I am a huge fan of Dave Ramsey’s baby steps from his book, The Total Money Makeover. It was the baby steps that helped us get rid of $52,000 in consumer debt in just 18 months, and we are not the only ones. Millions of people have taken his course and used them as well, so you can be confident that if you use these steps, you will build a strong financial foundation for you and your family.
Today we’re going to go over each step in detail and explain how it is vital to accelerating your path to financial independence.
Dave Ramsey’s Baby Steps
- Baby Step 1 – $1,000 in an Emergency Fund
- Baby Step 2 – Pay off all non-mortgage debt using the Debt Snowball
- Baby Step 3 – 3 to 6 months of expenses in savings
- Baby Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
- Baby Step 5 – Funding College for children
- Baby Step 6 – Pay off your home early
- Baby Step 7 – Build wealth and give a bunch away
The Breakdown of Each Step
To help you figure out where you are in the process here is a breakdown of what each baby step entails.
1. Save $1,000
Dave calls this step the “baby emergency fund”. It might seem silly to sock a grand in the bank when you could be putting that money toward reducing debt, but here’s the logic behind this first baby step:
Unexpected expenses happen to everyone, and for some reason they often tend to happen more when you’ve just committed to getting out of debt. In order to avoid being tempted to use your credit cards to handle these unexpected costs, save a quick $1,000 and put it aside as a buffer from those emergencies.
If in the course of paying off your debt, you have to use some of the money in your starter emergency fund, you simply stop paying extra on your debt and put any extra money into your starter emergency fund until it reaches $1,000 again. This step will help ensure that your credit card balances continue to go down and not up.
Bonus: The starter emergency fund also serves as training ground for both paying for emergencies in cash and for developing a habit of saving money. And, if you grow your emergency fund a little bit more, it can be a way to get started making your money work for you if you open an interest bearing checking account, like the Radius Hybrid Checking account. The interest rate is currently 0.85% on balances of $2,500.
2. The Debt Snowball
There’s little doubt that the debt avalanche (paying off debts according to the highest interest rate) will save money in the long run, but the debt snowball is often a better choice when it comes to keeping people motivated for the often long journey of becoming debt free.
With the debt snowball method, you start by listing your debts from smallest to largest. You make the minimum payment on all debts, putting any extra funds toward the smallest debt until it’s paid in full.
Then, you take the minimum payment you were paying on the smallest debt, the minimum payment on the next biggest debt, plus any extra funds, and put that money toward the next biggest debt until it too is paid off.
This method of keeping your total monthly minimum payments the same (instead of just coasting with the smaller amount of payments actually due) combined with adding any extra funds toward the current smallest debt means that you will pay off your debt at a faster rate.
Bonus: Being able to mark those smaller debts as “Paid in Full” more quickly will give you more motivation and faith that you can indeed win the battle against debt.
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3. Finish the Emergency Fund
Ramsey’s next suggested baby step is to increase your emergency fund until it contains 3 to 6 months’ worth of expenses for your household. The way he suggests accomplishing this feat quickly is to take all of the monies that you were putting toward your debt snowball (which should now be paid off) and put it toward finishing your emergency fund.
A 3 to 6 month emergency fund will keep you and your family well buffered against major financial emergencies such as job layoffs and large unexpected expenses such as major home repairs.
Bonus: Developing a habit of saving BIG money will make it easier for you to develop a habit of putting money into a separate countdown fund for expected major expenses.
4. Maximize Retirement Investing
After the consumer debt is gone and the emergency fund is fully funded, Ramsey suggests maxing out your retirement investing.
For 2016 this means contributing up to the legal maximum allowed by the IRS of $18,000 a year for 401(k)’s and $5,500 a year for IRAs (Ramsey suggests 15% of your income). Those 50 and over can contribute an additional $6,000 to their 401(k) and an additional $1,000 to their IRA holdings.
By maxing out your retirement investing based on your retirement funding goals, you are ensuring that your golden years will be secure and comfortable.
5. Prepare the Kids’ College Funds
One of the things I like about the college section of the Total Money Makeover book is that Ramsey is clear that college is not a guaranteed career success for your kids. He goes into great detail about how important it is to calculate the cost vs. the benefit of college before you go sending your kid out to spend $25,000 a year on schooling.
It’s important during this step to talk with your spouse about how much money you can comfortably set aside for your child (ren)’s education.
The dollar amount is totally up to you. Just be sure you research the different college saving options and make sure that what you’re planning on contributing to your kids’ college educations is affordable for your family – and make your plan clear to your kids so they know exactly what to expect from you where college education help is concerned.
6. Pay off the Home Mortgage
After you’ve paid off all consumer debt, have a fully funded emergency fund, are contributing at least 15 percent of your income toward retirement, and have a plan for contributing to your kids’ college educations, it’s time to dump the mortgage.
Put all extra funds (based on having created a solid budget) toward that mortgage and get it paid off in full as soon as possible. The less interest you pay to the bank, the more money you have to give to worthy causes and to fulfill your dreams, whatever those dreams may be.
7. Build Wealth and Give a Bunch Away
Here’s arguably the best step! Now that you owe no money to anyone and have a nice stockpile of savings, it’s time to start building some serious wealth.
That wealth-building can come in a variety of forms. You can invest in mutual funds, invest in real estate or simply sock the money away in a high-interest earning bank.
The goal is to put as much money as possible toward whatever your financial goals are, whether that means traveling the world, building your dream home or living life as a philanthropist.
Once you are completely debt free and have amassed a serious amount of wealth, the world is your oyster and your dreams are unlimited. So start working the baby steps in your life today, and work toward achieving all of your dreams.
Have you started working Dave Ramsey’s Baby Steps? If so, what was your experience like? Please let us know in the comments below!
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