Just how much money should you have in reserves in case of an emergency?
Let's be real, sometimes life gets hard. REALLY hard. In step 1 we built ourselves a $1000 emergency fund for when our tire blows out, our dentist finds a cavity, the dog needs an unexpected vet visit or whatever other small inconveniences comes our way. Don’t get me wrong, I am not trying to downplay how much these circumstances can suck! When you have no savings at all these small inconveniences can feel like full blown disasters! But in reality, it can get much worse. That is why after debt is paid off in step 2, the next step is to build 3 to 6 months of expenses to set aside for when a real disaster strikes.
What might be an actual 'financial' disaster?
I emphasize the word ‘financial’ because I'm going to add unplanned pregnancy to the list and don't want you to think I have something against bearing children. It's just that having a baby costs a lot of money and requires time off from making an income. Below are just a few examples of what might be considered a financial disaster.
Loss of Employment
Emergency Room Visit
These are examples that you may have been through or likely know someone who has been. These disasters can snowball into home foreclosure, bankruptcy, not being able to provide for your children, marital stress, divorce, and more. It can be very scary.
That's why it is so important that after you pay off all consumer debt, not including your home mortgage, you continue to roll that monthly payment that you were allocating towards credit cards, student loans, & car loans straight into a Money Market Account to sit in case of an emergency.
Why a Money Market account?
They typically yield higher interest rates than a traditional savings or checking account.
So why not just put the money in the stock market for better returns?
This money needs to be liquid and is not meant for the purpose of investing. We will get to that step later.
Why 3 to 6 months, why not just 3 or just 6?
If you are self employed or in a single income household it’s better to build a bigger hedge against your variable income. If you are a dual income household you may opt for 3 months. At the end of the day it will depend on what makes you feel better prepared. I chose the 6 month route for my household.
In summation ...
This money is set aside for when Murphys Law goes into effect, as Dave Ramsey puts it in his Financial Peace University Course. The saying goes like this "anything that can go wrong will go wrong."
And things will go wrong at some point.
Here is a quote that's been stuck in my head since my Air Force ROTC Days "failing to prepare is preparing to fail."
So get prepared! When you are finally free from your debt, make sure you stay that way by saving 3 to 6 months of expenses.