Building a new future with money is a lot like building a home. You don’t add the roof until you’ve finished framing, and you don’t frame until the foundation is secure. Dave Ramsey’s Baby Steps are designed to help you out of debt and stress and into a life of saving and giving. We’re all in different places with money. Start right where you are and get where you want to be. Know-how is 20% of the equation. Behavior change and self-discipline make up the other 80%. You can do it! Just follow the steps.
$1,000 to Start an Emergency Fund
An emergency fund is for those unexpected events in life you can’t plan for. Whether there’s a plumbing issue and everything but the kitchen sink is draining, or your brakes are squealing at every stop sign, you can be ready!
In this first step, the goal is to save $1,000 as fast as you can. Go through your storage boxes and sell some stuff. Work an extra job. Do whatever it takes to start saving money. Once you have it, open a checking account that is separate from your regular account and put the cash there. When a car battery goes out or a baseball meets a window in your house, you won’t have to go into debt to fix it. You don’t want to dig a deeper hole while you’re trying to work your way out.
Pay Off All Debt but the House
List all debts but the house in order. The smallest balance should be your number one priority. Don’t worry about interest rates unless two debts have similar payoffs. If that’s the case, then list the higher interest rate debt first.
This step will make a huge difference in your everyday life. You’ll use the debt snowball to knock out your debts one by one, from smallest to largest. Pay off the first one. Then add what you were paying on it to the next debt and start attacking it. When you start knocking off the easier debts, you’ll see results and stay motivated to dump your debt. As each debt is paid off, your cash flow will increase and the bigger debts will be gone sooner than you think. Before you know it, you’re debt-free!
3 to 6 Months of Expenses in Savings
This step is all about building a full emergency fund. It’s time to kick debt for good, with 3–6 months’ worth of emergency savings. Sit down and calculate how much you need to live on for 3–6 months (for most, that’s between $10,000 and $15,000), and start saving to protect yourself against life’s bigger surprises. You’ll never be in debt again—no matter what comes your way.
According to Money Magazine, 78% of Americans will have a major negative financial event in any given 10-year period. Most people lose momentum after Baby Step 2 and don’t push to complete their emergency fund. This pile of cash will make sure you aren’t caught off guard by a job layoff or a leaky roof. Keep your emergency fund in a simple checking account or money market account with check-writing privileges. That way, you can pay the doctor or wrecker service on the spot.
Invest 15% of Household Income Into Retirement
Now it’s time to get serious about retirement. With no payments and a full emergency fund, put 15% toward the retirement of your dreams. Between your 401(k), Roth IRA, and Traditional IRA, you have a lot of options. Find the fit that is right for you. The money you were using to attack debt can now help build your future.
This step is all about building long-term wealth. Take 15% of your gross household income and invest it first into matching company 401(k) plans and then Roth IRAs. If your company doesn’t offer a retirement plan or match your contributions, then go straight to the Roth. Spread the money across four types of mutual funds: growth, aggressive growth, growth and income, and international. Even a couple hundred dollars a month invested now can make you a multi-millionaire.
College Funding for Children
By Step 5, you’ve paid off all debts but the house, and you’ve started your retirement savings. Now it’s time to save for your kids’ college expenses. College tuitions and housing expenses continue to rise. Don’t let college sneak up on you. Saving now will put you ahead of the game when your kids graduate from high school.
Two smart ways to save for your kids’ college are 529 college savings funds or Coverdell ESAs (Education Savings Accounts). These are both tax-advantaged savings vehicles that let you save money for your kids’ education expenses. As with retirement, you can also spread the money across the four types of mutual funds: growth, aggressive growth, growth and income, and international.
Both 529 plans and ESAs allow you to save money in an individual investment account. But do your homework first! Depending on your income and what state you live in, a 529 might be better than an ESA. All that’s left then is to get started!
Pay Off Home Early
There’s only one more debt standing in the way of freedom from all debt—paying off the mortgage. Baby Step 6 is the big one! Can you imagine life with no house payment?
Any extra money you can put toward the mortgage will result in tens of thousands of dollars of interest saved and months (or even years) of not having a payment hanging over your head. If you currently have an adjustable rate mortgage, interest only, or even a 30-year mortgage, consider refinancing to a 15-year fixed-rate mortgage and pay off your home faster. It takes the average family five to seven years to pay their home off early. This journey to debt freedom is a marathon. Stay focused and intense, and keep a steady pace. And don’t forget to celebrate each little victory along the way.
Build Wealth and Give
This is the last step and, by far, the most fun. It’s time to live and give like no one else! Build wealth, become insanely generous, and leave an inheritance for future generations. You know what people with no debt and no payments can do? Anything they want! And it’s all because you had discipline for a few years. Now that’s leaving a legacy.
It took perseverance and good habits to get you here. Keep setting goals and budgeting every month. Stay intense and have fun along the way! You started investing 15% on Baby Step 4. Now you can max out your 401k and IRA so you can continue to live and give like no one else in retirement.