W.Dave Ramsey’s Baby Steps were often dissected individually. My goal in this post is to outline the steps as a unit and explain why the order is important.
Hopefully, these steps can help you create a focused life plan for your finances, regardless of your age or financial well-being.
First the baby steps:
- Step 1: $ 1,000 in an emergency fund.
- step 2: Pay off all debts except the house with the debt snowball.
- step 3: Three to six months of savings in a fully funded emergency fund.
- Step 4: Invest 15% of your household income in Roth IRAs and pre-tax retirement plans.
- Step 5: College funding
- Step 6: Pay off your home early.
- Step 7: Build and give wealth.
The power of focus
Dave’s premise with Baby Steps is that people can achieve great things if they can just concentrate. As you read through these seven steps, you will think, “Yes. I need to save money. But I also have to invest in retirement. I should cash out my house early. But I don’t have to go into debt any more and save up for my child’s college. “
You readily agree that all of these goals are important to successful financial planning. The problem is, with the prospect of doing them all, your stress level will skyrocket. You clench your jaw and do what you can while worrying about goals that are taking a back seat.
The Baby Steps plan works because, by focusing step by step, you can knowingly put some important goals on hold without the nagging feeling that you are undoing.
You can also check out my YouTube video where I break down Dave’s baby steps here:
Because if you take each step, you are in a great position to take the next step.
You feel empowered and in control as you take one step behind you and begin the next. You make progress instead of walking on water.
Why are the baby steps in the order they are in?
Steps 1 and 2: $ 1,000 Emergency Fund and Debt Snowball
Note that steps 3 through 7 are about using your money to do something positive for you and your family. Of course, that money comes from your income, but the problem in most parts of America is that we use our income to pay off debts.
Since we are paying others instead of ourselves, we need to get rid of our debt (step 2) in order to free up our income for steps 3 through 7.
“What if I could use all of the money I am currently paying to creditors to“ pay myself ”?
For many people, that’s $ 1,000 to $ 3,000 a month.
Baby Step 2 Debt Snowball is designed just for that. Step 1 is required before Step 2 as you don’t want to start paying off debt without a small pillow to absorb the small unplanned expenses incurred during Step 2.
Step 3: 3 to 6 months of savings
After following the first two steps, you will have no more debt (other than your home) and you will now have the cash flow you have dreamed of: all of the money you used to pay others is available to you. The temptation is too Invest in retirement or Saving for your child’s college or Pay off your house early.
NOT SO FAST! You will get to these, but doing so prematurely is far too risky.
Stop, take a deep breath, and use that cash flow to build your emergency fund so you are actually ready for emergencies. This fund must be liquid (in a Top savings account or money market account).
How would you deal with emergencies if you skipped the step and started one of the following steps? Withdraw money from your retirement account? Rob the kid’s college savings? Borrow money against your house? All bad ideas.
Step 3 is therefore always ahead of the following steps
Steps 4, 5, and 6: Saving for Retirement, College Funding, Home Paying
You can ask,
“Why is retirement before college funding? Wouldn’t a good parent put their children in front of them? “
Good question. But what if you don’t have adequate retirement income because you made college funding a higher priority? Who will you depend on in your later years? Their children!
The thing with Retirement planning is you only get one shot at it. Years go by and one day you will be of retirement age. They have no choice. On the flip side, college funding is full of opportunities: kids can get scholarships, they can work, they can attend community colleges, they can find work / co-op programs, etc., etc.
Step 4 therefore precedes step 5. However, note that step 4 is 15% of your income. If you have cash flow greater than 15%, you can apply that to college funding right away. If you have more than enough cash flow to complete both steps 4 and 5, then you can use all the extra to repay your home early (step 6).
Note that step 6 falls short of funding retirement and college, as reversing the order can potentially get you a paid home at the expense of a decent retirement or help your kids through college. Most of us wouldn’t want that.
Not sure where to start investing in retirement? Here are some tips:
- Best places to start a Roth IRA – It can be confusing figuring out where to start investing your 15% of income. A Roth IRA is a good place to start, but choosing a broker is confusing. This list will help you choose the best broker for your Roth IRA.
- Best Online Stock Broker Sign Up Bonuses – You can get hundreds of dollars or thousands of airline miles just to open a brokerage account.
- Investment strategies for beginners – If you’ve never invested before, it can be overwhelming. This list is divided into manageable parts.
Step 7: build and give wealth.
Life is very good now! You have no debt, a large emergency fund, and a paid home. All of the cash flow that was previously used for debt reduction and house payments is now available to you.
By the way, this is the step that Mandy and I are on. As a half pensioner we don’t have a lot of income, but it is very sufficient because we don’t have any debts either. We continue to invest every month and we can give more than ever before.
After paying for our house, we began to “bless” money that we put in an envelope every month to have available so we could bless others when we saw the needs. We are also able to assist our adult daughter and daughter-in-law with their college’s cash flow.
As I said, life is good. Mandy and I are having great financial peace and we are very grateful to Dave Ramsey’s Baby Steps.
I wish you the same.
This article is a general overview of what Dave Ramsey has to offer and is not intended to replace his course, nor is it sponsored or endorsed by Dave Ramsey or the Lampo Group.