Financial Peace University: Week 3
(This post is part of my Finance Peace University Review series from 2019, and updated in 2020 with additional content!)
Financial Peace University is a 9-week personal finance program created by Dave Ramsey.
The course was created to help people get on a budget, pay off debt, and create an effective financial plan that will lead to financial independence .
There is also an online version called Financial Peace University Flex available, which uses videos instead of volunteers to facilitate the lessons.
FPU Flex provides all materials online, including the video lessons and worksheets. There is even an online community for additional support.
An added bonus is access to the course videos and materials for a whole year!
Financial Peace University lesson 3 is all about Baby Step 3: Building a 3 to 6 month emergency fund.
What is an emergency fund?
An emergency fund is a cash resource that is allocated specifically for unplanned expenses that need to be addressed immediately. These surprise financial outlays could include unforeseen medical bills, costly home appliance repairs, or a sudden job loss.
Having a substantial emergency fund will minimize the dependence on high-interest debt vehicles to pay for these financial emergencies. This dedicated savings account also strengthens financial security, and reduces the risk of falling into a financial crisis.
How big should an emergency fund be?
The popular rule of thumb is to save 3 to 6 months of living expenses in your emergency fund.
Your savings target will depend on a few things, such as:
- how stable your income is
- how long you’ve been employed at the same company
- how many dependents you support
- if you have only one breadwinner or a two-income family
- if you’re self-employed or rely mainly on commission
- if you have high, recurring medical expenses
The more uncertain your financial situation is, the more you’ll need to save in your emergency fund.
Baby Step 3: Building your emergency fund
Once you’ve paid off all your debt except your mortgage (see baby step 2), the next step in the Financial Peace University course is to build a fully funded emergency fund. “Fully funded” means it would be able to cover 3 to 6 months of expenses.
The spenders who suffered through the discipline required to pay off debt may want to slow down at this point. But it’s critical that you keep moving forward with the same gazelle intensity as you move into baby step 3.
Because, in order to not slide backward, you must have a nice cushion of savings that will protect you when emergencies arise.
Yes, you can celebrate when you can finally say “I’m debt free!” – but don’t stop there. If you do, then Murphy’s Law will kick in, which means you’ll be charging that next emergency and be right back in debt. Let the fear of that possibility motivate you!
Commit to never going back! Keep moving forward and start saving with the same intensity you had with crushing your debt.
Changing Your Mindset
Did you know that 8 out of 10 Americans live paycheck to paycheck?
Our culture has convinced us that it’s normal and acceptable to live on the brink of financial ruin. You might be one paycheck away from a major disaster. That’s scary!
Then, when an emergency happens, the only option is to go into debt. It’s a crazy cycle that keeps us from building wealth.
It doesn’t make sense to keep doing the same thing and expect a different result. A change in behavior is necessary, and that starts with our thinking.
Having a little self-awareness is helpful:
- Why do you think you’re stuck in the debt cycle?
- What causes you to keep using credit cards?
- How did you get in this situation?
It can be tough to break down habitual behavior when it’s second nature. But it’s *really* important to figure it out if you want to change.
In the video, Rachel Cruze (Dave’s daughter) talks about the struggle with comparison.
Ten years ago you had to go outside your front door to actually see what you’re up against. These days, you just have to go on Facebook.
Social media really knows how to bring out the insecurities in all of us.
Unfortunately, trying to keep up with the Joneses can really suck the joy out of life. Not only that, it can suck the money out of our wallets, too!
Rachel reminds us of the importance of learning to be content.
When we’re not content, we’re always looking for the next thing to buy or do or consume that we think will offer fulfillment. But it never ends, because that’s not where fulfillment is found.
The key is being grateful for what you already have. When you’re grateful, you can be content.
Without contentment, it’s almost impossible to save money.
Comparing yourself to others and not being content with your current situation is like the gas that fuels the chase for that next big purchase.
When you’re satisfied with what you have, you don’t “need” to spend money on more stuff.
Start with practicing gratitude. This will lead to different priorities, and then you’ll be following a different path.
Saving up a 3 to 6 month emergency fund isn’t just about having the discipline not to spend. It’s an emotional exercise that challenges our hearts to change.
When our hearts are focused on gratitude, we can find contentment.
Don’t Be A Fake
Chris Hogan, the author of Everyday Millionaires, takes over the last segment of the video.
He begins by telling us that getting through baby step 2 is like getting a raise, because you’re taking your money back. You’re out of debt and now you have more control of your income.
It’s important to be intentional about all this extra cash flow. Otherwise, you’ll never get out of the paycheck to paycheck cycle.
You may feel a false sense of security now that you have wiggle room in your budget – but the fact is, just because you’re out of debt doesn’t mean you’ve reached financial freedom.
There are a lot of people out there who look like they’re doing great financially. New cars, big homes, the latest gadgets. But when you remember that 80% of Americans live paycheck to paycheck, the reality is that most of them are not doing as well as they look.
You don’t want to just *look* like you have money – you need to be intentional about working a plan that will actually get you there.
This is why the fully funded emergency fund is so important.
When your car breaks down and the fridge goes kaput, you’ll be ready.
Even if you get laid off, you won’t need to stress about covering the bills.
You won’t need to take a loan out from the bank, borrow from your 401(k), or start charging up your credit cards.
Your emergency fund will eliminate fear, stress, and drama.
You don’t want drama, you want progress – and progress comes from learning from mistakes. It comes from thinking differently, doing things differently, and being wiser with each step forward you take.
Figuring Out How Much You Need
Should you save three months of expenses? Or six? Or somewhere in between?
As mentioned above, this will depend on how stable your income currently is.
If you are self-employed, a contract worker, or are the sole provider for your family, you should work towards the six month mark.
If you’ve had a steady full-time job for several years, or your spouse contributes a significant amount to your monthly income, you can stay closer to a 3 month fund.
And remember that you aren’t working towards replacing your entire monthly income. Your goal is to have enough to cover all of your necessary expenses.
So don’t just look at your paycheck when figuring out how much you need to save. Look through your budget and pick out the categories that are non-negotiable.
So, things like your mortgage, utilities, and groceries. Leave off movie tickets and Starbucks frappuccinos.
Chris recommends using a money market fund for your savings. This keeps your money liquid (easily accessible) but also earning more interest than a regular savings account.
Don’t be concerned about having all this money just sitting in a bank account.
Your emergency fund isn’t an investment, it’s insurance.
It’s also not fun money – so start saying “no” more often to extra, unnecessary expenses. Don’t use it to go see your favorite artist in concert or take a weekend road trip. Remember – gazelle intensity.
Finally, two important points:
- Talk to your spouse or partner about how you will define an emergency expense (e.g., a flat tire is an emergency, upgrading your phone is not)
- When you use all or part of your emergency fund, build it back up to its original balance. This needs to be priority #1!
Of course, the amount of time it takes to complete each of these baby steps will vary for each person or couple.
For some, it could take years to pay off your debt. For others, the emergency fund may take the most time.
As your bank account changes, so will you. Your mindset, your behavior and your priorities will all start lining up with your one big goal: financial freedom.
It takes time, focus, and sacrifice. You’ll be tempted to quit and go back to your old, comfortable habits. You might feel like everyone around you is moving forward with life while yours is standing still.
Remember what Dave says – live like no one else, so later you can live like no one else.
Baby steps 4-7 are next, and are meant to be done simultaneously. They are all about looking towards your future. It’s where you work on building your wealth and accomplishing your dreams.
Stop looking around you at what others are doing. Decide for yourself that you are committed to doing what it takes to reach financial freedom.
Keep going! You can do it!