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If you’ve read anything about personal finance, it’s hard not to come across Dave Ramsey tips.
He runs a blog, does a radio show for an audience of 13 million, has several of his own apps, and has had 5 million students take his Financial Peace course.
But when it comes to personal finance, one size doesn’t fit all. So, are Dave Ramsey’s money tips right for you?
His story is unique because he’s a rags to riches…to rags…back to riches story.
He became successful in the 1980’s, building a 4 million dollar net worth by investing in real estate. But eventually, he took on too much debt, and lost everything.
He started again from scratch, now with a young child, and as he says, “a marriage hanging on by a thread”.
This time though, he took a different approach. Rather than building wealth through borrowing money and acquiring assets, he focused on basic personal responsibility.
Things like avoiding credit card debt, and systematically budgeting and saving. And it worked. So much so, that his seven “baby steps” done in a specific order, have help thousands of other people move beyond paycheck to paycheck life.
The 7 Most Popular Dave Ramsey Tips: The Baby Steps
The 7 steps that Dave Ramsey recommends, are intended to take you from paycheck to paycheck, to financially independent.
Here, we’ll describe each one, and then explain how to actually do them.
Step 1. Save $1,000 in an Emergency Fund
If you’re knee-deep in credit card debt now, then scraping together $1000 just to drop into a savings account might seem like a waste of time and money.
But there’s a strategy.
One of the biggest stumbling blocks to moving beyond paycheck to paycheck, is your inability to have a predictable budget. You can write down every single expense, and plan out your paycheck to the last dollar.
But when your car needs brakes and you need to come up with $500 fast, where does it come from? Charging it on a credit card, or paying with money budgeted for another bill, is guaranteed to keep you struggling.
So this step is like an “all hands on deck” situation. You’d make minimum payments on every bill, scrimp, save, sell things and do whatever you can, to get that $1000 saved into a separate account – other than your checking account.
How to Do This
Here’s how I started my emergency fund – and I could kick myself for not doing it sooner. I installed the Digit app, which connects to your checking account and moves small, affordable amounts every few days into an emergency fund.
So it does two things. It accomplishes the task of making the deposits, and it removes any doubt that you’ll be able to pay for your next emergency.
Digit is free for 100 days, then they’ll deduct $2.99/month from your account.
But after 100 days, I had over $600 dollars in my account. So for them to deduct the price of one coffee, while I had the comfort of knowing that I was prepared to pay for an emergency, didn’t bother me at all.
Step 2. Pay off All Debt - Except Your Mortgage
If you’ve been living paycheck to paycheck, and you’ve successfully scraped your $1000 emergency fund together, then you already know one thing – things can be different.
You’re prepared now for a basic emergency, so if you focus on reducing your debt, you CAN make progress.
But this step is about more than whittling away at your Visa bill or your student loan.
It’s also about shaking the ‘I want it now’ mindset. We as a society, have a problem delaying pleasure, and that’s why so many of us have regrets later in life. Living two decades stuck in debt would make anyone’s life come to a grinding halt.
So your biggest struggle here, will be to keep the focus on what you want over the next 3-5 years. And to ignore your neighbor who’s going to Disney and buying a new car.
Taking control of your life, and getting out from under debt is transformative. Sacrificing short-term ‘stuff’ to put yourself into position for the long term, helps you develop a sense of who you are, and what you value.
How to Do This:
There’s no way around it. Eliminating all your debt will require some belt tightening, and probably some lifestyle changes. But thousands of people have done this. You can too.
First, think about where you, or you and your partner want to be in 3-5 years. What do you want in life more than anything else? This goal will be the basis for every money decision you make for the next few years.
You’ll definitely want to write out a budget if you don’t use one now. Here are two posts that’ll help:
And here, I go over Dave’s two debt elimination strategies – the debt snowball, and the debt avalanche:
Are you struggling to pay off a car loan now? That can be a huge handicap when you’re trying to get into a position to actually save money. Not to mention, that cars depreciate so fast. Dave Ramsey has a pretty good method to get the cash together to buy a car without a loan. I go over his method in this post:
Step 3. Save 3-6 Months of Expenses in an Emergency Fund.
Once every bit of consumer debt is paid off, the idea is to put the pedal to the metal and save everything you can, to fully fund your emergency fund.
That first $1000 will protect you from average emergencies. But you need to be ready for the big ones, like a job loss. Believe me, it happens when you least expect it, and it can be devastating.
Paying off your debt is empowering, so at this point, you’ll not only have more money to build your emergency fund, you’ll now be pumped to build it quickly.
Once you have $15,000 – $20,000 in the bank, you can breathe easy, knowing that an emergency isn’t going to throw you into bankruptcy.
How to Do This:
So far, Digit has been a simple, reliable way to quickly accumulate over $1000 into an emergency fund. Here’s what I did at this point:
I kept my Digit account open, and just used it to accumulate a few dollars here and there to use for Christmas gifts. You can limit your contributions or freeze them anytime you want.
But to accumulate the larger amount of 3-6 months of expenses, I wanted an account that paid a better interest rate than a standard savings account, but was also easy to access.
The highest rate I’ve seen for savings accounts, is CIT Bank’s Savings Builder. They pay over 18 times more than traditional banks. It’s simple to open an account online, and withdrawals are easy. They’ll do a free transfer to your checking account whenever you need to.
But the bottom line is:
Your emergency fund needs to be separate from your checking account.
Step 4. Invest 15% of Your Income Into a Retirement Fund
Depending on the amount of debt you’re trying to eliminate, and getting your emergency fund built, you may have been working at this for a year or more now.
That’s perfectly normal, because remember, we’re focusing on our own plan. However long it takes, it’ll work.
But once you’re debt free, and have an emergency cushion, it’s time to start building wealth!
One big milestone in saving for retirement is accumulating your first $100,000 dollars. But once you do, each successive hundred thousand takes less time because your money is earning money.
That’s why getting to this point, and starting to save at least 15% is something you can’t wait two decades to do.
How to Do This:
There’s a good chance your employer offers a savings plan with matching contribution – possibly 50% for every dollar up to a certain percentage contributed. If they do, you want to sign up asap. Nowhere else, can you earn a 50% return.
If they offer both a 401k and a Roth, you may want to contribute enough before tax contributions into the 401k to get their maximum match, then contribute the rest to a Roth. The Roth will enable you to withdraw the money later, tax free.
Some employers will automatically raise your contribution by a percentage point each year. But if not, I’d manually raise it with every raise or bonus.
Step 5. Save for Your Child's College Fund
As the saying goes, you can finance college, but you can’t finance your retirement. You either have it, or you don’t. So once you’re debt free, and you’re contributing to your retirement account, it’s time to think about the kids.
How to Do This:
The most popular way to save for college is through a 529 plan because it offers tax-free growth and withdrawals. But you’ll need to show that you’ve used the money for qualified educational purposes.
Those would be things like tuition, room and board, computers, books, software and internet access.
Other people (like grandparents) can also contribute a tax-free gift of up to $15,000 to your child’s account each year.
But how much should you save?
It’s impossible to predict exactly what college will cost in 10-15 years, but one idea is to consider what type of school, in-state or out-of-state, and look at the tuition history, and rate of increases.
If you can make a ballpark estimate, then calculate what it would take to save about a third of that. Hopefully, you’d have other help in the way of grants, scholarships, or student work-study programs.
Step 6. Pay Off Your Home Early
Most people buy their first home with a 30-year mortgage, rather than a 15-year. A 30-year loan has a lower monthly payment, and when you’re about to make the biggest investment of your life, it seems more budget friendly.
But you’re also extending your largest monthly bill for another 15 years.
Owning your home free and clear within 15 years, or even 10 years, would save tens of thousands in interest payments. And once you’re mortgage free, your ability to build a retirement fund would skyrocket.
How to Do This:
This is one step where I’m not totally in lockstep with Dave Ramsey’s tip of always going with a 15-year mortgage.
Yes, a 15-year loan enables you to pay off your home much earlier, and is probably a lower interest rate. But you’re also locking yourself into a payment that’s around 50% higher than with a 30-year loan.
Most 30-year loans allow pre-payments, so sending in an extra amount each month towards principle will also pay it off much quicker.
How do You Know What's Best for You?
Before even looking at homes, you’ll want to do a bit of homework to see what size monthly payment you can afford. Dave recommends spending no more than 25% of your take-home pay on a mortgage payment.
- Your budget’s gonna come in handy now. Compare your net monthly income to every monthly expense. Don’t forget to include savings.
- Here are some tips on creating a budget, and here are 10 Free Budget Templates that’ll make it easy.
Once you know what kind of monthly payment you can afford, it’s time to see how much house that payment can buy.
Here’s a handy mortgage calculator that’ll help you to determine what price range you can start looking at:
Ultimately, it’s your decision whether to go with a 15 or a 30 year loan. I agree with Dave Ramsey’s view that paying off your mortgage early will open up the floodgates for your ability to invest in your retirement.
It boils down to how aggressive you want to be, and whether you have the discipline to make extra payments each month.
Step 7. Build Wealth and Give Wealth
If you can get to point where you’ve built an emergency fund, paid off your home, and have invested for retirement, you’ve accomplished a lot!
And you’ve done it yourself, through simple consistent habits.
So at this point, you may want to help someone else who may be in the same situation you once were. Or maybe there’s another local cause that could use help.
The idea of this step isn’t so much about giving back, because nobody helped you get where you are. You did it. It’s more about just giving, and helping.
So there they are. The 7 Baby Steps. Will they work for you?
The ideas here certainly aren’t revolutionary. Focusing on long-term goals, avoiding credit card debt, maintaining an emergency fund, paying off your home early… They’re common sense. Or as we say here, common cents.
I think the reason Dave Ramsey’s baby steps resonate with so many people, is because many of us learn best when someone who’s had success, lays out a plan. When they say:
“Here’s how I got from here to there. First do this… got it done? Now do this… then this… then this”.
So if you’re in a situation now, where you don’t maintain a budget, have no emergency fund, and you’re counting the hours till your next paycheck, then going through the 7 baby steps will:
- Help you to get out of the victim mentality where you expect the government, or the union, or some other miracle to take care of you.
- Give you a roadmap that’ll work as long as you have the discipline to follow it.
I may not agree with every single detail of the 7 baby steps, but I agree with the overall idea. The aim is to have long-term goals, and then make choices every day that align with them.
That’s what’ll put you into the position to build wealth as quickly as possible, and have less regrets in life.
How about you? Have you used any Dave Ramsey tips, or a variation of them?
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