Overview of Dave Ramsey’s Baby Steps
Ryan Guina is an entrepreneur and writer. He has worked for Fortune 500 companies and served six years in the USAF. He writes about money management and small business topics at Cash Money Life and military money topics at The Military Wallet. You can follow his twitter feed.
Dave Ramsey is one of the most popular money gurus. He is a best selling author, TV and radio personality and he runs of the most popular financial planning seminars — Financial Peace University. I don’t necessarily agree with everything he says, but I think Dave Ramsey is an entertaining guy and has a lot of wisdom to share. Part of Financial Peace University is a series of Baby Steps to follow to help you get on your path to financial freedom. I’ll share those steps with you, along with my thoughts.
Dave Ramsey’s Baby Steps
Step 1 – $1,000 Emergency Fund. I think starting an emergency fund is one of the most important financial decisions you can make. Ramsey recommends starting your plan with a $1,000 emergency fund so you can say no to debt, and avoid using credit cards for expenses you weren’t prepared to handle.
Step 2 – Pay off all debt using the Debt Snowball. A debt snowball is a way of paying down your debt efficiently. Basically, you list all your debts from small to large, regardless of interest rate. Then pay minimums on everything but the smallest debt, which you pay as much as you can on. Once you pay that down, you apply that monthly payment to the next smallest, and repeat the process. The effect is eliminating your debts one by one and each subsequent monthly payment “snowballs” into a larger payment, making it more efficient to pay off debts.
My thoughts? Great plan. The best mathematical way to pay off debt is by paying off highest interest loans first, but DR’s method gives you the psychological wins to keep you motivated. In my opinion, anything that gets you motivated to pay more than the minimum is a good thing!
Step 3 – 3 to 6 months of expenses in savings. Once you are out of debt, the goal is to beef up your emergency fund so you are prepared for small and large contingencies. $1,000 probably won’t last long if you lose your job, but 3-6 months of living expenses should keep you going until you can find something else. Looking for a place to stash the cash? Check out these banks.
Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement. Ah… time to invest! You’ve got your savings solid and now it’s time to start planning your retirement. DR recommends opening a Roth IRA, which I think is a great idea. Saving for retirement is one of the most important things you can do once your immediate financial needs are taken care of.
Step 5 – College funding for children. Save for retirement, save for children’s college education. I like where this is going. DR is a huge advocate of avoiding debt at all cost, and he strongly recommends going through college without student loans if at all possible. Two of the most popular tax advantaged college savings plans are the 529 and Coverdell ESA, which are both a great place to keep your college savings.
Step 6 – Pay off home early. Once you have no consumer debt, you are saving 15% of your income for retirement and you are saving for your children’s college fund, DR recommends paying off your home early. Many people claim having a mortgage is a good thing because the tax deduction you get every year when you itemize taxes. Really, what is the sense in paying money so you can save 1/4 of what you paid? If you have everything else in line, it’s time to get rid of that mortgage! Once you eliminate that, your monthly cash flow will increase, giving you more opportunities.
Step 7 – Build wealth and give! Keep growing what you already have, and give to family, charities, your church and other worthwhile causes. After all, you can’t take it with you!
Thoughts on Dave Ramsey’s Baby Steps
Overall, I think this is a solid plan to become financially stable, get out of debt, grow your wealth and ultimately be financially free. You don’t need to follow these steps exactly as written and you are free to do them as you see fit. In fact, you can easily work on steps 3-7 at the same time if your income and financial situation make it possible to do so. In the words of Captain Barbosa, the Baby Steps are “more what you’d call ‘guidelines’ than actual rules.”