Breaking Down The Financial “Baby Steps” For When You Don’t Know Where To Start
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 want to get crackin’. The articles circulating the web are from two camps: Dave Ramsey people, who are relentlessly devoted to the man and his teachings, 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
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 fund on should pain you. This money isn’t for a flash sale or unexpected gift, it’s for ER visits, car breakdowns, and job losses. If it doesn’t physically pain you to hand over the cash for it, it’s not what this fund is for.
2. Pay Off All Debt, Except Your House
This is the one DR gets a lot of flack on. But good for him — if you’re not being criticized, you’re not challenging anything. To put it shortly, 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 boats rock from time to time. That’s why becoming debt-free is important. If your goal is to just get by, then you don’t need to get out of debt. 80% of American have some form of debt, and 69% see non-mortgage debt as a necessity.
But if you want to be financially successful, you need to get out of debt. The cornerstone of the Baby Steps is The Debt Snowball: paying off your debts, smallest to largest, at a ridiculously fast past. 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 two-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, which is how long the average household takes to pay off all their debt (minus the mortgage).
3. Three To Six 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 you’ve paid off all your debt, you build your full emergency fund. Three to Six 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 Dave recommends you’ll be investing until you retire, it will only increase from here. If your 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 by step two) 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. 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. (My philosophy is, my husband and I both worked through college, so 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 Your Home Early
Baby steps four, five, and six are done simultaneously. By the time you get here, Dave says it takes an average of five to seven years for people to pay off their mortgage. Sound 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 $2,500 or so you save on taxes still costs you $7,500 more than if you were mortgage free! You can see the actual math here.
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. But trust me, 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
Jen writes about her and her husband’s journey to pay off $86,000 of debt in less than 2 years on her website, Saving with Spunk. Follow her on Twitter here!
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