Debt Reduction – Emergency Fund Savings – The Balanced 75/25 Method

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“The average millionaire can’t tell you who got thrown off the island last night.”  – Dave Ramsey

A little background on the 75/25 Rule…

Recently I have been receiving a lot of questions regarding my approach to paying off high interest debt versus contributing to emergency fund (and other) savings.  This topic has been an orbiter in many of my posts so I figured I would address it directly for everyone to read, analyze, critique, love, hate, smile about, cry over, and provide feedback to.

If you are immersed in debt reduction you are most likely following either the “debt snowball method” or the “high interest first method” of repayment.  Regardless of which method you choose you will almost immediately run into the following question:

Should I build my savings first or pay off more debt first?

The popular speaker, author, and fellow debt slayer Dave Ramsey would tell you to approach this question as follows:

  1. Start an Emergency Fund and focus on building it up to $1,000 – then…
  2. Shift 100% of your available funds toward high interest debt reduction using the debt snowball method – then…
  3. Resume contributions to your Emergency Fund until it can cover 3 – 6 months of living expenses.

As you read on remember the following Dave Ramsey quote, “You can’t go wrong getting out of debt.”  To that end, this post is not an attempt to exploit some “flaw” in Dave’s approach… because I do not see a flaw.  Personal finance is… PERSONAL.  Every situation is unique and each person/family will have their own intimate and unique approach that works for them.

So what works for me?

I am one of those people who likes to see my savings grow… no matter what!  I LOVE to see my debt decrease in HUGE numbers, but I also need to see my savings grow each week.  I feel this way for three main reasons:

  1. Always pay yourself – I do not like to see ALL my money go out each month without paying myself at lease some of it.
  2. $1,000 is not enough for us – we built our initial $1,000 EF and a few weeks later the transmission on our only vehicle died costing us $1,600.  Shortly after that we ran into another even larger unexpected expense.
  3. Balance is always good – when I see 100% of my money going out, but none staying home with me, I do not feel properly balanced.

Combining Dave’s great advice with the 2 statements from above, I set out to do what I always do… come up with a strategy that works for me.

I like to cook, and whenever I have a craving for a particular dish that I have never prepared, I find at least a couple highly rated recipes and combine them into a recipe that suits my own tastes.  For me, it is no different when it comes to debt reduction and emergency fund savings.

With this in mind I developed what I call The Balanced 75/25 Method.

Here is a detailed breakdown of how I balance my Emergency Fund savings contributions with my debt reduction contributions.

  1. Contribute 100% of my available monies to build a $1,000 Emergency Fund.
  2. Once the initial $1,000 is there, start attributing 75% of my available resources to high interest debt reduction and 25% to all my savings funds*.
  3. Once my high interest debt is gone, resume 100% contributions to EF until it reaches $20,000 (6 months worth of expenses for my family).
  4. Once that savings is fully funded we plan to fix all (or at least a vast majority) of our available funds on our low rate mortgage and student loans.

*My current Personal Saving Fund goal amounts:

  • Emergency Fund – $20,000 – (70% available resources go into this fund)
  • Auto Fund – $10,000 – (15% available resources go into this fund)
  • Vacation Fund – $2,000/year – (15% available resources go into this fund)

What about you?

Remember above all things… “You can’t go wrong getting out of debt!”

That said, what plan do you follow?  Do you follow the Dave Ramsey plan to the tee?  Do you follow some other popular debt reduction/personal savings plan to the tee?  Or do you create a personalized plan?

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1 CJ Perry

I decided to actually sell my house and downsize in order to pay off debt. I bought my house before the housing bubble and I bought too much house to begin with anyways. So I decided to sell it and downsize into a smaller house and used that to pay off all but the mortgage.

I’m a huge fan of big wins. I think selling items like a boat or oversized car or even just having a garage sale to pay off debt is the best. Obviously you may not be able to pay off ALL of your debt this way but it gives a huge psychological boost… at least to me. If I see that I have to pay $10,000 off and I can only make $200 payments towards that, I lose hope. If I put $3,000 down and then start making $200 payments, I feel I can conquer anything.

That’s what works… or rather worked… for me. Now I’m determined to stay debt free so I don’t have to deal with that.

2 Matt Jabs

Great story CJ… very encouraging. I love how everyone has their own spin on getting out of debt!

3 Jason @ Redeeming Riches

I think your discussion needed to be turned into a post to clear up exactly what you’ve got going on. I like the idea of balance. There’s a reason it’s called Personal Finance. It is personal and each situation is unique. If a person is single and makes decent money they may only need $1,000. Because I’m self-employed I do not feel comfortable with that amount and while we were climbing out of CC debt my wife and I had much higher EF than that. Pick an option that works best for you and the key is sticking to the plan.

4 Lance

What I have done to eliminate most of my debt is to put all of the available money into a savings account and then pay off the cc bill in full when I have enough in the saving account. My credit cards are no more than 10% interest and my savings gives me 1.5%. I feel that it is a good balance to pay a little more in interest and have an emergency fund as the asavings account available than paying all of the debt at once. Good post!

5 Golfing Girl

We followed Dave’s advice with a couple of exceptions (FYI we’re 33 and 35). We continued contributing to our 401K plans up to the company match and even continued to put small amounts into our daughter’s 529 college plan while we paid off the car loan, 2nd mortgage, and 401K loan. It’s against Dave’s rules but we thought it was important. We even still use evil credit cards but pay them off weekly and get the cash back rewards. Don’t tell Dave! 🙂
But we definitely used the snowball method after we established the emergency fund of $1000 and paid off about $60K of debt over 5 years. Now the only debt we’re left with is a 15 year mortgage so we’re working on the 3-6 month EF and have increased retirement savings to 18% plus company match. It’s been a long road but we’re ready to live like no one else someday!

6 Matt Jabs

Such an encouraging story to those just starting out! Thanks GG… and congratulations.

7 a.b. @ Modern Tightwad

We brought up our emergency fund to $2000 (a little over one months expenses for us). Unfortunately, since much of our income is from tips, if I snowflaked everything leftover at the end of the month, the next month we probably couldn’t pay our bills. So I put an extra $100 towards debt each month, and the rest into a savings account. If at any point the savings account is high enough to pay off a bill completely, we talk and determine if that would be in our best interest, or if it would leave us too exposed. Seems to have worked very well so far.

8 Matt Jabs

Another great example of how it is very important for people to understand that they can take wisdom of the modern day and shape it to fit their situation… thanks a.b.

9 Paul @ FiscalGeek

I’m a rule follower by my very nature and I bought onto Dave’s plan early on. I’m all in, I hate to dillute my debt payments even slightly. That being said, I make sure that I make my debt payments at the end of the month so in a sense I’ve built more buffer into my emergency fund without actually funding it. I pay down about $2000 in debt every month so that coupled with my $1000 emergency fund can see us through most local emergencies. This way I have the best of both worlds.

10 Matt Jabs

Basically a “rule followers” 🙂 way of creating a similar buffer – excellent Paul.

11 Jason R Fisher

We actually just posted about paying off our debt today. We had our EF up to 2K which was good for us then slammed the high interest debt. Now we are going to build a more solid EF 6 months of expenses then decide what we are going to do with our upside down house.

12 lrgche

So from the comments above it looks like everyone thinks that a $1,000 is a bit too small for most people and especially for families. I agree.

We decided that we would not let our emergency fund drop below $4,000. When we made the decision to follow Dave’s plan we had around $10,000 in savings and back then the dollars didn’t have any names. So the first thing we did was to take $5,000 and paid off one of the car loans and then the other $1,000 to the other car loan. That was in Oct of 2007. So at this point we have no CC debt, 1 car loan and a second mortgage (15 yr balloon).

Then we took all available “extra” money and started pounding on the car loan. Paid off the remaining $14,000 car loan 6 months later in Apr of 2008. Then kept pushing the budget and pounding on the second mortgage and paid it off this past June. Took us 14 months to pay off the $23,000 second mortgage. So by following the debt snowball method, we were able to pay off $42,000 in 21 months while keeping around $4,000 in our emergency fund.

So that’s was our method and our story. I don’t think that’s much different than what Matt is trying to accomplish overall but there are 2 underlying issues I would not agree with or recommend.

Matt says: “Once the initial $1,000 is there, start attributing 75% of my available resources to high interest debt reduction and 25% to all my savings funds*.

I personally think you would be better served by setting an initial EF target that is a little higher and then pump 100% to the debt reduction. Matt mentions that he hates seeing everything going out and not paying himself something, well for me, every time I eat out, watch basic cable TV, or use the home internet service, or my cell phone, then I’m paying myself, because I don’t HAVE to have those things, they are luxuries I’m willing to pay for while still in debt.

The other thing is that little asterisk. Even if I thought the 25% balance was ok, I could never bring myself to save for a new(er) car while still owing high interest debt.

Where’s the intensity? Would you rather give away money in interest just so you can buy a new(er) car 6 months sooner? Maybe that’s just me. I’d rather drive a beater every day than pay money in interest.

Well that’s my two cents for what it’s worth.

All in all Matt’s right with the quote:
“You can’t go wrong getting out of debt!”

Good luck Matt!

13 Matt Jabs

The disconnect lies in the notion that intensity = 100% of resources directly toward immediate debt repayment alone.

Intensity also = using 100% of resources to repay debt and avoid future debt at all costs.

Either way… 100% = 100% – It all depends on point-of-view.

Once again, “You can’t go wrong getting out of debt!” 🙂

14 Kreestee

Finally, an approach that isn’t all or nothing! We currently have our $1,000 Emergency Fund established but I’m apprehensive that it’s not big enough. We also have a 97 Ford Explorer that’s about to roll over 200,000 miles as well as a 98 Pontiac Grand Am that’s seen better days. I’m worried about losing either of those two cars (worst case scenario: BOTH!) in the next year but felt guilty about putting aside $$ towards a car payment when I should be slamming our CC debt (roughly $18,000). Add a 3 month old baby into the mix, which required a complete revamp of our budget, and I was at a loss of where to focus.

Ran across your blog from one of the Personal Finance Carnivals – have definitely added it to my daily ‘must reads.’


15 Matt Jabs

Awesome Kreestee, glad the info was useful to you. Like I say in the post… I treat my financial planning a lot like my recipe planning – take the best parts of the best plans (recipes) and combine them to fit my situation & needs (tastes) 🙂


16 lrgche

Even though I can see the desires and appreciate that some things work better for some people than others. I still, after more comments, don’t like taking 25% and doing something other than paying off the debt. (after an appropriate emergency fund of course)

Matt your recipe analogy was pretty good, but here’s one for you.

You have a recipe with a list of ingredients. You go to the grocery store to buy said ingredients but then you end up spending 25% of your money on junk food that wasn’t on the list. With the 75% you are then forced to buy inferior ingredients and therefore the quality (taste) of your recipe suffers. Yes, having that bag of popcorn & candy for the movie a few nights later is great and all but you could have done without it and had a better dinner recipe.

I still stand by my opinion that if you build an adequate and appropriate (for your family situation) emergency fund, then you should put 100% of available funds toward debt reduction.

17 Matt Jabs

Equating saving money with junk food? That is an interesting opinion…

18 lrgche

Nice, but you know what I’m saying…

Spreading your money thin so that you can treat yourself.

I’d rather be one step closer to debt free rather than closer to a new/used car.

The car is the junk food.

19 Matt Jabs


20 MichiganPete

We haven’t set up fixed percentages, but after accruing our $1000 EF, we are paying down our debt at the same time as funding our Freedom Account (from Mary Hunt’s books). I gather this works similarly to your three savings accounts, but we’re treating them more like short-term savings/designated spending subaccounts (auto, travel, clothing, household, medical, etc.). I’m sure we’d pay down our debt faster if we cut back more on this sort of spending, but it lets us stay on track without feeling too deprived. Our goal is to have all our little debts (i.e., not the student loans) paid off by this time next year, and we’re well on our way – I make my last car payment this month!

21 Matt Jabs

Congrats on the car Pete!

22 droed

This article exposes a part of Dave Ramsey’s baby steps that I think confuses some people. If you have read any of his books or listened to/watched his show, he stresses the importance of getting on some sort of a budget and after getting your baby emergency fund set up, squeezing as much extra as you can out to pay off debt. However, the goal here is to get you to think about how to spend your hard earned cash.

Whether you choose to save a little in your budget is irrelevant. If you have a vehicle that is on the edge of breaking down, then you should be putting money into the repair fund line of your budget w/o feeling bad about it. Just be sure not to let the pizza man get your repair fund. What you are willing to contribute toward your debt snowball is simply indicitive of your gazelle intensity.

I think Dave would rather people be safe and get out of debt a little slower than be ridiculously fast and reckless about it. There are some debt-free calls that he gets that he is astounded at after hearing income and how much debt was paid off, and I think those folks probably tempted fate of a murphy setback a little bit. So remember, make your budget first (including your mininum payments) and then look at what you have left over. Then, if you are not satified, cut back on something that you can prune a little.

23 Matt Jabs

You have successfully broken down my exact philosophy as it relates to Dave’s plan. Nice work. I see things this exact same way.

24 lrgche

I just couldn’t help but chime in again in order to get some clarification.

I agree with was you are saying, it’s just that doesn’t jive with what Matt says in this post.
Matt you say you see things the exact same way, except that the post doesn’t indicate that.

Let me explain with some examples:
First droed says “If you have a vehicle that is on the edge of breaking down, then you should be putting money into the repair fund line of your budget w/o feeling bad about it.” I agree, but Matt does not indicate that is what he is referring to in the post. He says that after the budget breakdown (I’m assuming Matt has a budget) with the money he is able to save, and then he is going to take that amount and only apply 75% of it to debt reduction. Then he is dividing the other 25% by putting 15% of it into an auto fund with a target of $10,000.

This is NOT a repair fund line in a budget. This is “indicative of your [Matt’s] gazelle intensity” level and his choice to do something other than debt reduction with his available funds after the budget.

If you have an aging auto, budget in repair. If you want to go on vacation, budget in a vacation fund. But once you have a budget and you still have high interest debt, IMHO, the available funds should go 100% toward reducing that debt. Of course this is after establishing an initial emergency fund appropriate for your family.

Here’s another way of looking at it.
The scenario: you have an established initial emergency fund of $5,000 and you have $11,000 in debt at 9.32% with a minimum payment of $350. You have $500 available every month to put toward the high interest debt so you are making some progress. What if you were suddenly given an inheritance of say $12,000 (after taxes)? Well Matt’s post says that he would take $9,000 and pay down on the debt, put $2,100 into the emergency fund, put $450 into an auto fund and then put the remaining $450 into a vacation fund. That means that next month there is still $2,000 left on the debt with 4 months to go. What would I do? I would take $11,000 and kill the debt, I wouldn’t have an auto fund until I had 6 months in my fully funded EF, which Matt’s target is $20,000, and then my vacation fund would either be in my monthly budget already or nonexistent. So then my EF would be $6,000 and for the next 4+ months I would be able to put the $500 of extra money straight into my EF to build it up to $8,000 and more. Which way would you go? Put $450 into a car fund or be debt free?

25 Matt Jabs

This post does not address my position on lump sums.

26 lrgche

But you have a “lump sum” of available money each month.
Why differeniate?

27 Matt Jabs

Honestly… if I were to get a “lump sum” in the amount of $10,000+ I would have to figure out the best use of it for the current situation.

I suppose if I were to run across a large lump sum right now, I would probably put it all toward my debt simply because I know I still have my regular savings coming in each month.

28 BG

I’d have to agree with lrgche here. Matt, you should have a plan for newly available lump sums, just like you have a plan for surprise expenses (emergency fund).

Also, if you think about this plan with ‘gazelle intensity’, you would see that you are basically taking a loan out today, to have a future car tomorrow (by hoarding cash in an automobile fund and not paying off today’s debt).

Think of it this way: if you were debt free today, would you take a loan out to (initially) fund a cash account that you would eventually save up to buy a car with? If the answer is no — then nuke the automobile fund.

As you said, it’s personal, and I’d personally keep a portion of the emergency fund reserved for car repairs ($500), and direct 100% of any cash above and beyond the emergency fund amount (current and future) towards the consumer-level debt reduction goal. I’d forget about saving for a car upgrade (but do save for the repairs).

Once you are out of consumer-level debt, then you can worry about saving for a better (used) car if you want one, but I’d be pretty surprised if you even wanted one after you pay off your debt.

The vacation fund is even more personal: for me, it depended on my wife. A vacation trip is not a ‘vacation’ for me: I’d rather just stay at home.

The force of a focused husband & wife is unstoppable! Just make sure you keep focused.

29 lrgche

Finally someone agreed with me!

30 Matt Jabs

Ha ha… it was only a matter of time right! 🙂

31 Matt Jabs

Good points. Right now the auto fund is being funded very minutely. Currently, it is more of a placeholder to remind us to save for future automobiles before we are struck w/the need to go get one. As soon as the consumer debt is gone, the auto fund will be much more heavily funded.

In the interim, I will continue down the current path because after taking all of these variables into consideration… the balanced 75/25 method is still the best choice for us.

32 droed

Hmm… What if you knew you knew you needed to replace the front and read main seals on the engine or your car. For those not mechanically inclined, this is an issue where your car starts slowly leaking oil, and the amount leaked increases over time. So it is not an issue that requires immediate action (i.e. not an emergency).

This is a repair that ranges anywhere from $500 to $1000 dollars. Wouldn’t it be advisable to budget money to save and make the repair, or are we to throw caution to the wind and wait until the car runs through a quart of oil every 500 miles, before trying to scrounge up the cash? My guess is most people will opt to save money over time to make the repair.

I see a car replacement fund the same way as a repair fund. The key is to plan your spending. If you can be out of debt in 24 months and your car is in good enough shape to make it that long, you probably don’t need a replacement fund. However, if you are on a 5 year mission, it may be a good idea to send some cash to that category about half way through.

33 Matt Jabs

We have about $4k saved for our next auto, which is sufficient for now. We budget $100/vehicle/month for repairs and maintenance. All extra income is going toward our debt snowball now because our savings are now at a level we’re comfortable with.

34 SS4BC

Great advice. I’m also doing both without really thinking about it, but I haven’t gotten the $1,200 EFund that I want before I start going full throttle at the debt. That said, I think the 75/25 rule is great – after doing some calculating I realized that mine is currently set at 80/20 without really thinking about the numbers before hand.

I’m guessing that after the E-fund is at a comfortable place for me I’ll probably do a 90/10 until the debt is gone or the E-fund is at $10,000 – whichever happens first! Thanks for a thought provoking post. =D

35 Matt Jabs

Great testimony. For some of us, we have found it important to create security while also paying off debt. Sounds like you are doing so quite nicely… good job.

36 Steve in W MA

I use an approach very similar to the 75%/25% approach outlined here.

A lot of it has to do with the fact that the interest on my outstanding debt of $7600 is only 5.9%, which will come out to around $300 total in the next 12 months when taking into consideration my rate of debt payoff over that period. If the interest rate were 12%, I would feel differently.

Having experienced what it’s like to have an emergency fund of $4000 or more, I really don’t want to go back to the $1000 level for a number of reasons, basically because I feel freer and more secure at the same time knowing I have cash at hand available to take care of unforeseen circumstances or opportunities.

So out of the $600 monthly dollars I have devoted to debt repayment I pay just over my minimum payment of 4% of the balance every month, or $350, to Discover Card. Then I take the last $150 and put it into a SmartyPig account called “Discover Escrow”. It’s money designated for that debt, but held in a cash account to supplement what I consider to be a relatively meager $1500 emergency fund in the event of a true emergency.

And I take another 450 or so and put it towards various sinking funds in my monthly budget, such as car repair and my actual Emergency Fund.

I could pay the debt off in exactly 7 months with the $1050 from my budget that is potentially available after mandatory expenses. But I don’t want to live on the edge like that for 7 months, it’s just not worth it. So I choose to spread out the debt payment for 18 months and build up my liquid cash reserves at the same time.

Over the next 18 months, it will cost me (off the top of my head) an extra $200 in interest to do so (compared to paying off in 7 months). But having cash on hand is worth the $200 expense to me. I don’t ever intent to go back to my previous financial set point of having $1000 or less available, whether or not I am paying off debt ( unless it’s 20% interest rate debt–that would feel different because the cost would be much higher).

By the time my last debt payment is made in 18 months, I will have about $7000 in my emergency fund, which is most of the way to the $10,000 I have set as a goal. And every month thereafter I will be able to increase my savings by $1000, which is going to feel fantastic.

37 Matt Jabs

You obviously understand the exact reasons why I choose to save while I pay down debt. It may cost a little more, but “buying security” is worth it – to a certain extent, which you touch on per the $200 you will pay to have the added financial security of a decent savings to hedge against emergency.

I love what you say regarding the extra $1,000 in savings you will have when this debt is paid off – I focus on that often – what a GREAT feeling it will be to finally be paying ourselves instead of others!

38 Maria

Hi Matt,
I found your site when looking for DIY laundry detergent. You have great recipes and they are simple, I love it! I also read a few articles on your debt reduction page and I felt compelled to post our story. I found Dave Ramsey’s site 2 years ago and implemented his strategy and we are out of debt except for the house (paid off nearly $50,000). We sacrificed, sold a truck, travel trailer, several smaller things around the house, worked like mad (alot of overtime) and now we are increasing our emergency fund to 3 months saving, we are 1/2 way there. We should have a 6 months savings by the end of this year ($12,000). No we do not make alot of money, both years about $40,000, but we sold alot and now we run an old Chevy S-10 (paid cash) we also have a very low mortgage ($300). We are not paying our house off, because we are selling in three years and moving to warmer climates. Getting mad worked well for me, never, never again will I let debt come into my life!!!

39 Matt Jabs

Hi Maria,
Awesome, awesome… awesome! I’m very proud of you and your husband and I’m thankful that you took the time to share your experience with us… I love hearing debt success stories like this. Glad you like the laundry detergent… don’t for get to try the dishwasher detergent, it works great too – we love making things ourselves. Keep up the good work and God bless!

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