I‘ve been writing about personal finance for just over 3 years now. During that time I’ve written about Dave Ramsey and his “Financial Peace University” class, but I realized that I’ve never written a general review of his 7 baby steps plan to getting your finances in order and on track. So today I’ll be writing a post about his baby steps plan and what I think of it.
NOTE: This article is only a general overview of the 7 basic principles of Ramsey’s Baby Steps, and is not intended to replace his full look at the 7 steps or his FPU course in part or in full. I am not affiliated with Dave Ramsey or the Lampo Group in any way. You can find Ramsey’s free online discussion of the 7 Baby Steps here.
Who Is Dave Ramsey?
So first of all, who is Dave Ramsey, and what are the 7 Baby Steps? Dave Ramsey is a personal money management expert, radio talk show host and TV personality who over the years has helped thousands of people become debt free and change their financial lives. He gives no-nonsense advice to folks who have gotten in over their heads, and helps them to find their way out, in a responsible way. If you’re afraid of hard work, you may want to look elsewhere for your advice.
In addition to his best selling books and radio and TV shows Ramsey also teaches “Financial Peace University” at huge live events, and the 7 Baby Steps are an offshoot of the FPU class.
So what are the 7 Baby Steps?
Dave Ramsey’s 7 Baby Steps
On his website Dave Ramsey lists what his 7 Baby Steps to financial freedom are:
- Baby Step 1 – $1,000 to start an Emergency Fund
- Baby Step 2 – Pay off all debt using the Debt Snowball
- Baby Step 3 – 3 to 6 months of expenses in savings
- Baby Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
- Baby Step 5 – College funding for children
- Baby Step 6 – Pay off home early
- Baby Step 7 – Build wealth and give!
For a more in depth discussion of the baby steps, head over to Ramsey’s site. They basically involve planning ahead for emergencies, paying off debt and then planning for the future in a variety of ways. They also look at the importance of giving. Even though a lot of these points may seem like common sense to a lot of people, for some they just don’t think about doing these things if they haven’t actually been told how to do them.
Before The Baby Steps: Making A Decision To Change
Before you even decide to head down the road of using or exploring the 7 Baby Steps, I think it’s important to point out just how key it is that you sit down, talk with your significant other (if you have one), and actually make a decision that you want to change.
A lot of people talk about how to change their financial lives, but never touch on the fact that if you or your spouse isn’t ready to change, it isn’t going to happen. You have to want to change.
I know for my wife and I there wasn’t one moment where we decided that we wanted to change, it was just a gradual realization that we weren’t spending our money as wisely as we should, that we were accepting too much debt as a part of our financial plan, and that we craved the freedom of not carrying any kind of debt. We wanted to be free!
Getting to the point where you want to change might mean that you’ve hit bottom and declared bankruptcy, or it might just mean that you’re sick of not saving enough towards retirement. It’s a different point for everyone. But when you get there you’ll know.
Before The Baby Steps: Make A Decision For No More Debt
Once you’ve made a decision to change, you need to be able to begin the change immediately and make a decision as a family that you aren’t going to incur any more consumer debt. Credit cards and home equity lines of credit are off limits now. No more high interest auto loans! If you want a new TV or a new kitchen counter tops, you’re going to have to save for them. No more store credit cards to buy clothing at ridiculous interest rates!
Cut up your credit cards, and draw a line in the sand. No more debt!
My wife and I used to use our credit cards in a variety of ways. We would use them to pay for vacations because we wouldn’t plan ahead and save up for them in advance. We’d use them as a safety net for our household, instead of saving up a cash emergency fund. If we needed new furniture we would just finance it at the store, and pay it off over time. Once we made a decision to change, we realized that we couldn’t do that any more. We had to make a life change. Using the 7 Baby Steps we were able to make a change in the way we looked at money, and in the process change our lives for the better. So let’s do a review of what is involved with Ramsey’s baby steps, and what I think of them (even if the previous sentence clued you in to the fact that I’m a fan!).
Baby Steps: Getting Rid Of Existing Debt
After saving a small emergency fund 0ne of the very first things you’ll be doing in the baby steps plan is working on paying off all of your debt. Dave Ramsey is a proponent of his plan for paying off debt called the “Debt Snowball“. Basically you order your debts from smallest to largest, and pay them off in that order. By doing this you can optimize the effect of getting quick victories by paying off the smaller debts faster.
Some people would say that the Debt Snowball isn’t mathematically the best way to pay off debt, that something like the Debt Avalanche (highest interest first) method would be better. Personally I’m in favor of using some sort of a hybrid debt repayment plan where you pay off some of your smaller debts first and then re-arrange your higher dollar debts to pay them off in the order of higher interest first.
Whatever you do to pay off your debt, it’s important to make a plan of some sort, make a budget and stick to it.
Baby Steps: Planning For The Future
In baby steps 3 through 7, Ramsey explores setting savings, investment and college savings goals, as well as talking about the reasons for why we should be building wealth – to be able to be free from debt burdens, and be able to give more to others. The general ideas he talks about are all sound in my opinion, even if his reasoning in the details isn’t always something I can agree with 100%.
Saving, Investing, Giving
Baby step 3 looks at saving a 3-6 month emergency fund – in other words saving up enough money to cover just about any emergency that could come up from a broken down car to a job loss. I’m a big proponent of emergency funds, and as such I think this is a great idea. At our house, however, we decided to have an even larger emergency fund with 8-12 months in savings. In this economy we just felt better having more money than Ramsey states you should have.
After you’ve set up a contingency plan for the present Ramsey suggests looking at the future. He suggests investing 15% of your income into a Roth IRA or pre-tax retirement accounts. While I can agree that saving 15-20% of income for retirement is definitely sound advice, I’m not always in agreement with Ramsey when it comes to the assumptions he makes about getting a 12% return in the stock market, or about what types of mutual funds to invest in. I think Ramsey’s advice has been shown to be a bit suspect in this area – and should be taken with a grain of salt.
Next Ramsey suggests saving up for your kid’s education – only after saving for your own retirement. I think this is sound advice as your child can pay for their education via loans or grants, but you probably won’t be able to do the same to fund your retirement. He suggest saving up in an ESA or similar account, while I think some other options like saving for college in a Roth IRA should be considered.
When it comes to homes and real estate Dave Ramsey has some pretty strict rules about what kind of mortgages he thinks you should get, what percentage of your income you should spend on a home, and how you should work to pay it off. Ramsey suggests trying to pay off your mortgage early if at all possible after saving for retirement, your kids college and other necessary expenditures. I think having a paid off home is a great idea and it’s a great hedge against uncertainty in today’s environment. While I don’t agree with his statement that you should only ever get a 15 or fewer year fixed mortgage – I do think his advice about homes and real estate is pretty sound. Of course I’m not following it completely with our 30 year mortgage, but we are making extra payments in order to pay it off early.
After doing all those other things – saving, investing, college funding, mortgages – Dave says you move on to the mythical 7th step where you just continue building wealth, and giving a large percentage of what is left over. For me I think the giving portion should be stressed as it is such an important part of this. We’re all happiest when we’re giving to other people, and building wealth for wealth’s sake is pretty pointless. I’m glad he points out that giving is so important, and I’m glad that he points out that money and wealth won’t make you happy, but having a personal relationship with Christ – and giving as he did – will.
Dave Ramsey’s 7 Baby Steps are a debt management process that I became familiar with while i was taking Dave Ramsey’s Financial Peace University™ course a couple of years ago. I believe the process it lays out is a sound one whereby you plan for the present through emergency funds, you pay off your debts incurred in the past, and then you set about planning for your own and your family’s future.
I do think that there are certain points of the plan where I don’t have 100% agreement with Ramsey, especially when it comes to investing assumptions and methods, as well as college savings plans, but overall when you look at his plan with a 10,000 foot view, I think the ideas behind it are sound.
I would recommend using the 7 Baby Steps if you’re looking for a good debt management course, when used in conjunction with Ramsey’s Financial Peace University™ class (which I’ve found to be well worth the minimal cost). For a full look at Ramsey’s 7 Baby Steps, head on over to his site: 7 Baby Steps