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These are the steps that introduced me and my husband to what financial independence is and for that I am eternally grateful. But a lot of important considerations get looked over if you just find a list of the steps and start crackin. The articles circulating the web are from two camps: Dave Ramsey people, who are relentlessly devoted to the man, and people on the other side, who do math. My goal is to neutrally answer the question: What are The Baby Steps?
The Baby Steps, outlined in the book The Total Money Makeover, are the foundation of personal finance guru Dave Ramsey’s debt free empire. And as with anything popular, they don’t come without their critics. I’ll be the first to say that The Baby Steps are not the right financial plan for everyone but I am 100% passionately convinced that anyone can do them, and they work 100% of the time.
1. $1,000 in a Starter Emergency Fund
The foundation to your financial house is your emergency fund. It’s in place to allow you to make rational financial decisions in an emergency. It also keeps you from going into more debt. It can’t be emphasized enough that anything you have to spend your emergency fun on should pain you. This money isn’t for a flash sale or unexpected gift, it’s for ER visits, car breakdowns, and job loss. If it doesn’t physically pain you to hand over the cash for it, it’s not for this fund.
2. Pay off all Debt Except Your House
This is the one DR get’s a lot of flack on. But good for him, if you’re not being criticized then you’re not changing anything. There is no such thing as good debt. Owing someone money strains a relationship right? But owing to a bank cuts out that relationship so we don’t feel bad about saying “you’ll always have debt.”
Owing money to anyone/thing is a liability and prevents you from becoming financially secure. Unfortunately, most people have settled for stable. But we all know boat rocks from time to time. That’s why becoming debt free is important. If your goal is to just get by then you definitely do not need to get out of debt. 80% of American have some form of debt and 69% see nonmortgage debt as a necessity.
If you want to be financially successful you need to get out of debt. What are the baby steps without The Debt Snowball: paying off your debts smallest to largest at a ridiculously fast past. I’m talking unsustainably fast, like when you’re done you won’t just be tired, you’ll be almost dead. The math will not make sense but don’t give yourself too much credit, if you were thinking about math you wouldn’t have taken out the loan in the first place.
Dave’s method is rooted in psychology. Little and more frequent wins upfront motivate people to keep persevering. By the end, when the wins are fewer and farther between, the habits you’ve built will push you through. Think of it like training a puppy, you use treats in the beginning but you’re not giving your 2-year-old dog a biscuit for peeing outside.
This is the hardest baby step but the rest are significantly less effective if you don’t finish this one. Anything is survivable for two years, that’s how long the average household takes to pay off all their debt (minus the mortgage.)
Learn how to budget to find extra money to throw at debt.
3. 3 to 6 Months of Expenses in Savings
This is where you can slow down, quit one of your extra jobs, take a vacation, or sleep for a week (or all of the above.) Once paid off all your debt you build your full emergency fund. 3 to 6 months is a good amount, enough for major illnesses but not anything your retirement account will miss. For most people it’s $10,000-$15,000. This amount will depend on your age, job volatility, and family size. Read my Emergency Fund Guide if you need help figuring this out.
4. Invest 15% of Household Income Into Retirement
15% is the minimum you’ll be investing until you retire, it will only increase from here. If you’re company has a 401K match start with that, then set up and max out a Roth IRA then go back to the 401K and throw the rest in there. Most people will be done for now but if you have more (first, be my friend) then you can invest in non-retirement related regular ol’ mutual funds.
Whether this is 15% of your gross or net pay depends on how much you want in retirement. If you have multimillion dollar dreams you’re definitely gonna go gross, but if you live a simple life then you’re fine with net. The point is not “how little can I put in?” (Fear not, you should be cured of that mentality in step 2) but “what do I need to put it?” Check out this tool from Chris Hogan that calculates how much you’ll need in retirement based on your goals.
5. College Funding for Children
There’s no rule for this one but Dave just recommends a 529 or ESA for this one. Maybe it’s because I don’t have kids or because 90% of our debt is student loans but I am not sweating this one. I’m not going to save $100,000 for my kid to go wherever they want for an education. I do plan on saving to match whatever scholarships they get and what they make in their paycheck. (We both worked through college why shouldn’t they?)
This financial journey we’ve taken has shaped our marriage and us as individuals. I’m not going to take away the difficulty of some financial lessons because I look forward to talking about those decisions with my children one day. As much as I wish I’d had a free ride in college (without working for my scholarships) I’m a smarter person for having done the hard work, and who doesn’t want smart kids?
6. Pay off Home Early
Baby steps 4, 5, and 6 are done simultaneously. By the time you get here DR says it takes an average of 5-7 years for people to pay off their mortgage. Sounds impossible on a 30-year mortgage? Not when you consider that this step comes roughly three years into the program. By this time you know how to save, be frugal, work hard, and you owe nobody anything so every penny you make is yours. Sounds doable for someone like that right?
Some people will point out the tax benefit that a mortgage gives you but again, don’t call yourself a mathematician just yet. The $2500 or so you save on taxes still costs you $7500 more than if you were mortgage free! You can see the actual math here.
Also read: Are you Ready to Buy a House?
7. Build Wealth and Give
This is the one we’re all trying to get to. At this point everything your own, you actually own. You don’t owe a cent to any bank, school, or store out there. Now every dollar that comes in you bank account goes only where you want it to go! This is the time to be generous, have fun, and look forward to retiring early. This is financial security; your money is no longer at the mercy of your obligations.
Why do the Baby Steps Work?
These steps break down the basic principles of personal finance into bite-sized tasks that anyone can accomplish. Most people don’t question whether they work numerically but they don’t believe it’ll work for their situation or lifestyle. The glaring truth is that just because these steps are “baby” sized doesn’t mean they’re easy.
These steps are accomplishable by any adult with the ability to say the word “no.”
So to anyone interested in Dave Ramsey’s rationale on the baby steps and success stories I highly recommend getting his book The Total Money Makeover. Otherwise, you have everything you need to start a new direction on your financial journey. The power is your hands and your bank account. What are the baby steps doing for you right now?
Disclaimer: This post contains affiliate links. Making purchases through these links gets me closer to Baby Step 7. Cheers!
Jen Smith is a personal finance expert, founder of Modern Frugality and co-host of the Frugal Friends Podcast. Her work has been featured in the Wall Street Journal, Lifehacker, Money Magazine, U.S. News and World Report, Business Insider, and more. She’s passionate about helping people gain control of their spending.