dave ramsey baby steps

Dave Ramsey’s 7 Baby Steps Explained

If you’re working your way out of debt, chances are you’ve heard of Dave Ramsey’s baby steps.

The baby steps are Dave’s systematic approach, or steps, to getting out of debt, saving for emergencies, and ultimately building wealth. It’s the sequence of financial steps that millions have used to transform their finances, myself included.

So what’s so special about the steps? Nothing really. It’s simply age-old, practical components of financial management and wealth building.

Though most people think of it as an all-encompassing approach to finances, it should only be considered as a minimum of what you should do.

As many critics of Dave Ramsey note, there are some components and considerations that are missing. I’ll discuss those at each step.

To get more details on the 7 Baby Steps, I recommend checking out Dave’s book, The Total Money Makeover.

Baby Step 1: Save $1,000 for emergencies

The first baby step is to save $1,000 for emergencies. The point of this emergency fund is to have money set aside when life happens.

The reality is that most families don’t have money set aside in case of an emergency. In these instances, many find themselves getting into debt to cover the costs of unexpected events. As a result, they continue in a cycle of living paycheck-to-paycheck and being in debt.

Having $1,000 saved is a way to mitigate the financial impact of emergencies. Though there is no significance to the $1,000, it is enough to cover most emergencies while not tying up funds that can be put toward paying off debt.

Ultimately, you will want to put more money away for emergencies. However, this is just the start of your emergency fund and the foundation for step two.

Need help with saving? Try these savings challenges.

Baby Step 2: Pay off all debt (except the house) using the debt snowball method

One of the key characteristics of millionaires is that they have little to no debt. So it’s no surprise that it would be a part of the seven baby steps.

In this step, you’ll leverage the debt snowball method to pay off every debt except for your house.

The debt snowball is another method made popular by Dave Ramsey. It is simply a way of paying off your debt from the smallest balance to the largest.

How the debt snowball works

  1. List all of your debts from smallest to largest, regardless of the interest rate
  2. Pay the minimum on all except the smallest debt. You’ll put as much extra money toward the smallest debt as possible. Once you pay off the smallest debt and apply funds to the next smallest debt while still paying the minimum on the others.
  3. Repeat the process until all debt has been paid off.

As you begin to pay off your debt, you’ll pick up more momentum along the way—like a snowball rolling down a hill.

Though Dave recommends the debt snowball method, there is another popular method for debt repayment called the debt avalanche. In that method, you will pay off your debt from the largest interest rate to the smallest.

While the idea behind the debt avalanche method is to save you more money over time, the debt snowball method seeks to provide quick wins that will keep you motivated. In some cases, you’ll find that the time to pay off debt and the final cost is the same.

A great way to determine which method is best for you is to use an app called Undebt.it. This site allows you to input your debts and it will compare both methods so that you can decide which is best for you.

Baby Step 3: Save 3-6 months worth of expenses

After paying off all of your debt except your home, the next step is beefing up your emergency fund. Though having $1,000 stowed away in case of an emergency is great, you’ll want to put more away.

The recommended amount to put away for emergencies is 3-6 months’ worth of expenses. The idea here is that if you lose your primary source of income, you’ll be able to support yourself for up to 3 or 6 months without having to go into debt.

Though Dave recommends 3-6 months, I’d venture to say that 12 months should be the goal.

I’ve personally been in a situation where I’ve been laid off and having the funds there gave me the option of going back to work or at least not settling for a job out of desperation.

This emergency fund isn’t just for a job loss. It’s for other emergencies that pop up, like a car breaking down.

Where to put your emergency fund

Foremost, your emergency fund should be separated from your everyday checking account. You want to avoid the temptation of dipping into it to pay for non-emergency expenses. That’s why I suggest putting these funds in a completely different bank—preferably online.

Online savings accounts offer significantly higher interest rates than traditional brick-and-mortar banks.

What does that mean for you? It means that you’re able to make a little cash off of the money that’s sitting in your account.

The downside of having your emergency fund in a separate bank is that it takes a few days to transfer. So in the case of an emergency where you need cash immediately, it can be a hindrance.

In this scenario, I recommend keeping $1,000 in a savings account at a bank that you can easily access. This may mean another brick and mortar bank that you can physically access for funds.

Baby Step 4: Invest 15% of your income in retirement savings

While you’re paying off your debt, you may opt to not put money in your retirement to free up cash. In fact, that’s what Dave actually recommends in his version of the debt snowball method. But, at this step, you’ll start investing again.

At a minimum, you should take advantage of your employer’s match if it is available. If your employer does not offer a 401(k) or if you’re self-employed, you can open your own Roth IRA account.

In case you’re wondering, there is no real mathematical reasoning for the 15% that’s suggested in this step. However, if you make $50,000 per year (approximately the median income) and invest 15% of that gross amount each year, you can retire with about $4 million if you start at age 30.

*This number assumes an average of 12% return from the S&P-500 over 30 years.

The point is that you should invest a portion of your income for the future, while not inhibiting your ability to actually live and give. If you’re out of debt, 15% should be doable.

Baby Step 5: Save for children’s college fund

This baby step obviously comes with some assumptions. It assumes that you have children and they’re going to college.

If you don’t have children, it’s obvious that you can skip this step. However, if you do have children you may want to just rename it, “Save for children’s future.”

The reality is that every kid isn’t going to go to college. So instead of not saving at all, start putting money aside to help them start a business, buy a home, or toward investments.

To specifically save for college, you can leverage a 529 or Education Savings Account (ESA). These are specifically designed to put money away for your kids’ education.

In either case, you’ll want to start putting away money for your children’s future as soon as possible!

Baby Step 6: Pay off home early

This step is where you become completely debt-free by paying off your home early. Your mortgage is likely your largest debt that will take the longest to pay. So instead of including it with the other, smaller debts, it is its own stand-alone giant to conquer.

Because the mortgage is a long-term play, the debt pay off for it isn’t as aggressive as in Baby Step 2. Though, you can certainly get aggressive and pay it off even more quickly.

For this step, Dave recommends that you have a 15-year, fixed-rate mortgage. If you have anything else, you may refinance so that you can start to save money in the long term.

Although the mortgage is scheduled over a 15-year period, this step implies that you’ll put any extra cash that you have towards your principal balance to pay off the home early. The intent, however, is to do so after you’re squared away on your savings, retirement, and funding other life things like travel.

Baby Step 7: Build wealth and give

This final step is where you’ll start to build wealth and give generously. That includes maxing out your 401(k) or Roth IRA.

Don’t think of this step as finality, though. In fact, I’d venture to say that you should be building wealth and giving generously throughout each of their other steps. That could mean giving of your time, to philanthropic efforts, or to your church through tithes.

Giving doesn’t just happen at the end and neither does building wealth. In fact, getting out of debt in and of itself is building wealth by increasing your net worth.

3 Ways to Build Wealth

Though Dave explicitly mentions maxing out your 401(k) and Roth IRA, he doesn’t give any more details around building wealth. Below are a few things that you can do to build wealth for yourself and your future generations.

  • Purchase rental properties – Real estate has long been the front runner in wealth building.
  • Invest beyond your 401(k) or Roth IRA – Investing in the stock market can sound scary, but it’s another important piece of the wealth pie.
  • Start a business – Though starting a business doesn’t guarantee wealth, it’s a plausible means to it. Consider creating a business that can be passed down or even sold for profit.

There’s no one path to wealth, but these are tried and true components of building wealth over time.

Summary of Dave Ramsey’s Baby Steps

Dave Ramsey’s baby steps are intended to be a guide to help you transform your finances and begin building wealth.

As previously mentioned, it is the minimum that you’ll need to do if you want to get out of debt and begin building wealth. Beyond these steps, I recommend reading books like the ones I suggest here to continue your financial journey.

Posts Related to Dave Ramsey

Fo Alexander

Sharing is caring!

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.