Baby Step Three: Save 3-6 Months Of Living Expenses
Now that you are free from the burdens of debt and monthly payments (excluding your first mortgage) it is time to save three to six months of living expenses in case of an unforeseen financial storm. Your baby emergency fund (step one) was a great safety net to get you started, but now it is time to fully fund that emergency fund. It may sound intimidating thinking about saving that much cash when you are sitting on top of a large pile of debt. However you need to remember that after you have completed baby step two you no longer are making monthly payments to credit cards, student loans, etc and that money can now be used to pay yourself!
The amount you save needs to be biased on your living expenses and not your income. You will need to have a monthly total for your mortgage, car insurance, health insurance premiums, groceries, gas, utilities, etc. Personally, I would recommend aiming for the six month mark instead of the three. To me that just feels safer and you never really know how long a financial storm may last.
Once you have fully funded your emergency fund you can then begin to save for things like a new car, a down payment on a house, save for vacations,etc. This is the time when you will have the extra money on hand to do so.
Baby Step Four: Invest
Now that you have fully funded that emergency fund (step three) it is time to look towards the future and increase your retirement savings. Dave recommends totally stopping your retirement funding while working on the first three baby steps so that every available dollar would go to paying off debt and building your emergency fund. That is the one area where my husband and I differ from Dave’s plan. We are continuing to invest in his 401K, although it is only the minimum amount.
Your future, and you retirement are fully in your hands. Only you can save for the years you will spend in retirement. It is not your children’s responsibility to care for you and who knows what the government will be up to when you retire. If you don’t want’ Alpo on the menu then take your retirement investing seriously.
Dave has some very specific guidelines (suggestions really) for you to fallow, as everyone situation is different not every one of these suggestions will be a perfect fit for you.
1. Invest up to the match in your 401K, 403B, or the TSP if you have an company match through your employer. Do not contribute above that match point.
2. Fully fund a tax-free savings/investing account such as a Roth 401K or a Roth IRA. They allow you to put up to $2,500 per person each year into the account. You and your spouse should each have an account in order to maximize the savings ability of these accounts.
3. If you still have money to invest look into other pre-tax savings plans.
4. Dave also recommends investing in good growth stock mutual funds for long term investing.
Dave recommends saving 15% of your income for retirement. If however you are late to the game you may want to increase the amount you are saving for retirement.
Baby Step Five: Save For Kids College
Baby step five is all about saving for your kids college education. This step is an important one to some, but others may feel that it is their children’s respectability to pay for college. Some of you, like me, however may feel that it is important to help your children get through college in a limited capacity making them at least partially financially responsible for their education. Where ever you stand on this topic Dave has some suggestions for you as well.
If you decide not to save for your children’s education you are now ready to move along to baby steps six and seven. However, if you are interested in saving for their future education, keep reading.
Education Savings Accounts (ESA)
ESA’s is Dave Ramsey’s number one recommendation for college tuition savings. The Coverdell Education Savings Account allows you to contribute up to $2,000.00 tax-free per child per year. These savings accounts will grow tax-free until the funds are withdrawn. The funds that are withdrawn and used for furthering education and their related expenses like tuition, class fees, text books, equipment and supplies, room and board, etc.
Another popular option for college savings is a 529 plan. Each state has its own guidelines as to how you can set up the 529 education savings plan so you will need to do your own investigation to see if this is a good fit for you.
If you missed baby steps one and two you can read about them in my previous post, Baby Steps To Financial Freedom – Part One.