Dave Ramsey’s 7 Baby Steps
Dave Ramsey’s 7 baby steps have helped millions of readers and listeners improve their finances. Some experts disagree with some of the advice offered, but there’s no denying they have been instrumental in helping many people conquer their debt.
Of course, if you find one of the steps doesn’t work for you (or doesn’t apply to you), it’s always possible to tweak his approach. You could consider it more of a framework than something you must follow exactly.
Still, having a step-by-step approach is valuable because it is both actionable and easy for anyone to follow. The steps are sequential and meant to be completed in order; you shouldn’t start the next step until the current one is completely done.
Before we dive into the details of the steps, let’s answer a few basic questions.
Who is Dave Ramsey?
Dave Ramsey is an American talk radio host who was born in Tennessee in 1960. He has spent most of his life there and still lives in Tennessee to this day.
Like many personal finance connoisseurs, Dave initially built his wealth through an extensive real estate portfolio.
However, due to the sale of the bank that financed his mortgages, he was told he had to repay the loans. He was unable to pay which caused him to file for bankruptcy.
At that point, he began giving financial advice to couples at his local church. This was in the late 1980s/early 1990s; this was the beginning of the Dave Ramsey character we know today. He started co-hosting a radio show, The Money Game in 1992.
Since then, Ramsey has written several personal finance books and formulated his baby steps in his book, The Total Money Makeover. Dave has a “tough love” approach to finance; it’s not for everyone, but for others, it’s very effective.
Dave is also a devout Christian which is a theme that is prevalent throughout his talking and writing. Though he has been a controversial figure at times, his advice is powerful and therefore worth considering if you are in serious need of financial help.
Which brings us to our next question…
Who Are Dave Ramsey’s Baby Steps For?
If you are already an expert at personal finance, you may not get much value from Dave Ramsey’s 7 baby steps. As their name suggests, these steps are intended for those who are just getting started.
If you have thousands of dollars of consumer debt – especially high-interest debt such as credit cards, personal loans, and payday loans, these steps could be for you.
If you have little to no savings (especially an emergency fund), these steps could be for you.
And if you are saving little to nothing for retirement, these savings could be for you.
With that said, let’s dive into the steps!
What Are The 7 Baby Steps?
- Baby Step 1: Save $1,000 in an Emergency Fund
- Baby Step 2: Pay Off All Non-Mortgage Debt
- Baby Step 3: Save 3 to 6 Months in an Emergency Fund
- Baby Step 4: Invest 15% of Your Income for Retirement
- Baby Step 5: Save For Your Children’s College Fund
- Baby Step 6: Pay Off Your Mortgage Early
- Baby Step 7: Build Wealth and Give
Baby Step 1: Save $1,000 in an Emergency Fund
This is step one for a reason. You could find yourself in serious trouble if you don’t have a decent emergency fund.
Why? Because things happen. What if your car breaks down? Or the water heater breaks? Or you get sick and rack up a bunch of medical bills?
Sure, you can take certain steps to make these things less likely, but it’s almost impossible to totally avoid unexpected expenses. So, what are you going to do if you don’t have an emergency fund?
Most people will borrow money from a friend/family member, charge it to a credit card, or take out an expensive personal or payday loan. But each one of these is dangerous in its own way.
Borrowing from friends/family can ruin relationships, and credit cards and loans can ruin your finances.
By having a healthy emergency fund, you ensure you can pay for unexpected expenses without putting yourself in an even more problematic situation.
You can put that money in a high-interest savings account to keep it liquid while also protecting it from being eroded by inflation.
In fact, Dave recommends putting money in a savings account intentionally to keep it separate from your checking account. Doing so will add a barrier to accessing that money, and any type of barrier will like you less likely to tap into it.
Plus, savings accounts are typically FDIC-insured, so you aren’t going to lose any of it like you could with stocks.
In a way, this step is the most important since it means covering the bare minimum. But once this one is done, it’s time to move to the next step!
Baby Step 2: Pay off All Non-Mortgage Debt
This step is fairly straightforward: pay off any kind of debt that is not your mortgage. This could be credit card debt, student loans, payday and personal loans, and others. To do this, you use the debt snowball approach.
Why does it make sense to focus on these first?
A couple of reasons: One, each type of debt is likely much smaller than your mortgage, and the debt snowball focuses on the smallest debts first. Plus, mortgages often have lower interest rates than other forms of consumer debt.
Dave actually advocates for ignoring interest rates as part of his debt snowball. Still, the fact is that tackling the debt with higher interest rates first is a smart thing to do.
The Debt Snowball
Because this step depends on the debt snowball, we’ll cover how it works in case you aren’t familiar.
The idea is simple: list your debts in order of smallest to largest. Interest rates generally don’t matter, but if two debts have very similar balances, the one with the higher interest rate should be considered larger.
Pay the minimum balances on all debts. You can do this with an auto-debit. Then, start paying as much as you can toward the smallest debt. Maybe you have $50 on a credit card.
Once that is paid off, move the amount that was put toward the minimum payment on the smallest debt to the next smallest debt. Then, continue to pay as much as you can on that next smallest debt.
As soon as the second debt is paid off, the third smallest debt would get the minimum payments from both the first and second smallest debts. This is why it is called a snowball; as you move up the chain, you are rolling more and more money into a single debt payment.
Then, you simply repeat this process until all non-mortgage debt is repaid. Because this method (mostly) ignores interest rates, it’s not necessarily the fastest way. However, the psychological wins the snowball provides can help those who are having an especially hard time repaying their debt.
The other method is the debt avalanche. With this method, you would still pay the minimum balances on all debts, but your extra money would go toward the debt with the highest interest rate rather than the smallest balance.
The important thing is to do what works for you, though. Ultimately, whatever enables you to get out of debt most quickly is the best approach.
Baby Step 3: Save 3 to 6 Months in an Emergency Fund
Baby step three is obviously an extension of the first step (save $1,000). That first step is just to get you started; to help you avoid complete financial peril. But even then, $1,000 isn’t that much.
Few, if any people could actually live for 3 months on $1,000. Even single people! Whatever your monthly expenses may be, multiply them by 3 months and then by 6 months. This is where you should be.
You might be able to cover small expenses with $1,000, such as a flat tire. But if something bigger happens, such as being laid off from your job, it may not be enough.
That’s why you should work to have 6 months of expenses covered.
Saving up six months’ worth of expenses could take a while, but once you make it there, you’re ready for the next step!
Baby Step 4: Invest 15% of Your Income for Retirement
While it is difficult to estimate exactly what percentage of people save for retirement, you can confidently say that not everyone does so.
Although the study is a bit dated, the Economic Policy Institute found in 2013 that only 53% of families ages 32-61 participated in a retirement plan. And you can expect that percentage to be lower for households without someone working where a retirement plan is offered.
Let’s say you are married and you and your spouse both make $40,000/year. If you both save 15% of your income ($12,000 per year total), with an 8% return, you would have over $1.3 million after 30 years!
Yes, 8% interest is a high rate of return – but then again, we are using modest numbers here saying you have a household income of $80,000 and save 15%. Many financial independence people save much more per year.
The point here is that saving for retirement is extremely important. Due to compound interest, you can save a huge amount of money, even on a modest income.
It’s difficult to predict where Social Security will be 30 years from now; saving on your own is much easier to predict.
Dave recommends saving 15% of your income in a Roth IRA (one for you and one for your spouse). If necessary, can also use other pre-tax retirement plans, such as your 401(k) or 457 plan.
Baby Step 5: Save For Your Children’s College Fund
This is the step the SINKs (single income, no kids) and DINKs (dual income, no kids) can ignore. Unless, of course, you intend to have children in the future.
However, if you do have children (or plan to), this step is important because powerful tools are available to help with saving for college.
Considering the average cost of college has quadrupled over the last 30 years or so (even after accounting for inflation), it’s becoming more and more important to save for college. If you expect your child or children to attend college, this is an important step.
Dave recommends a 529 plan or an education savings account (ESA).
529 plans and ESAs are both investment accounts designed to help you save for your child’s education.
While there are slight differences in the details, such as the type of investment you can choose and by what age the money must be used, they are both solid options.
Baby Step 6: Pay Off Your Mortgage Early
There has been an amusing trend on Twitter and Facebook recently: people celebrating the fact that they are now “worthless.”
No, they are not chiding themselves; what they mean is that they once had a negative net worth due to debt. But now, they have repaid all their debt and are “worthless.” Of course, “worth” in this case refers to their net worth, not their worth as a person.
That’s what repaying your mortgage can allow you to do. If you’ve followed the rest of the steps in order, you won’t have any other debt at this point. So, when you finish paying off your mortgage, you are “worthless!”
And having no debt means zero dollars paid toward interest! Interest charges are a killer for millions of people; having no interest charges could easily save you tens of thousands over a lifetime.
However, it’s worth mentioning that some people disagree with this step. Considering you have to be somewhere close to the 1% to buy a home with cash, having a mortgage is a reality for most people in the US.
But some critics say that having a mortgage isn’t automatically bad. Those whose interest rate is low might choose to use some of that money to start buying rental properties or start a business.
The possibilities are endless. This is one of those things where you should pick the approach that works best for you. Maybe paying off your mortgage early is the best thing for you – but make sure you take your individual goals into consideration.
Baby Step 7: Build Wealth and Give
The first six steps were all about looking out for yourself – and your family (if applicable).
Step seven is the first time you go beyond only thinking about yourself and your loved ones. As you build wealth well beyond what you need for yourself, you can start to give some of it away. This could be a strange concept for many of us.
The main thing Dave mentions when he talks about giving is leaving an inheritance for your children. Most of us – especially those from middle-class families – probably didn’t have an inheritance. That is certainly a nice gift, though.
While Dave doesn’t actually mention giving to charity on his site, there is no reason that can’t be tacked on. If you have an extraordinary amount of wealth, why not give some of it to a cause that matters to you?
Really, at this stage, the possibilities are endless – and that’s kind of the point. You can spend your money how you want to spend it – not just let bills dictate where your money goes.
The Baby Steps Are About Mindset
Dave Ramsey’s baby steps are an actionable plan that anyone can use to their advantage. Sure, they are easier to follow if you make $1,000,000 per year, but you don’t have to be rich to get your finances in order.
What you do need, however, is to make a conscious decision to take control. You will never be able to get to a better place financially if you don’t do that. But, once you do, you’ll be well on your way to moving past the baby steps and working toward a better financial future.