As indicated in a previous post, The Total Money Makeover by Dave Ramsey is my #1 all-time favorite book on personal finance. The principles I learned from this book form the foundation of my personal finance philosophy. Among other things, Dave has taught me that:

• Debt is not a tool to create wealth
• Debt creates a master/slave relationship
• Invest for the long-term
• Emergency funds are the best hedge against emergencies
• Slow and steady, as opposed to get-rich-quick, wins the race

In this post I want to focus on Dave’s teachings about emergency funds.  Emergency fund, rainy-day fund, umbrella (ella-ella, great song, Rhianna), they all mean the same thing: cash savings set aside for the express purpose of covering an unexpected expense.

Debt is Not A Tool!

When an unexpected expense comes up, you have two options: use the emergency fund, or borrow the money (from credit cards, family, the bank, etc.).  But if we want to become wealthy, only the first option is viable.  Debt is not a tool to becoming wealthy.  I’ll let Dave explain:

I have found that if you look into the lives of the kind of people you want to be like, you will find common themes.  If you want to be skinny, study skinny people, and if you want to be rich, do what lots of rich people do, and not what some mythsayer [a proponent of debt] says to do…When surveyed, 75 percent of the Forbes 400 (rich people, not your broke brother-in-law with an opinion) said the best way to build wealth is to become and stay debt-free…I have met with thousands of millionaires in my years as a financial counselor, and I have never met one who said he made it all with Discover Card bonus points.  They all lived on less than they made and spent only when they had cash.  No payments.

As you can see, Dave has strong opinions about debt, and I agree with him. So, since we aren’t going to use debt to cover emergencies, that means we better be prepared for them by saving up cash ahead of time.

Dave suggests having 3-6 months of expenses set aside as an emergency fund. Others, such as Suze Orman, recommend up to 8 months.  Our family has six.  I suggest using your level of risk tolerance and the steadiness of your income to determine how big the emergency fund should be. Also, the emergency fund must be liquid, or easy to access.  This means putting it in a high-yield savings account, not a CD (Certificate of Deposit).

Destroy Murphy’s Law

Murphy’s Law states that “Anything that can go wrong, will”.  By setting up an emergency fund, you turn crises into inconveniences.  Here is a real-life example that I heard just last week:

Some friends of ours recently had an unexpected expense come up.  Now, these people are not (yet) millionaires, they’re college students with a young child.  But they have no debt and several months of savings.  One evening they were preparing to go out for a romantic dinner.  Just as they were getting ready to leave, they were made aware of an unexpected bill of over $1,000.  Now, imagine if they had been a few thousand dollars in debt (like the average college student) and had no savings.  How would their romantic dinner have tasted that night?

Instead, because of their emergency fund, they were able to acknowledge the inconvenient bill, close the door behind them, and enjoy a paid-for dinner.

I hope you now see the importance of an emergency fund.  It is definitely a Big Idea worth writing about.  We have incorporated it into our personal finance plan, and have enjoyed the financial peace it brings.  The Total Money Makeover devotes two chapters to the emergency fund, discussing how to find the money, where to put it, and what to use it for.  Check it out!