reality we have, consider that Wealth Builder magazine’s poll found 80 percent of Americans believe their standard of living will go up at retirement, even though CNN found that 56 percent of all workers have less than $25,000 in retirement savings. Talk about living in a fantasy!
I grew up poor, so I know the value of a dollar. My grandma raised me, and I watched her struggle every day to provide for us. She taught me early on how important it was to save for a rainy day.
My first job was picking cotton. Eventually I got a job working for a natural gas pipeline, and I worked for that company for 35 years. I never made more than $60,000 in any given year, but I always put 10 percent of my check into a stock purchase plan, which is what we used to have instead of a 401(k). At first, I didn’t think I could afford to put that much of my paycheck into a retirement plan, but then I figured that, in the long run, I couldn’t afford not to.
After thirty-five years on the job, I was able to retire at age fifty-eight—seven years early—with about $1,000,000 in my retirement accounts! Since retiring, I built myself a workshop and spend a lot of time tinkering in it, just having fun. My wife and I even took a month-long vacation out west—just because it’s something we’ve always wanted to do, and we had the money to do it!
Since we were focused on putting a little money away every month instead of keeping up with the Joneses, we’re now free to do whatever we want for the rest of our lives!
Jim (age 64) and
Kay (age 60) Robinson
Both retired. Jim was a technical
specialist for a natural gas pipeline,
and Kay was a nurse and stay-at-
home mom.
The reality is much colder. USA Today reports that out of one hundred people age sixty-five, ninety-seven of them can’t write a check for $600, fifty-four are still working, and three are financially secure. Bankruptcies among those sixty-five and older went up 244 percent in a ten-year period. Getting older is going to happen! You must invest now if you want to spend your golden years in dignity. Investing with the long-term goal of security is not a theory to ponder every few years; it is a necessity you must act on now. You must actually fill out the paperwork for your mutual fund. You must actually put money in that thing. According to these statistics, the level of denial the average person has on this subject is alarming.
Baby Step Four: Invest 15 Percent of Your Income in Retirement
Those of you concerned about retirement are relieved we have finally gotten to this step. Those who have been living in denial are wondering what all the fuss is about. Baby Step Four is time to get really serious about your wealth building. Remember, when you reach this step you don’t have any payments but a house payment, and you have three to six months’ worth of expenses in savings, which is thousands of dollars. With only one payment, it should be easy to invest heavily. Even with a below-average income, you can ensure your golden years will have dignity. Before this step, you have ceased or have never started investing, and now you have to really pour on the coals.
Gazelle intensity in the previous steps has allowed you to be able to focus on growing a sizable nest egg. The tens of thou
sands of people we have met have helped me develop the 15 percent rule. The rule is simple: Invest 15 percent of before-tax gross income annually toward retirement. Why not more? You need some of your income left to do the next two steps: college saving and paying off your home early. Why not less? Some people want to invest less or none so they can get a child through school or pay off the home superfast. I don’t recommend that because those kids’ college degrees won’t feed you at retirement. I don’t recommend paying off the house first because I have counseled too many seventy-five-year-olds with a paid-for house and no money. They end up selling the family home or mortgaging it to eat. Bad plan. You need some retirement investing at this stage before saving for college and the mortgage payoff. Plus, by getting started now, the magic of compound interest will work for you.
When calculating your 15 percent, don’t include company matches in your plan. Invest 15 percent of your gross income. If your company matches some or part of your contribution, you can consider it gravy. Remember, this is a rule of thumb, so if you cheat down to 12 percent or up to 17 percent, that is not a huge problem, but understand the dangers of straying far from 15 percent. If you underinvest, you will one day be buying that classic cookbook 72 Ways to Prepare Alpo and Love It. If you overinvest, you will keep your home mortgage too long, which will hold back the wealth-building power of your Total Money Makeover.
