If you’ve followed this blog at all you know I’m a big fan of Dave Ramsey and his baby steps. Step one is to save up $1000 in an emergency fund. I had a conversation the other with a couple that thought it should be more than one thousand so I thought I’d go over that viewpoint and let you know what I think about this.
First off, Dave actually allows for different amounts as he is teaching the baby steps. In general, he says that if you have a household income of less than 20k a year baby step one should be to save up 500 dollars. Otherwise he puts the amount at $1000. My friends just had several emergencies pile up on them in a short time frame, and it has led them to believe one thousand isn’t enough. We had an interesting discussion on this, and I came away with the following conclusion – it depends.
For most people, I think that one thousand is probably a good number. If you have credit card debt at all then I think this is a good number. You really need to get on to baby step 2 and attack that credit card debt. In general, the credit card debt will have a fairly high interest rate and getting it paid off sooner rather than later is a good thing. If you have a big emergency and you absolutely have to you can put it on the card. It should be a last resort, but if you don’t have any other choice it is there.
Now, the situation my friends found themselves in was there only debt was college loans that were at about 2% interest. In the last month, their oven, hot water heater, and air conditioner broke. Now, I have no idea how you get that unlucky, but needless to say the expenses were well over what their 1k emergency fund could cover. In their situation, having only low interest loans and owning a house, having a slightly bigger emergency fund might be a good idea. When deciding how much your emergency fund should be, you need to take into account what would count as an emergency for you.
If you are a renter, one thousand should be plenty as you don’t have to take care of lots of potential problems. If anything in the house or apartment breaks you get to call the landlord to fix it. If you own your own home, it adds many potential “emergencies” to list of things to take care of. Hot water heaters, ovens, washers and dryers, AC, furnace, roof, siding, windows, and plumbing are all things that you might need to replace / fix at some point. If you own a car or two that increases your potential for problems as well. If you are a renter in the city who takes the subway to work you don’t need as much.
The other thing to take into account is what type and how much debt you have. As I said before, if you have lots of credit card debt you need to get started on paying it down. If you only have 2% college loans left, a bigger emergency fund is more reasonable. The other thing to consider is how much total debt you have. If you only have a few thousand it makes sense to get started on it. If you have fifty thousand in debt left, the odds are much better that you will have a few emergencies before you get it paid off. It might make sense to have a slightly bigger fund so that you don’t backslide when something hits.
Basically, I think Dave goes with $1000 because it is a nice round number that will work nicely for most people. That being said, they call it personal finance because it is personal. You have to decide what’s best for you and your family. For me, I used $1000 when I was single and renting, but when I bought a house and got married I decided to bump it up to $2000. Take into account your situation and then decide on a number. Make sure you get on to baby step 2 as fast as you can though. You have to attack that debt so you can bump up the emergency fund to fully fund 6+ months of expenses.