Whether you’ve read his books, listened to his audiobooks, or attended his Financial Peace University classes, you’ll never forget the blunt, in your face financial advice of financial guru Dave Ramsey. This man pulls no punches. His plan for your financial success is relatively simple and summed up in seven baby steps to financial freedom.
7 Baby Steps to Financial Freedom
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In Dave’s opinion, most of us are wimps who fail to man up or women up to take control of our own financial destiny. As he explains in his book, The Total Money Makeover, “You are the problem with your money. The financial channel or some late-night infomercial gimmick isn’t your answer; you are. You are the king of your future, and I have a plan.”
If you are willing to make the financial sacrifices that most people aren’t willing to make, Ramsey argues, later on, you’ll be able to live a financially free and secure life that most people will envy.
Step One: Save $1000 as starter emergency fund.
Life happens. It throws you financial obstacles when you least expect them. Your car breaks down, your water heater stops working or your kid needs braces. That’s why Ramsey argues that, above all else, you need an emergency fund to protect you from life’s financial road bumps. Unfortunately, nearly 7 out of 10 Americans have less than $1000 in savings. But with a little effort you can create this necessary security blanket for life’s unexpected curveballs.
Step Two: Pay off all your debt as quickly as possible
Dave Ramsey hates debt and feels you should too.
“The reason I am so passionate about your getting rid of debt is that I have seen how many people make huge strides toward becoming a millionaire in the short time after they get rid of their payments.”
Ramsey suggests the debt snowball for attacking your debts. Make a list of all your debts in order of smallest to largest debt. Pay the minimum on all of your debts, but then use any extra money and apply it to the debt with the smallest balance. By dedicating extra money to the smallest debt, you can pay it off quickly, creating psychological wins that will motivate you to pay off additional debt. Once the smallest debt is paid off, use all extra money to pay off the next largest debt, and so on.
Step Three: Build your emergency fund to cover three to six month of expenses.
While $1000 should cover small bumps in the financial road, Ramsey wants to make sure you can weather the more severe financial storms as well. That’s why he advises that, once you tackle your debt, that you supersize your emergency fund to cover 3 to 6 months of expenses. This will help you deal with more severe financial catastrophes like a job loss or major illness.
Step Four: Invest 15% of your income into your retirement
Once you’ve taken care of the basics, Ramsey wants you to start looking toward the future and begin building wealth. Invest in your Roth IRA and other pre-tax retirement vehicles like your employer’s 401(k) or 403(b) plans.
Here is where I differ with Ramsey. While he suggests investing in mutual funds through your Roth or 401(k)/403(b) plan, evidence points to index funds being a much more financially prudent choice than actively managed mutual funds. I also suggest having a mix of bonds in your investment portfolio to help hedge against market downturns, especially as you near retirement age.
The key point where we agree, however, is that you must consistently invest a portion of your income into your Roth IRA or 401(k)/403(b) plan to secure a prosperous retirement.
Step Five: Invest in college funds for your children
You must save for your child’s education. This should be easier once you have your major debts paid off and have built up a significant emergency fund. Notice that this step comes after taking care of your retirement. You can use an Educational Savings Account or 529 investment plan to prepare for that eventual day when your kid leaves the nest to pursue higher education dreams.
Step Six: Pay off your home mortgage.
Dave is a big advocate of attacking your mortgage because of all the money you’ll save in interest charges. If you’re financially able, he even suggests switching from a 30-year mortgage to a 15-year mortgage. The move will give you financial peace of mind when you pay off your home years ahead of time and will save you thousands of dollars in interest.
Step Seven: Continue to build wealth but have fun and learn to give some of your money away
This is the pinnacle of Dave’s financial blueprint. At this stage, you’ll have the money you need to supercharge your investments and enough cash to be able to live like only others wish they could. But having all the money in the world is of no use if you don’t use some of your money to help others, whether it be family members or your favorite charities and causes.
Dave Ramsey’s baby steps plan consists of taking charge of your behavior and committing yourself to paying off debt so that you can build savings and investments. It requires sacrifice up front in order to reap the benefits down the road. Not everyone has the discipline to follow his plan, but if you do you’ll be handsomely rewarded.
BMWK: Are you ready to take the necessary steps to financial freedom?
Editor’s Note – This post was originally published on May 2, 2017, and has been updated for quality and relevancy.