There is a financial concept that says “pay yourself first”. This concept is very common in Dave Ramsey’s Debt Free and Simple Plan.
You pay bills first, then you pay yourself, and then you pay your rent or mortgage. If you don’t have an emergency fund then you’re paying yourself last. If you have an emergency fund then you’re taking your bills and paying them, and not only that but you’re paying your budget before you pay your self. The first part of most of his plans only teaches you to pay yourself first, but not always for everyone.
What’s the emergency fund?
The emergency fund is a fund you have that is two or three times your monthly non-dischargeable income. This doesn’t mean it should be an amount equal to three months of expenses, just enough to cover that amount of money that you spend each month. However, the more you have this fund then the less stuff you have to pay on bills and other stuff. If you have a $7.50 a day non-dischargeable income expense case and the price of some of those essentials you’d be better off to put that money into this fund and save yourself some money.
The way it works is when Dave’s Budgeting program says you should have a $3,000 emergency fund at the start of the year, salary income is $50,000 per year. If you don’t have enough after-tax income to put $3,000 in a savings account you would stop saving, because your income is already there. But if you have $30,000 in savings and $2,000 in earned income before taxes then you would put $15,000 into savings and the other $12,000 would go into your emergency fund.
If Dave’s program were based on the three-month rule, you would put $3,000 in savings, then you also put $1,000 dollar in rent and utilities so you have a good cushion save in case you got laid off and you still have a roof to live on. Then, if the heating got hit again this is the money that would pay for it. Dave’s program uses the three-month rule often because it’s cheap and easy. However, if you lost your job and you had to rely on the emergency fund then you could really struggle.
The problem with the three-month rule is that you don’t get peace of mind when you can’t afford something the last week of the month. It’s not like in Dave’s program that you automatically have money put aside so you won’t have to borrow from him because you have technically gotten even now because you have a savings account plus an emergency fund.
Is it better to pay your expenses yourself?
Okay, at first glance it seems like you should pay your expenses yourself. But, is it really better to pay your expenses yourself?
It’s important that you don’t think of this account as your rent for life. As you pay your rent, you’re cutting out a lot of your expenses, and for some this is essential. However, if this is our only emergency fund, then we’re in trouble.
The fact is, Dave’s account balance has no direct bearing on whether or not you have an emergency fund because your money isn’t passively making a payment for the next three months. If you have no money in your emergency fund, then you have no savings. You have no protection if you lost your job, and no access to retirement when you needed it. It’s advisable to pay yourself from your free spending account rather than from your salary as the%- silicon commanding alerts about your job keeping you on your toes,- is quickly and easily dangerous.
If you’re not saving for three months for at least six months, then it’s tough to predict the stability of your account even if you started out with $100 initially. It’s even tougher if you didn’t even have that. As a result, saving your money in an emergency fund is the best wealth-building strategy for emergency. Using this savings to pay bills and buy things that actually require spending money are important benefits of building a robust emergency fund. If you pay bills first and then put your emergency fund into something that has to be repaid but dibs your money for something else, then you can be relatively sure that you’ll make it.