Paying Off Debt versus Emergency Fund (3 to 6 Months)
I've been reading a lot on the YNAB method (I'm fairly new to the method and the software) and have also become familiar with Dave Ramsey's baby steps.
I currently have an Emergency Fund of almost 500 dollars. According to Dave Ramsey, you need to squirrel away 1000 in the Emergency Fund and THEN start paying off debt using the snowball method, but I know other people recommend that the Emergency Fund is high enough to cover all expenses from 3 to 6 months (considerably more than 1000) and then work on debt.
I just signed with a new job that will give me a small sign-in bonus. Would you recommend that I put all of the sign-in bonus into the Emergency Fund? Or just enough to get the Emergency Fund to 1K and then use the remainder to attack my debt?
It depends on the debt you are paying off and what would happen in case of emergency. If the debt is a mid-to-low interest loan, then once you make the payment, you can't get the money back in case of emergency. But if it's a high interest credit card, in the worst case emergency, you have to use the credit card again, but you saved money on a lot of interest in the meantime.Reply
Think of your first Emergency Fund as a small pool of money that will help you avoid using your credit cards (and building more debt).
Having 3-6 months of income tucked away is more of an Income Replacement fund in case of illness or employment loss.
It can take a long time to build your Income Replacement fund and ideally is something you want to do after you’ve eliminated all debt (except for the mortgage perhaps).
Ultimately there is no One Size Fits All and it comes down to your priorities and how you plan to meet them.Reply
Got kids? Or are you single? Stable income? Or seasonal/commission income? Did you cut up your credit cards? Or do you still have them?
Different circumstances will be key in what kind of fund is right for your circumstance and for your own peace of mind.
When I was getting started on the debt-elimination phase of this journey (more than 12 years ago), I do recall that $1,000 didn't feel like enough because I didn't have credit at the time. I had eliminated all sources of credit, so I made my e-fund half a month of my then income.Reply
Hi Sara Ivette !
Here's how to think about that: you want to have enough in savings that, should something happen, you don't have to go back into debt to deal with it.
Some people can get into trouble with dealing with their debt too quickly. The debt is gone, but so is all your cash. Set aside a little emergency fund, fill up your True Expenses (sounds like you might already be there!), then make a debt plan. And keep an eye on your Age of Money - grow that number and you know you're more secure. :)Reply
And AoM isn't totally meaningless; it's just meaningless for people whose finances are such that they aren't in danger of creating overdrafts.
No. It's universally meaningless. Primarily because it tells you something about the last 10 transactions you made, and nothing about the next one you are going to make.Reply
The great thing about personal finance is that it's personal.
If you follow the reasoning, Baby Step 1 is designed for minor emergencies, such as a minor hospital visit or a small car repair. Your full emergency fund at Baby Step 3 covers a major emergency or loss, such as a long-term loss of income.
Of course, Baby Step 2 (debt payoff) sits right in the middle of these. I think that you should just ask yourself: How much "risk" do you want to take on? Is your job in turmoil? Is your car on its last leg? Rather than $1000 at Baby Step 1, maybe you consider getting 1 month worth of expenses saved up. Or maybe, since personal finance is personal, you bump up your Baby Step 1 emergency fund because it lets you sleep better at night.
Or maybe you do something like this:
1. Save 1/2 month of expenses for emergency.
2. Pay off debt #1.
3. Save 1 month of expenses.
4. Pay off debt #2.
5. Save 1 1/2 month of expenses.
6. Pay off debt #3.
7. Save 2 month of expenses.
... and so on.
For me, the biggest things are acknowledging that you want to pay off the debt and build up an emergency fund. How and in which order is up to you.
And just for reference, I followed Dave Ramsey's Baby Steps to a T.Reply
Stick to Ramseys rules. They work.
Build up your $1000.
3-6 Months of expenses is Baby Step 3. Dont skip ahead.
Remember: $1000 is just the starter Emergency fund and meant to get you motivated. PLUS what you can do is when you have $1000 is maybe raise your car or house insurance excesses/gap because now you have $1000 for such things. That will then lower your monthly insurance payment (if monthy paid) and give you more money to throw at the debts.
THEN you hit Baby Step 2 for the debt snowball.
One thing people possibly forget or dont talk about is the pain and discipline you learn and go through in the debt snowball puts you in a fantastic position to apply that to all the good stuff you'll do with your money moving forward i.e. saving up 3 -6 Months of expenses.
It should happen pretty fast once you get there.
I'd put your bonus on the emergency fund to make up the $1000 and anything left straight onto your smallest debt.
I can appreciate the spirited debate around certain methodologies on this thread. And while I'm not a moderator, I do want to gently encourage/remind folks that responses should be an attempt to be helpful to the person looking for assistance :-) I'm not throwing shade. I promise!
As for the initial question posted by Sara Ivette , here's a thought: One reason why an emergency fund can fail is if you don't plan for the expenses that only come up on occasion. In my budget, I am building a car repair fund, a home repair fund, etc. So, if something happens in those areas, I don't have to touch my emergency fund. That's different than saving up for 3 - 6 months of expenses and is a little more attainable. And if I'm repeating any advice that's already been given; sorry. There are a ton of posts here :-)Reply
I would politely ignore Dave & go with this method. Aging your money is basically your 1-6 Er plus your saving for small stuff is your debt prevention method.
So you are more insured to stay out of debt while getting out. Unlike Dave’s method the $1000 was never enough to survive & we spent YEARS paying debt & replenishing the $1000 Er. No vacations or living, just felt like crap every day.
We are new to YNAB, but I aged a month ahead, add to our savings funds monthly (debt prevention fund) & throw the rest at debt. Good luck!Reply