Introduction to Dave Ramsey's 7 Baby Steps

debt

Introduction to Dave Ramsey's 7 Baby Steps
November 27, 2019

Dave Ramsey is a personal money-management expert and extremely popular national radio personality. He talks about getting out of debt, building wealth, and giving to others when you are capable.

His 7 steps, known officially as “Dave Ramsey’s baby steps” are the preeminent guide to go from broke and in debt to multi millionaire.

Dave details the steps in his book: The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness

I believe that for financial education novices, his plan is great. Here are his seven baby steps:

  1. Save $1,000 in an emergency fund
  2. The Debt Snowball: Pay off all debts from smallest to largest (except home)
  3. Save up 3-6 months of savings in an emergency fund
  4. Invest 15% of your household income
  5. Fund your child’s college
  6. Pay off the house
  7. Continue to build wealth, invest, and give to others

This all starts with “Gazelle” Intensity

By compartmentalizing the baby steps, and forcing you to stay intense on checking one off at a time, Dave Ramsey gets you to be laser focused.

While ALL of the steps above are important, the order in which you do them, according to Dave, is the secret sauce. Having you stay intense on one goal at a time is what removes the anxiety of feeling stretched too thin. And I think he has done a great job. Lets run through the steps in order in more detail.

Step 1: $1,000 Mini Emergency Fund

Here in step one, Dave wants you to build a cushion because life happens!

Tires go flat? No longer an emergency. Get em fixed without having to charge your card (putting you further into debt).

Leaky pipes? Get rid of the bucket in the middle of the living room and call a plumber. No need to charge it, you have the $1,000 ready for this type of thing.

Ultimately, Dave knows that life happens and that you need this cushion to keep you out of rolling back into debt when it does.

Step 2: Dave Ramsey’s Signature Debt Snowball

avalanche

This is one of the most controversial of the 7 baby steps. Mathematically, you would expect a personal finance expert to tell you to pay down your highest interest debts first. (Known as the debt avalanche)

So why does Dave Ramsey preach his Debt Snowball? Because humans aren’t computers. He understands that we need the emotional support as humans.

By knocking off small debts first, it keeps people motivated to continue down the path of becoming debt free.

You will find that in the later steps, you start putting your capital to work and investing it, but you can’t free up that capital to invest until you are done paying off what you owe to others!

Step 3: 3 - 6 months of expenses in an emergency fund

Now that you are out of debt (Hooray!) you will want to start investing right away. But hold your horses!

Investing without a proper emergency fund could be detrimental to your financial health. Building that emergency cash buffer is not only critical, but it should be much easier to build now that you don’t have to send so much money to debt payments.

Lets say you jump by Dave Ramsey’s baby step 3 and just started investing right away. What would you do If your car’s tranny went, or your house needed a new roof?

To keep yourself from borrowing on credit cards, against your house, or raiding your retirement funds: stay focused on the Steps in order and build that emergency fund before you start investing.

Note: Depending on your income level and monthly cash flow at this point - it is possible to do steps 4, 5, and 6 all at once with a little bit of automation. But if not - do the steps in order.

Steps 4: Saving for Retirement

Now that you have a cushion to fall back on if it all hits the fan - get your capital working for you by investing. (We have a ton of blog posts on that, check out a good one for beginner’s here)

Dave says in Baby Step 4 to invest 15% of your take home pay to retirement. Generally this will take place in 401k and IRA accounts. NOTE: The 15% number he quotes does NOT include company match if you have one!

Here, Dave is preaching that the more of your income you can save, the better. (Our posts on the power of percentages and Financial Independence/Retiring Early or FI/RE dive into this a bit deeper)

Steps 5: College Funding for Your Child

There are many options when choosing higher education: 4 year private/public school, 2 year programs, trade schools, or simply no college at all. Either way, you should be ready for it. Look into a state 529 option to save for college with beneficial tax treatment.

Steps 6: Pay Off Home

home

This one comes after saving for retirement and your kid’s college funding because it would be sad to own your house outright without having a solid retirement or being able to help your child pay for a quality education. This step is the icing on the top - a fully paid for house is a necessary staple when pursuing wealth.

(Note that many disagree, or believe that a single family residence is generally a poor investment. Read here for more on that.)

Step 7: Build Wealth and Give

Imagine this: You have no debts to repay, a rock solid emergency fund to fall back on, and you own your house outright.

The juicy cash flow you were sending to others in the form of debt payments is now YOURS to keep! This affords you the ability to be wildly generous with your money, because you no longer need all of it to scrape by. You also have more to continue building wealth for yourself, potentially changing your family tree forever.

I think that is the point here with Dave Ramsey’s steps. These are the 7 bullet pointed actions that ANYONE can take to go from nothing (even owing others money!) to wealthy. You can certainly change your family tree by following his Baby Steps.

Is it the most mathematically efficient way? No. Is it going to be easy? HECK NO. But does it work? Give it a whirl and find out for yourself. You might come out the other end a millionaire.

MDAS

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P.S. New blog posts coming your way every Monday!

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