Dave Ramsey’s Seven Baby Steps
Dave Ramsey is a personal finance public speaker who teaches people how to get out of debt and stay out of debt. His class, Financial Peace University, lays out a “simple” seven step plan to do just this. The plan itself is very “simple”, but completing all of the steps is anything but simple. I have had a few family members go through the program and they have said that it was very beneficial. Even though I don’t fully agree with everything he teaches, I do believe his teachings are great for just about everyone.
Here are his seven steps with details:
1) Save $1,000 to start an emergency fund
As the title suggests, in order to complete Step 1 you need to put $1,000 in a savings account. This savings account should not be touched except in “emergency” situations which are unexpected events that are unavoidable (i.e. car crash, medical bills, etc.). This is not supposed to be touched for things you “want” (i.e. a new Ipad or dinner at a nice restaurant). Hopefully this step is pretty easy because then you can jump right to step 2
2) Pay off all debt using the debt snowball
This step can either be really short or really long depending on how much debt you have. Dave Ramsey says to list your debt in order from lowest outstanding balance to highest outstanding balance. Then pay them off in that order. I don’t agree with this. I think loans should be paid off starting with the highest interest rate first (even if it’s the largest balance), then finishing with the lowest interest rate. Dave uses the term “debt snowball” because he believes that as soon as you pay off one loan you’ll gain momentum and want to pay off another. This makes sense, but you are paying more in interest (even if it is only a few dollars) if you pay off a lower interest rate loan first.
3) Save up 3 to 6 months of living expenses
Up until this point you’ve only had $1,000 in an emergency fund. After this step you’ll have much more. Three to six months of living expenses varies depending on your budget. In order to figure out this amount, calculate how much you spend in any given month and then multiply it by 3 (or 6). It is probably in the $10,000 to $30,000 range for most people. This money should then be added to your $1,000 emergency fund and it has the same stipulations (only used in emergencies!) as the $1,000 had.
4) Invest 15% of household income into Roth IRAs and pre-tax retirement
Now that you have no debt and a decent amount saved up you can begin to look towards your future. This is the step where wealth really begins. Many companies have a 401k match or some sort of retirement plan. Begin by giving enough to get your full match (in my case this is giving 6%) and then give what’s left of your 15% to an IRA account. Your IRA should then be invested in 4 different growth stock mutual funds. This will make you diversified enough and you should see long-term growth in the 10%-15% range (yes, this is possible).
5) College funding for children
This is the step where you begin to plan for your children’s future. College is already expensive and it will only get more expensive as time goes on. That makes it essential that you begin to plan and save for that expense as early as possible. Dave suggests either Educational Savings Accounts (ESAs) or 529 plans. Determine how much per month you should be saving at 12% interest in order to have enough for college.
6) Pay off home early
The majority of people (myself included) have probably resorted to the fact that they will always have a mortgage. I don’t really even consider it debt even though it is. It is in step 6 where you will begin to tackle this daunting task. It may be daunting, but with no other debt and the essentials taken care of it shouldn’t be too hard to tackle this. Dave says that the feeling you get when you are completely debt free is like nothing else and is worth the hardship you just went through to make it happen. I can’t attest to that being that I haven’t gotten there yet, but it makes sense.
7) Build wealth and give
This is my favorite (and probably everyone’s favorite) step. Dave regularly says, “Live like no one else so that someday you can live like no one else”. Meaning that if you live on rice and beans now, you’ll be able to live like a champion later in life. Another point he brings up is that poor people can’t help many other people whereas rich people are able to help many more. This step is where you build your inheritance, give to your favorite charities, and enjoy the life that you’ve worked so hard to get to.
These steps cover just about everything you would need to know in order to get out of debt and build wealth. Even though I don’t fully agree with how to get each step done, I still think the whole premise that the steps are built on is solid. He has helped millions of individuals and hopefully this article has given you a quick overview of how he has done so. If this process interests you, I encourage you to look more into and begin the process yourself!
Jake Erickson works in corporate finance and blogs about personal finance at Common Cents Wealth
Photo by Tim Green