Dave Ramsey’s Seven Baby Steps

Part two in my series, Baby Steps to Financial Freedom.

A brief recap: What does money management have to do with your overall health and well-being? Here’s my reasoning…

• Stress is a top contributor to a weakened immune system and resulting illness.
• Money (or a lack thereof, whether real or perceived) is a top stressor.
• Hence, good money management can greatly reduce stress, thus reducing risk of illness.
• Like other areas of conscious living, responsible money management is about 20% head knowledge and 80% behavior.

Here are Dave Ramsey’s Baby Steps, as taught in his Financial Peace University seminar.

Baby Step 1: $1000 in the bank as an emergency fund.
Your goal is to achieve financial freedom, so wouldn’t you want to get right down to paying off your debt? Yes, but this first step is critical.

Look at it this way. Up to now, what’s been your MO in emergencies? If you’re living paycheck to paycheck and don’t have much of a savings, chances are credit cards have heretofore been your emergency fund. In order to break that cycle, it’s crucial that you have at least $1000 in the bank so you won’t default to those credit cards anymore. (If your household income is less than $20,000, a $500 emergency fund is probably acceptable.)

It’s a good idea at this point to sit down and define the word “emergency.” You may have only a few months of budgeting discipline under your belt, and the clearance rack at DSW or a big sale at Best Buy, might be calling your name. But sales do NOT count as emergencies! For us, “emergencies” are defined as things like repairs to the car, house or major household appliance that couldn’t have been planned for. Unforeseen medical expenses for us or our pets. Ongoing expenses in the event that one of us lost our income. Since I live on the opposite side of the country than most of my family, an unexpected trip due to an illness or death in the family. Ransom money in case one of us gets kidnapped. (Just making sure you’re paying attention!) You get the idea.

Write down these definitions on paper, and if you’re married, make sure you both agree on them. If you’re single, give a copy to a friend who will hold you accountable.

Now you’re ready for step 2.

Baby Step 2: Pay off debt (credit cards; car, student or home equity loans; medical bills; etc.) using the “debt snowball” strategy.
I was lucky enough to have very little debt when I went through FPU so I never really got to do a debt snowball. Now that we’re married, we have my husband’s student loans and a mortgage, so I get to snowball! It’s fun to watch the balance go down: We’re tackling the smallest student loan first, and in less than six months we’ve paid down the balance by 34%.

I’ll go more into the debt snowball in a later post, but here’s the general idea:

• List all of your debts in order from the smallest balance to the largest, including the payoff balance, the minimum payment and how many payments you have remaining.
• Continue making the minimum payments on each debt, but pay extra on the smallest one as you are able to.
• When you’ve paid off the smallest debt, add what you were paying on it to the minimum payment of the next smallest debt. Continue doing this until you’ve paid off all your debts and you are DEBT FREE!!!

Baby Step 3: Save 3-6 months expenses for a fully-funded emergency fund.
In this economy, if your job security is at all at risk, it doesn’t hurt to have more than six months expenses saved.

Revisit your list of agreed-upon emergencies. Ironically, the larger your emergency fund, the fewer emergencies you have! Dave calls the emergency fund “Murphy Repellant.” This is partly because as your budgeting improves, you save for things like doctor visits or to replace or repair your cars, so those expenses won’t have to come out of your savings. As you watch the money in the bank grow, you become reluctant to dip into that hard-earned savings at all. When you do have an emergency, you get creative at finding ways to pay for it without using your savings. (No credit cards though!)

It’s worth noting that there is no “get rich quick” scheme here. As Dave puts it, he’s in the crockpot business, not the microwave business. Consequently, I have yet to get past baby step 3 in my personal journey! So these last four baby steps are uncharted waters for me, topics I know less about.
Baby Step 4: Invest 15% of your household income into Roth IRAs and pre-tax retirement funds.
Baby Step 5: Save for your kids’ college educations.
Baby Step 6: Pay off your mortgage early.
Baby Step 7: Build wealth!
As I learn more I’ll write more about them.

I’m eager to get to the “build wealth” part.

Questions or comments about this article? Contact me here.

Other posts in this series:

• My Journey Towards Financial Freedom
• How to Make a Budget That Works

Stay tuned over the next few weeks for upcoming posts in this series:

• How to Do a Debt Snowball
• Myths About Debt: Why It’s Not a Wealth-Building Tool
• The Necessary Components of Every Financial Plan
• How to Calculate Your Net Worth
• Extra Wealth: This is What It’s All About!