Baby Step 3—Dave Ramsey's Approach to Building an Emergency Fund

Dave Ramsey's financial advice has become extremely popular. But many experts criticize it.

Is it financially sound?

Is it too rigid and strict?

To answer these questions, we analyze Dave Ramsey's approach in detail. Then, we give you practical advice on how you can tailor it to your needs.

First off, let’s get one thing straight: Baby step 3 is particularly hard to tackle. But there's a way to handle it.

Here's how you can get rid of debt and build an emergency fund.

Who Is Dave Ramsey?

David Ramsey is one of the most famous financial experts. He went bankrupt at a young age and rebuilt his wealth from zero.

Now, he has a net worth of about $200 million.

Most people know him from his popular radio show and podcast channel, The Ramsey Show.

He's the author of several books on finance, including:

• "The Total Money Makeover"
• "Financial Peace: Restoring Financial Hope to You and Your Family"
• "Dave Ramsey’s Complete Guide to Money"

In this article, we focus on Ramsey's plan for financial freedom.

He calls it "the 7 baby steps."

What Are Dave Ramsey’s Baby Steps?

Ramsey's baby steps are a debt reduction and savings plan with seven components:

Baby Step 1: Save $1,000 for Emergencies

In this first step, your goal is to save $1,000 as fast as possible. This will help you cover unexpected life events, such as small car or home repairs.

Of course, you can treat this amount as a suggestion and save up more. That said, the idea isn’t to prepare for big emergencies. Not just yet.

It is to have a rainy days fund so that you don’t fall into more debt while you’re paying off what you currently owe.

Baby Step 2: Pay off All Debt Except Your Mortgage

The debt snowball method is a way to pay off debts in order from smallest to largest, regardless of interest rate. The main idea is to see results quickly so you can stay motivated.

That said, many criticize Dave Ramsey's snowball baby steps. While it's good for motivation, this method can cost you more in interest payments over the long run.

Instead, you can use the debt avalanche method.

It is essentially the same approach, but it targets the highest-interest loan first. While it might be slower at the beginning, it will save you a lot of money in the long term.

Baby Step 3: Build an Emergency Fund

The third baby step is to build a fully-funded savings account for emergencies.

This means saving up enough to cover three to six months of living expenses. 

That way, you’ll have protection in case of an unexpected job loss or another financial emergency.

Baby Step 4: Save for Retirement

Once you're debt-free and safeguarded by your emergency fund, you can start saving for retirement.

David Ramsey’s financial advice is to set aside 15% of your income every month. This way, you will have peace of mind when you retire.

Some experts recommend saving 20%, especially if you start later in life. Whether that’s right for you depends on your financial situation.

Baby Step 5: Save for Your Children’s College Education

Baby step 5 is about saving money for your children's college. You can use a 529 college savings plan or an Education Savings Accounts (ESA).

Now, this step obviously isn't for everyone. If you don't have children, you can just skip it or replace it with another big goal that is important to you.

Although Dave Ramsey's financial freedom plan doesn't mention this until step 7, by this point, you'll have enough security to start growing your wealth.

For example, you might have a business plan you want to realize. You can save enough to kickstart it

Alternatively, you can begin investing part of your income.

Baby Step 6: Pay Off Your Mortgage

The only thing between you and financial freedom, according to Dave Ramsey, is your mortgage.

Repaying your mortgage early could save you tons of money in interest.

Still, many criticize this step.

Debt isn't necessarily a bad thing. It is just a way to pay for things.

Sure, a big credit card debt is a huge drag on your budget. But a mortgage can actually help you increase your credit score.

If you have debt with low interest and make all payments on time, it can be an opportunity rather than a problem.

Baby Step 7: Build Wealth and Give Back

Once you've covered all "musts" by Dave Ramsey's standard, you can focus on building your wealth and giving back to society.

It's your money, so you can do whatever you want with it. But to leave it lying around when it could be working for you would be a waste.

So, you can fund your business, go into real estate, start investing, and so on—the options are limitless.

The good thing about this ambitious plan is that it breaks down everything into chunks. Step 1 is relatively easy to accomplish. Maybe you've managed to tackle step 2 as well—paying your debt.

But now you've reached step 3—Dave Ramsey’s emergency fund goal, and it seems beyond your power.

Don't worry. Most people get stuck here.

But there are ways to make it more manageable.

What Is a Fully-Funded Emergency Fund?

Building an emergency fund can be a long and painful process.

But it’s worth it.

It gives you a cushion to fall back on in case of a financial emergency. This can help you avoid going into debt to cover unexpected expenses.

Here's how you can complete baby step 3 more easily.

Steps to Building an Emergency Fund

Saving up three to six months' worth of income can be difficult.

But if you break it down into smaller goals, it will seem much more manageable.

So, here’s what to do:

Calculate Your Monthly Income and Expenses

To kickstart baby step 3, calculate your monthly earnings and essential expenses. This will help you set realistic savings goals.

To do this, add up all your sources of income (including your salary, investments, and side hustles) and subtract your expenses (including your rent, bill, and food).

This will give you the amount left after you cover the essentials. Distribute this surplus between your discretionary purchases and savings.

Choose an Amount

Once you know your monthly surplus, you can set a savings goal.

According to Dave Ramsey (and most experts, for that matter), you should have three to six months of expenses saved in an emergency fund. 

That said, as with other parts of Dave Ramsey’s baby steps, you can tailor it to your specific situation.

The amount you should save depends on how long it will take you to find another job. Typically, people working in the public sector have higher job security.

So, they may need a smaller emergency fund.

But there are other factors in play as well, like your family situation.

If you are newly married and have a small rent payment each month, then saving for three months might be enough.

But if you are a single parent with two children, then having six months or even one year of expenses saved up might make you feel more secure.

Complete Baby Step 1

If you haven't done so already, complete the first one of Dave Ramsey’s baby steps.

Once you've paid off your debt and are ready for step 3, you'll have a kickstart.

Stay Motivated

Now comes the difficult part.

Creating a budget is easy.

Sticking to it long enough to reach this ambitious goal will be challenging.

Here are some tips on how to maintain your motivation:

• Break down the amount into smaller chunks. Set monthly or even weekly goals.
• Track your progress. This is a great way to keep yourself accountable.
• Set a few milestones along the way, and reward yourself when you reach them.

Although Dave Ramsey's steps to financial freedom don't leave much room for diversions, taking a break is essential.

If you want to stick to the end, you need to maintain a good balance. It's okay to reward yourself for accomplishments. As long as you don't overdo it and you budget for it, it can give you a boost.

For example, you could set aside $5 for your reward for every $100 you put toward your savings. Once you've reached a big milestone (e.g., $10,000), you can treat yourself with the "rewards" sum.

Don’t Let Setbacks Discourage You

Like everything in life, your journey to financial freedom is bound to have some ups and downs.

Dave Ramsey’s rules are strict, but you should cut yourself some slack from time to time.

For example, your income may drop unexpectedly, forcing you to reduce or even freeze your savings for a while.

You may also need to borrow money from your account before you've reached your goal.

Don't let that discourage you!

After all, your emergency fund is exactly for that—emergencies.

Be thankful you're prepared for them when they arise, then pick up your savings from where you've left them.

Where to Keep Your Emergency Fund?

Dave Ramsey recommends money market accounts, savings accounts, or online banks for your emergency fund.

All these options offer easy access to your funds and can help you earn a bit of interest on your savings.

In the meantime, they’re safe, so you won’t lose your money.

Pros & Cons of Dave Ramsey’s Baby Steps

Critics argue that Ramsey's solutions are too rigid and don't account for people's real-life needs.

All the same, if you take it as a guideline and adjust it to your situation, it can do wonders for your budget.

Another common criticism is that Dave Ramsey's debt advice isn't financially sound. While it may be better for your motivation, the snowball method will cost you more than the avalanche approach.

What's more, not all loans are bad for your credit. Getting rid of a mortgage isn't necessarily a priority for everyone.

Other than that, Dave Ramsey's baby steps are a great way to tackle debt and save up for emergencies quickly.

Wrap Up

Dave Ramsey's baby step 3 is a great way to build your emergency funds quickly.

The debt approach is subject to criticism, but it can do wonders for your motivation.

While the rules are rigid, they help you get your finances in order.

If you take them as guidelines and adjust them to your needs, you can achieve financial freedom in no time.