This week in our finance Facebook Group, we are discussing Dave Ramsey’s Baby Steps. His theory is that by taking small steps, you can get out of debt, build wealth, and give outrageously. In all honesty, it isn’t a theory anymore; he has had massive success helping people who are determined to get out of debt to achieve their goals.
If you’re unfamiliar with the baby step program, here are the basics.
- Step 0: Get caught up on your house payments, car payments, and utilities.
- Step 1: Save $1,000 in a starter emergency fund. This is just a starter fund. once your debt-free, this will increase
- Step 2: Pay off all your debt using the debt snowball.
- Step 3: Save a full emergency fund of 3-6 months of expenses
- Step 4: Begin Saving for retirement at 15%
- Step 5: If you have children start saving for college
- Step 6: Pay off your house early
- Step 7: Build wealth and give outrageously.
You’ll find many opinions on rather or not this is the best plan, but we aren’t here to discuss that. Let’s look at why this works.
At step zero, you stop paying for all the extras. You go down to the bare bones of what you put any money towards, including stopping retirement contributions. No cable, no amazon prime, you get rid of everything. This is also a great time to start selling off all your extra stuff and get another job.
Why this works: once you take out all the extra spending, you’ll find you have far more money than you originally thought. Sometimes these sacrifices are difficult, but the point here is to pay off all your debt as quickly as possible so you can start taking back your finances and tell your money where to go.
Step one is about building a starter emergency fund. This is just a bit of extra money set aside to keep you from small emergencies, like a broken windshield or a minor medical emergency. This isn’t supposed to be used for a dinner out; it’s only for emergencies. You shouldn’t have more than $1,000 in your savings account, but you should leave all your investment accounts alone unless you in a unique and extremely desperate situation.
Why this works: even though it’s just a starter emergency fund, it provides an enormous amount of relief during step 2. Even though the idea of emptying out your bank account down to $1,000 may seem scary to some, it’s all about getting out of debt as fast as possible. For others, the idea of saving $1,000 might seem hard, but finishing this step is extremely important and rewarding.
Step two is paying off all your debt (except for your house) using the debt snowball method. Start by listing all your debts out and then organizing them from smallest to largest. Then pay off the smallest amount first, using every extra penny you have to pay it off as quickly as possible. Once that debt is paid off, you’ll use all the money you were using to pay off the last debt and put it towards the next debt. Eventually, you’ll pay off all of your debt.
Why this works: in two words, small victories. Once your first debt is paid off, and you begin to build the momentum, you’ll get excited about paying it off as quickly as possible. While there are other debt payoff methods, this one seems to be the most successful because of the small success that stack up over time.
In step three, you finally get to start paying yourself in the form of a fully-funded emergency fund. 3-6 months of expenses, and since you’ve just been living a scorched earth lifestyle, you will know clearly what the minimum amount you need to survive is. Choosing how much you want in your emergency fund depends on how stable your job is.
Why this works: After working so hard to become debt-free, it’s good to see that now your money is yours, and it’s now working for you. This emergency fund stands well in front of you and most large emergencies. Lose your job; you have some time to find a new one. Hospital stay; you have some money to help you make ends meet and pay off the bill.
It’s important to note that you should be doing steps 4, 5, and 6 at the same time.
For step four, you finally start your retirement savings up again at 15%. This is a great amount to start building a retirement account that will actually be enough to live on when you’ve retired. There are several different types of retirement accounts. Check with your employer to see what they offer and then with an investment professional to finalize your plan.
Why this works: this amount of retirement is going to be very useful when you are ready to retire, but when you reach step 7 you can begin putting even more towards retirement. Knowing that your future is even more stable offers a tremendous amount of peace of mind.
Step five is only applicable if you have children and you are in a place where you can afford to save for their college. Remember that paying for your child’s college education is very nice but not a requirement for being a good parent. There are many factors to consider when helping your child choose a college everyone can afford as well as grant opportunities.
Why this works: Rather you want to save enough to be able to pay their whole way, or you just want to help out a bit, this is about a conscious effort to make sure that you have actually put the money away. College debt can feel crippling, and making sure that your children don’t have to spend years paying it off will jump-start them into a better life.
Now in step six, it’s time to put all your extra money into paying off your house. It’s also recommended that you have a 15-year mortgage, which will also help you pay off your house even earlier than most people.
Why this works: once your house is paid off, then you are truly in charge of where your money goes. You will have the incredible opportunity to choose what you want your money to do for you. Imagine what your life would be like without a mortgage payment or rent payment each month.
Finally, in step seven, you’ll be in the place to max out your retirement options and give outrageously. Once you have no payments at all, including your mortgage, the opportunity to do good abound.
Why this works: giving back after struggling through these steps and being able to bless others will make all the hard parts worth it. This is the dream. You’ll be able to live like no one else.
Overall this plan is extremely comprehensive and allows you to tackle your finances head-on and get you to the financial freedom you are looking for. We highly recommend it!