If you’ve been reading up on personal finance, you’ve likely come across Dave Ramsey and his seven baby steps. If you're reading this, you're just starting down the debt management path, wondering if that $1,000 is realistic.
If you’re not familiar with them, here are his steps to financial independence:
- Set aside a $1,000 "baby" emergency fund
- Pay off debt as fast as you can, with intensity
- Set aside 3-6 months of expenses as a full emergency fund
- Invest 15% of your income into retirement
- Save for your kids’ college
- Pay off your house
- Build wealth and give generously
His explanation of “the snowball method” of paying debt off is one that we’re working now in my own home, and I can say that it does work. We’re still on the journey, and squarely in step two. As we tackled step one though, we discovered one big thing:
When it comes to a starter emergency fund, "one size fits all” doesn't always, well... fit.
Ramsey's $1,000 baby emergency fund wasn’t big enough
As I’ve read over the years, the reason for the $1,000 mini emergency fund is just to keep you from pulling out the credit cards when you’re faced with some minor emergency - an unexpected vet bill, minor car repairs, replacing your tire when you’ve had a blowout, etc. It’s not meant to carry you for six months in the case of a job loss, to be your down payment on a car, or another BIG event.
I get the intent. I’ll give you that $1,000 will typically cover those smaller emergencies you might come across. In much of the U.S., it works just fine. But depending on your situation, and your location, you might find that $1,000 doesn’t go very far.
Depending on your situation and location, $1,000 may not go far.
We live in an expensive part of the country. Not New York or San Francisco expensive, but we have a high cost of living. When I watch House Hunters, I’m amazed at what $200,000 will get you in other states - because in our area, that same house would easily go for double. It’s not just houses, though. Other things are more expensive here, like medical care, vet costs and more.
Did you know that the cost of living in Seattle is nearly 40% higher than Omaha, or that the cost of living in Chicago is about 20% higher than Nashville? Those are big swings.
Will a $1,000 emergency fund work for you? Consider...
How old are your vehicles, and how many miles are on them?
While one of our vehicles is only a few years old, the other is twelve with more than 150,000 miles on it. $1k will cover more minor repairs like brakes, but significant engine work is definitely above that line. Are you likely to have a bigger repair job in your future?
Are you driving an SUV, and one blowout could potentially mean four new tires at about $1k on the low end? You might want to adjust that baby emergency fund up a bit.
How old are your house and the appliances inside it?
Within the past 18 months, we replaced a furnace and a water heater. The DIY water heater came in at around $600 when all was said and done (about $1,000 less than paying a pro). But a furnace is not a DIY project. Do you have central air? A central air conditioning unit lasts about 14 years, and a furnace can last up to 20. How old is your refrigerator? What are your estimated repair or replacement costs for those things, based on how old they are?
Do you have high deductible insurance?
Anymore, many health insurance policies have high deductibles, to the tune of $2-4,000 or more. If you got sick or hurt, how much might you be expected to come up with, that wouldn’t be covered by your health savings account?
What are your deductibles on your car and homeowners or rental insurance policies? Make sure you have enough in the bank to get your claim started.
What’s your job situation?
Note that this question skews more toward asking if you need to set up the "baby emergency fund" and move into step two to pay off debt. If your job situation isn't stable, you might want to just stash cash and wait out the "storm" before getting back to the steps outlined above.
But think about it. Do you or your spouse have contract jobs that wouldn’t be covered by unemployment if a contract was cancelled? Would unemployment be enough to cover your bills should you lose your job? Keep in mind you may also have to pay more for health insurance via COBRA. If you're unsure of your job right now or in the next several months, you might want to set aside a little more to be safe.
What is a good starter emergency fund?
So if $1,000 isn't enough of an emergency fund, what is? The truth is that the answer varies. For starters, you can see how your nearest city stacks up against the national average at Salary.com's Cost of Living Calculator. That $1,000 might work o.k. for the national average. If you're above it in your area and you have an aging vehicle or appliances, or some of the other situations listed here, then you might want to kick it up to $1,500 or $2,000.
Remember though, that this is a starter emergency fund. It's not supposed to be what will keep you going for six months or so. If your job isn't at high risk right now, your goal should be to save enough to guard against those "smaller" issues and get to paying off debt as fast as you can.
The most important thing you need to do today is start!