Dave Ramsey Tactic or 35% Savings Rate

[VanteBoll]

Hello All,

I hope everyone reading this is well on there way to FIRE. I appreciate the responses in advance. My question:

I am currently debt free and have no payments besides a mortgage payment. I have two budget plans and want opinions on which I should follow. One plan is going by Dave Ramsey's baby steps (baby step 3 specifically) of building up my Emergency Savings Fund of 3-6 months (I'm aiming for 20,000 by October).

The other plan is implementing a 35% savings rate and dispersing automatic payments to Index Funds, Savings Account, Roth IRA, and my Real Estate Fund Acct. (for future rental property ventures).

Should I stick to building up the 20k solely or spread the savings with the 35% savings rate?

Some information that may be helpful:

I am 25
Serving in the United States Coast Guard and I do IT work for H&R Block on the side (A little over 50k a year)

Thank you.

[jlcnuke]

With your likely very high job security with the USCG, I'd go ahead and max out your Roth IRA, get your TSP funded for any match, and then contribute to a taxable account beyond that. I'd use your Roth contributions and taxable account "as" your emergency fund, then shift to having your "emergency fund" as just part of your investments once your investment balance is high enough.

Let me explain a bit better: Say you want a $20k emergency fund. Start by
1.a.  Put $5.5k in the Roth, invest this in "safe" investments.
1.b.  Put in enough to get any matching contribution from your employer (if available)
2. Build up until you have $14.5k in your taxable accounts.
once both of those are done, I'd
3. Continue maxing out the Roth each year.
4. Continue putting getting your max match from the employer.
5. Split remaining available investment money into employer tax advantaged account and taxable accounts (based on what works best for your tax situation etc.)
then, when your Roth contribution amount + taxable brokerage account is sufficiently high for you to feel confident that a major market downturn would still leave enough available for your emergency fund:
6. Invest the "emergency fund" as per your standard asset allocation (money is fungible, so once you have enough that you can supply an emergency fund even in a bad situation it makes sense to me to invest that money so it can grow as well).

[frugaliknowit]

I think it's in your long term best interest to follow the Dave Ramsey way.  In the long run, your EF protects your retirement stache.  If you don't have the EF, you will tend to borrow more money over time and tend to "raid" your retirement (tax protected) stache over time.

Here's what I would do:
1.  Get any match at work (you don't indicate what you get).  Dave says first build the EF, but I say get any match first.
2.  Save up your EF to 20K.
3.  Resume investing.

[solon]

Could you do both?

Implement the 35% savings rate right now, there is no reason not to. But before your start saving for all those other things, you build up 3-months expenses in an emergency fund. At 35% savings rate, I think you'll be surprised how fast you can build up the EF.

[thd7t]

With your likely very high job security with the USCG, I'd go ahead and max out your Roth IRA, get your TSP funded for any match, and then contribute to a taxable account beyond that. I'd use your Roth contributions and taxable account "as" your emergency fund, then shift to having your "emergency fund" as just part of your investments once your investment balance is high enough.

Let me explain a bit better: Say you want a $20k emergency fund. Start by
1.a.  Put $5.5k in the Roth, invest this in "safe" investments.
1.b.  Put in enough to get any matching contribution from your employer (if available)
2. Build up until you have $14.5k in your taxable accounts.
once both of those are done, I'd
3. Continue maxing out the Roth each year.
4. Continue putting getting your max match from the employer.
5. Split remaining available investment money into employer tax advantaged account and taxable accounts (based on what works best for your tax situation etc.)
then, when your Roth contribution amount + taxable brokerage account is sufficiently high for you to feel confident that a major market downturn would still leave enough available for your emergency fund:
6. Invest the "emergency fund" as per your standard asset allocation (money is fungible, so once you have enough that you can supply an emergency fund even in a bad situation it makes sense to me to invest that money so it can grow as well).

I agree with your approach, but I'm curious about your specific order of investments.  They don't seem to be tax optimal.  I don't believe that OP should consider a Roth until he can lower his tax liability as far as possible, which would require maxing out his pretax options.

[robartsd]

With a secure government job, I'd be inclined to invest as much as possible after 1-2 months expenses are in a savings account. I think 3-6 month emergency fund is larger than you need, especially since you can cash flow an unexpected 50% bump in spending. I'd max tax advantaged accounts pretty much right away.

If investment property is more than 2 years away, I'd be inclined to build up investment fund in taxable investment (though with a much higher bond allocation than I use for retirement savings). Once investing in real estate, I'd want to retain an emergency fund to be able to deal with unexpected expenses of 2% of property value.

[jlcnuke]

With your likely very high job security with the USCG, I'd go ahead and max out your Roth IRA, get your TSP funded for any match, and then contribute to a taxable account beyond that. I'd use your Roth contributions and taxable account "as" your emergency fund, then shift to having your "emergency fund" as just part of your investments once your investment balance is high enough.

Let me explain a bit better: Say you want a $20k emergency fund. Start by
1.a.  Put $5.5k in the Roth, invest this in "safe" investments.
1.b.  Put in enough to get any matching contribution from your employer (if available)
2. Build up until you have $14.5k in your taxable accounts.
once both of those are done, I'd
3. Continue maxing out the Roth each year.
4. Continue putting getting your max match from the employer.
5. Split remaining available investment money into employer tax advantaged account and taxable accounts (based on what works best for your tax situation etc.)
then, when your Roth contribution amount + taxable brokerage account is sufficiently high for you to feel confident that a major market downturn would still leave enough available for your emergency fund:
6. Invest the "emergency fund" as per your standard asset allocation (money is fungible, so once you have enough that you can supply an emergency fund even in a bad situation it makes sense to me to invest that money so it can grow as well).

I agree with your approach, but I'm curious about your specific order of investments.  They don't seem to be tax optimal.  I don't believe that OP should consider a Roth until he can lower his tax liability as far as possible, which would require maxing out his pretax options.

The Roth contributions can be used as an emergency fund because they can be withdrawn at any time without penalty. That is not the case for TSP contributions. Additionally, at his low tax bracket (he mentioned a $50k total income), a Roth is likely to provide more or "on par" total returns adjusted for taxes. Additionally, his Roth won't be subject to RMDs which can greatly impact the overall negative tax effects of a traditional retirement plan.  Reducing taxes paid "now" is not always the best policy and, at 25, what will happen with OPs income, spending, and future tax rates is so hard to predict that a balanced approach (investing in both traditional retirement accounts as well as Roth) is a good way to "hedge bets" for the future (in my opinion). That's why I put the options in that particular order. I'm always welcome to other's rationale for differing opinions though, so if you feel otherwise I'd be happy to hear why.

The general order (minus HSA which OP doesn't have available) follows the basic investing priority order that is espoused in many places such as here https://www.bogleheads.org/wiki/Prioritizing_investments

[Catbert]

I don't think a single (?) person with a rock solid job needs a separate emergency fund of 20K.  Build up to 5-10K readily available and use your Roth IRA and/or TSP loan as a back up in the event you really need more.

[VanteBoll]

I appreciate all of your responses and perspectives. They help more than you know. I had a feeling 20k in a savings account was overkill (have always been the "have more than enough" type). I am excited to start the 35% savings rate and eventually increase it as milestones are hit.

[MDM]

Should I stick to building up the 20k solely or spread the savings with the 35% savings rate?

If you think $20K is what you need, do that first.

If you think less is sufficient, that's OK too.

There is no objectively "correct" e-fund size - see Investment Order for more thoughts.

[Lanthiriel]

Could you do both?

Implement the 35% savings rate right now, there is no reason not to. But before your start saving for all those other things, you build up 3-months expenses in an emergency fund. At 35% savings rate, I think you'll be surprised how fast you can build up the EF.

This is what I'm doing. Maxing out my and the husband's 401ks while taking my 3-month emergency fund to 6-months. Then planning to start in on the Roth IRAs next year.

[HawkeyeNFO]

Forget the Dave Ramsey stuff, and go with the second option you have laid out.  Why not worry about an emergency fund?  Because you have a very stable income source.  Even if you get hurt and can't do your job for a few months, your income continues at the present rate.  Your healthcare is taken care of, even if you have a major illness or injury.  So you have a much lower probability of needing to tap an emergency fund.  Your risk is lower than most from a financial perspective. 

The only reason I would recommend a large emergency fund is if you are heavily invested in real estate, and might have some vacancies which could result in negative cashflow for some months.  But if you're 25, my guess is that you are not a major landlord. 

Max out a Roth IRA, and max out your TSP as much as possible.  Remember that you can take your contributions out of the Roth IRA with no penalty.  For this reason many others view their Roth IRA as their emergency fund.

[VanteBoll]

Forget the Dave Ramsey stuff, and go with the second option you have laid out.  Why not worry about an emergency fund?  Because you have a very stable income source.  Even if you get hurt and can't do your job for a few months, your income continues at the present rate.  Your healthcare is taken care of, even if you have a major illness or injury.  So you have a much lower probability of needing to tap an emergency fund.  Your risk is lower than most from a financial perspective. 

The only reason I would recommend a large emergency fund is if you are heavily invested in real estate, and might have some vacancies which could result in negative cashflow for some months.  But if you're 25, my guess is that you are not a major landlord. 

Max out a Roth IRA, and max out your TSP as much as possible.  Remember that you can take your contributions out of the Roth IRA with no penalty.  For this reason many others view their Roth IRA as their emergency fund.

Very good point.

You're right, I am not a major landlord yet. With your suggestion, by the time I am a major landlord the 35% savings rate contributions will have me in a comfortable position cash reserves wise (especially if I raise the savings rate over time).

Thank you for your insight!

[Sorinth]

An emergency fund serves two purposes, unexpected 1 time expenses and job loss.

In terms of job loss this is highly dependent on your job (Sounds secure), labour laws where you live, and your ability to find another job. In your case it sounds like the job is secure and with a part time job on the side it's likely that you could easily survive a job loss. So I wouldn't worry too much about this possibility.

Which leaves 1 time expenses, again this will be dependent on many factors not least of which is how credit worthy you are. Personally I have a line of credit, nothing is ever on it so I pay nothing, but in an emergency it would cover any one time costs and presumably I would use it instead of selling parts of the stache since the interest rate is reasonable. So if you have access to a decent amount of credit at a reasonable interest rate you probably wouldn't need much of an emergency fund.