Dave Ramsey’s Baby Steps

Dave Ramsey’s most popular creation are his Baby Steps. These seven Baby Steps are feature in Financial Peace University and The Total Money Makeover. The premise is that, by breaking down a large goal (financial freedom), into manageable steps, you are more likely to succeed in achieving your large goal.

Baby Step 1: Save $1,000

The first step to take is to save $1,000 in an emergency fund. You must keep this money for true emergencies. It must be in an account that’s liquid and easy to get too, but don’t make it too easy to take money out. As an add-on to this step, you need to create a budget and make sure you don’t take on any additional debt. Taking on new debt while you’re working on paying down your current debt doesn’t make much sense. This should by far be the easiest and quickest baby step. Later on, you’ll add more to make this a complete emergency fund. For now, $1,000 is sufficient to keep most “emergencies” from derailing your financial plans.

Baby Step 2: Debt Snowball

This step is probably the hardest for most people. And I think that’s interesting, because it comes so early in the process. Once you pass this step though, the rest becomes easy. In this Baby Step you’re going to get rid of all of your debt except your home mortgage. Because the rest of the steps most deal with saving money, they’re much easier to accomplish when you aren’t making payments on your debt. Dave Ramsey is famous for what he calls the Debt Snowball. I’ve covered Dave Ramsey’s Debt Snowball before. In its simplest form, you create a list of all of your debts. Then, order them from lowest balance to highest balance. Pay the minimums on all of your balances, and put any extra income you have toward extra payments on the debt with the smallest debt. Once that one is knocked out, you’re going to have more money to pay on the next debt because you have one less monthly payment. Just keep working your way down the list until you’ve paid them all off.

Baby Step 3: Fully-Funded Emergency Fund

Now that you’re debt-free, it’s time to complete your emergency fund. Dave recommends having three to six months of expenses. If you lose your job, this is going to hold you over so that you can focus on finding a new job rather than being worried about how you’re feeding the family tonight. If you think the risk of losing your job is high, or you’re the single income earner in the household, you should have six months of expenses saved. If you are a dual-income household and your job is relatively safe, three months is probably fine for now.

Baby Step 4: Investing for Retirement

Dave Ramsey recommends saving 15% of your before-tax gross income for retirement. Dave’s strength is in getting out of debt, not investing. So, I wouldn’t put too much weight behind his particular investing advice. Just keep saving the money and invest it in a diversified portfolio of index funds. Make sure to utilize any accounts that can help save you taxes. Roth IRAs and 401(k)s with match are the best. Also, you have Simple IRAs, SEP IRAs, traditional IRAs, and other accounts. If you maximize these accounts and still have money in your 15% to invest, you’ll need to just invest in a taxable investment account. Just try to stay away from short-term gains.

Baby Step 5: Funding College

In this step you save for your children’s college. College costs continue to raise about 2x the inflation rate. A great way to give your kids a head start is to help them get through college with no debt. I think that saving enough for a public education is reasonable, and if your children choose to pursue private education, they can get loans. It’s important they understand the choice they’re making and weigh the costs and benefits of different schools. You should start by saving in a Educational Savings Account (ESA) and then moving on to the 529.

Baby Step 6: Paying off the Mortgage

Very few people ever end up paying off their mortgage, but I think it’s one of the best ways to reduce your personal finance risk. Some will argue that paying off your mortgage doesn’t make sense because then you lose the tax deduction. However, if you’re getting tax deduction, that means you’re paying mortgage interest. I’d rather keep $10k in interest in my pocket than pay that just to get a $3k deduction. Paying $10k to save $3k is a terrible financial plan.

Baby Step 7: Building Wealth

The last Baby Step is to build obscene amounts of wealth. Imagine having absolutely no debt payments each month. If you saved all of the money you currently are paying on your debt, you’d probably be saving a few thousand dollars every month. Imagine how fast that would add up.

If you want to look at the Baby Steps in greater detail, and from the man himself, you should check out Dave Ramsey’s The Total Money Makeover.

Dave Ramsey the Debt Crusher

This is Dave Ramsey. I call him the debt crusher. You may have heard your co-workers or friends talk about it. Or you may have heard about him at your church. He’s a financial guru, with a nationally syndicated radio show, a series of best-selling books, and a large seminar business. Dave Ramsey is best at motivating and helping people to get out of debt. If you have any amount of debt, you need to check out what Dave has to say. Dave Ramsey the Debt Crusher

I honestly don’t remember where I first heard of Dave, but he has absolutely had an impact on my financial perspective. I listen to Dave’s free podcast on my way to work nearly every morning. You can get the podcast in the iTunes for free by searching for Dave Ramsey. I also recently read one of his books, the Total Money Makeover. When I say that Dave had an impact on my financial perspective, that’s a definite understatement. He literally changed the way I think about debt. I used to think of debt as a tool, but after listening to Dave, I realized that debt was a burden. This includes the normal debt that most people have, such as car loans, credit cards and mortgages. If you’re willing to follow Dave’s plan, he’ll help you eliminate your debt for good. Whether you have $10k in debt, or $500k in debt, this will work for you. It’s not easy, though. Dave will be the first to tell you that becoming debt-free is not easy. There is no magic pill to take here.

First Task: Create a Written Budget

To follow Dave’s plan, the first thing you must do is to create a written budget. Every dollar you are going to receive for the month needs to have a name. You’re going to control your money this next month, rather than letting your money control you. Each dollar must be spent on paper before the month begins. If you’re married, you need to sit down with your spouse and do this together. The budget is going to be a written contract. If, during the month, you or your spouse wants to go over the budget in a category, you must sit down together and re-draft the budget. You must allocate money from one category to another in order to pay for that expense. The goal here is to have a plan. You won’t get it perfect the first month. Dave says that it usually takes families about 3 months to get it right.

A New Promise

Before starting down the path of becoming debt free, you must also make a promise to yourself. You cannot take on any additional debt. It doesn’t make sense to pay off your car loan if you’re adding to your credit card debt. Dave takes a hardline approach and suggests that you cut up your credit cards. I think that if you’re able to control your credit card spending, then it’s fine not to cut them up. If you have credit card debt, though, you really shouldn’t keep them around where you can easily access them. Instead of cutting them up, trying putting them in a safe somewhere that makes it difficult to get to them easily.

Dave Ramsey’s 7 Baby Steps

Once you’ve created a written budget and promised not to take on any additional debt, you can begin Dave’s Baby Steps. These are his bread and butter. After listening to his show for a few months I can tell you most of the time what Dave’s response is going to be to a particular call. He has a set of rules he follows, and he very rarely deviates from this plan.

Baby Step 1: Create a $1,000 emergency fund
Baby Step 2: Pay off all debt except the house, using a debt snowball
Baby Step 3: Finish off your emergency fund with 3 to 6 months of expenses
Baby Step 4: Invest 15% of your income from retirement
Baby Step 5: Save for children’s college
Baby Step 6: Pay off the mortgage
Baby Step 7: Keep investing and give

I’ll be covering Dave’s Baby Steps in more detail soon, so make sure to check back. In the meantime, download his podcast, watch an old episode of his TV show on Hulu, or buy his book, The Total Money Makeover.