How Dave Ramsey’s 7 Baby Steps Will Change Your Life
Who is Dave Ramsey?
Dave Ramsey is a highly successful personal finance Guru with a special formula that has helped millions of people get out of debt (including myself). Yes, it’s true. I followed his 7 Baby Steps method to help pay off nearly $23,000 in student loan debt by age 23. Fortunately for you, armed with Dave Ramsey’s financial compass, you can also successfully navigate your way out of any financial challenges you’re currently facing.
In this article, we will cover Dave Ramsey’s 7 Baby Steps in detail and provide our honest feedback on some key aspects to consider. Keep reading below or check out our YouTube video to learn more about Dave Ramsey’s 7 Baby Steps to Financial Freedom which can truly transform your life, forever.
Dave Ramsey’s Financial Philosophy Explained
Before covering the 7 Baby Steps, we need to understand Dave Ramsey’s financial philosophy and how it differs from other financial gurus. Unlike most, Dave focuses primarily on changing people’s behaviors rather than simply suggesting mathematical fixes to money problems. We will uncover this further in the coming sections of this article.
Some critics consider his financial baby steps flawed as they are a one-size-fits-all approach, and this often is something you want to avoid when it comes to personal finance. Nevertheless, as mentioned millions of people have found financial success by following this fairly simple process.
Now the seven baby steps are mainly for people who truly need to get their financial lives in order. For this, you can think about people drowning with thousands of dollars in credit card debt or hundreds of thousands in student loan debt. Although this is the case, I believe anyone looking to improve their financial life can benefit from Dave Ramsey’s method.
What Are Dave Ramsey’s 7 Baby Steps?
1. Save $1,000 For a Starter Emergency Fund
For those who are unaware, an emergency fund is simply money you set aside and reserve for unplanned life events. For this, you can think of things like unexpected medical bills, home repairs, and car repairs. The idea with this first step is as you set out on this intense financial Journey, you have a buffer between you and life.
You may be thinking that $1,000 is a relatively low amount. How could you afford a major car repair? How can you afford a serious medical bill?
While this is true, the idea behind this first step is more so a psychological mindset shift, again tying back to Dave’s Financial philosophy. Of course with inflation, this $1,000 amount does not cover as much as it did back in the 90’s when this plan was created.
If you want to increase this $1,000 amount slightly you can go for it, but according to Dave at this step, you do not need a fully funded emergency fund. Later in this article, I’ll explain another step that helps this make more sense.
2. Pay Off All Your Debt (Aside From Your House) Using Debt Snowball Method
For this step, list all of your debts, whether it’s student loans, credit card debt, car loans, etc. When it comes to actually paying off debt, there are 2 main methods most people follow: Snowball and Avalanche
Since Dave Ramsey’s financial philosophy is focused on behavior and mindset, the 7 Baby Steps suggests following the Snowball method.
Snowball: Pay off debt balances from smallest to largest, regardless of interest rates. Also, make minimum payments on all other debt balances aside from the smallest one you are focusing on first. Once you pay off the smallest balance, you move on to the next smallest balance until you are debt-free.
In my financial situation, I ended up going against this step. Instead, I followed the Avalanche method while following Dave Ramsey’s plan since this allowed me to pay less in debt overall.
Avalanche: Pay off debt balances with the highest interest rates first.
In your own life, when deciding between Snowball and Avalanche, you have to think about whether you’re focused on paying less overall or getting the psychological benefit. After completing step 2, the idea is that you can breathe easy as you only have your house payment. From there you can move on to step 3.
3. Build a 3 to 6-Month Emergency Fund
Once you finally pay off your debt, the next step is to increase your emergency fund to a ‘safer’ level. 3 to 6 months is a typical rule of thumb when considering an adequate amount to save for your emergency fund. To calculate the amount you need for your own life, simply follow the below formula:
monthly expenses * (3 to 6 months) = Emergency Fund
For example, let’s say on average you spend $1,500 per month on rent, $300 on groceries, $200 on gas, and $150 on dining at restaurants and want a 6-month emergency fund. In this case, you would calculate your emergency fund based on the below:
($1,500 + $300 + $200 + $150) * 6 = $12,900
Keep in mind that although 3 to 6 months is a standard emergency fund amount, if you are more risk-averse you may want to aim to save even more. I strive to keep a 12-month emergency fund in my bank account, just in case anything major happens in my life.
To store your emergency fund, I recommend using an FDIC-insured HYSA (High Yield Savings Account), as a safe, liquid option. Here are some of our top picks.
4. Invest 15% Of Your Household Income in Retirement
For this step, aim to make this 15% contribution every month to a pre-tax or tax-advantaged account. (For this, you can think of 401(k), 403(b), or different Roth Accounts.)
Admittedly, when I tried following Dave’s baby steps, I ended up investing in my retirement a little bit earlier than this step. I started my first job, saw the employer match available, and felt like I would be missing out on free money. For this reason, I contributed up to that employer match amount.
If you’re anything like me you probably understand the importance of compound interest and recognize generally the best way to gain on your savings is to invest early and often.
Depending on your financial situation you may want to wait until the step to start contributing to retirement. For example, if you have tons of credit card debt at high-interest rates, it usually makes more sense mathematically to focus on paying off those balances first.
Essentially the interest that would build on this credit card debt balance would likely outweigh any potential gains you’d make from the markets. In this way, paying off these high-interest debts first could save you more money in the long run.
With regards to the 15% contribution, this is a good rule of thumb, but if you’re a little bit older and closer to retirement, you may have to increase this percentage to reach your retirement goals. Even if you are younger and want to retire early, you’re likely going to have to contribute more than 15%. I do recommend meeting with a financial adviser to determine the best approach for your own life.
According to Dave Ramsey, while you work on Baby Step 4 you should also be working through 5 and 6.
5. Save For Your Children’s College Fund
To avoid the cycle of endless debt in your family, Dave wants your offspring to go through college debt-free. However, paying fully for your children’s education is extremely difficult for most people. Still, if you can contribute to something like a 529 Plan, according to Dave this is a great approach.
The issue with this step is that the amount needed is different for every single person. Some people have large families whereas others do not have any children. If you do not have children and want to move on, head to Step 6.
6. Pay Off Your Home Early
Now this step is often controversial to listeners and critics of Dave Ramsey. The reason is there are ways to make a better return on your money besides paying off your mortgage early. This is especially true when your mortgage has a relatively low-interest rate.
To make more money you could instead invest in index funds, but there is of course risk in the markets. Further, the average person will more than likely not consistently invest the additional money they have by not paying off their mortgage early.
In support of Baby Step 6, some people truly value the emotional freedom of having paid off their home early. At this point, you no longer have the stress of a mortgage and gain an asset that you fully own.
7. Build Wealth and Give
As your financial journey is nearly complete, the last step is to live and give like no one else. At this step, you get to invest as much as possible to eventually retire early, travel, and spend time with friends and family.
In all honesty, I suggest starting to give back before reaching this step though. If possible, you could make small donations or volunteer time for local charities. Little things like these can have a big impact on the lives of others and in my opinion giving back should be one of the core goals of reaching financial freedom.
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