Does 7 Baby Steps by Dave Ramsey Work?

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Dave Ramsey’s 7 Baby Steps

Dave Ramsey is a well-known money expert, he has written numerous personal finance books and is best known for his 7 baby steps.

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By the way, if you haven’t read his book: The Total Money Makeover, I highly recommend it!

7 Baby Steps

Baby Step 1. Save $1,000 for your starter emergency fund.

Baby Step 2. Pay off all debt (except the house) using the debt snowball method.

Baby Step 3. Save 3-6 months of expenses in a fully funded emergency fund.

Baby Step 4. Invest 15% of your household income for retirement.

Baby Step 5. Save for your children’s college fund.

Baby Step 6. Pay off your home early.

Baby Step 7. Build wealth and give.

Baby Step 1: $1,000 starter emergency fund

The first baby step is to save $1,000 for an emergency. The reason Davey Ramsey recommends this initial $1,000 dollar is because frankly, life happens.

When you’re your financial journey there are obstacles that will come your way. These financial setbacks include things like an unexpected car repair, medical bills, home maintenance among other things.

This $1,000 can help cover these unexpected expenses. Make sure you set this money aside in a separate account from your regular checking account. Why? Protect it from yourself! If it’s readily available, you may just spend it.

I suggest putting it into a high yield savings account such as Sofi Money, Betterment Cash Reserve, or another similar account.

Another good option is to put your money into a money market account. The current one that I am using is the Vanguard Federal Money Market Fund (VMFXX).

I am happy to declare that I am finished with baby step 1!

Baby Step 2: Pay off all debts

The next step after you’ve secured $1,000 for a starter emergency fund is to pay off all debts, excluding your mortgage.

So this is where you will focus on paying off all of your debts. If you’re a pharmacist or another high-income earner then student loans are your biggest debt after graduation.

Other debts includes credit card debts, car loan and other personal debts.

Dave recommends using the debt snowball method where you will pay the debts with the lowest amount first. This has a psychological component and helps you be more successful at least in the beginning. I paid off my student loans using a hybrid approach where I incorporated both the debt snowball and the debt avalanche.

The debt avalanche method is where you pay off the accounts with the highest debts first why paying the minimum amount on the other debts.

My approach is to pick off the low hanging fruits (small debt accounts). When those are paid off then I look at the remaining ones with the highest interest rates to tackle one by one.

Lastly, when the amount is more manageable, I opted to refinance my loan through Sofi and paid it off in 2 years time.

I am happy to report that I have paid off all of my debts including a hefty credit card debt and my student loan debt. I still owe around 5 thousand dollars for my car loan, however.

Due to the fact that my car loan is only charging a 1.9% APY, I’ve opted to invest my money instead of paying off the car loan early.

The rule of thumb is to look at interest as the benchmark to determine if you want to pay off your debts first or invest. The benchmark is 5% interest. Anything above 5%, you should pay off. Anything below 5% you have the choice to invest or pay off your debt.

This step is a very important step to pave the way for your financial future.

Baby Step 3: Fully Fund an Emergency Fund of 3 to 6 Months

This step is self-explanatory. If you know that your monthly expenses are $2,000 then you need to save up to $6 to $18 thousand dollars.

Similar to Baby Step 1, you can choose to put this money into a good high-yield savings account or a money market account.

They key is to have liquidity to these accounts. You have to be able to access these funds quickly in case of an emergency

Baby Step 4: Invest 15% of household income

So far bay steps 1 through 3 are about saving and paying off debts.

This is where Dave wanted you to invest at least 15% or more toward your retirement. It can be in a pre-tax or other tax-advantaged accounts such as 401k or a Roth IRA.

I have to admit since I graduated in 2011, I have been stuck on baby steps 1 through 3. Now I only have the mortgage to worry about. I have the money to pay off my car loan if I wanted to but I chose to invest that money instead.

Investing for your retirement is important because according to research the average 401k account still lags behind what is expected.

If you’re able to, you need to start contributing to your 401k as soon as possible. Make sure to save enough to get the employer’s match. Otherwise, you’re leaving money on the table.

Since 2019, I have successfully mastered baby step 3 because I paid off my student loan that freed up some money that allowed me to maximize both my 401k and Roth IRA.

I contributed to a Roth IRA through a tax loophole known as a backdoor Roth IRA. High-income earners and pharmacists should definitely take advantage of it and maximize your Roth IRA account.

Baby Step 5: Save for Children’s College

As of this writing, I have successfully passed this baby step as well. I opened a Vanguard 529 college savings plan a few months ago and feel pretty good about it.

At first, I choose to build a two-fund portfolio consisting of the total stock market index fund and the total bond market index fund. However, this proved to be cost-prohibitive since Vanguard is charging $20 per year per fund on top of the normal expense ratio of these funds.

For some odd reason, the funds offered through the Vanguard 529 plans have higher expense ratios than index funds outside of the plan.

I ended up opting for the aged-based funds offered since it only charges one $20 fee annually and the expense ratio was reasonable at 0.15%. I should have opted for the automated age-based portfolio but since I chose a custom plan I will have to move the funds from it’s current 80%/20% fund to a 70%/30% fund in a couple of years.

For baby step 5, if you don’t have any kids or don’t plan on having any kids, you can still open a 529 plan on behalf of a niece, nephew, or other family members.

Baby Step 6: Pay off Home Early

Paying off a home mortgage early is controversial and you can prove mathematically that you can earn more interest from investment than paying your montage off early.

In my opinion, the peace of mind that comes from paying off your home early cannot be understated. This is true when you’re already investing at least 15% of your income toward your retirement.

Actually, if able you should aim higher such as 20% or as much as you can until you cannot save anymore.

Since I’m in the camp of paying off your mortgage early, we’ve been paying extra and put it toward our principal since the beginning of this year.

My wife and I hope to have our house paid off in the next 5 to 7 years. We’ve got about $118,000 to go and our mortgage interest is 4.375%.

So after many years of following Dave’s baby steps, we’re now stuck at step number 6.

Baby Step 7: Build Wealth and Give

This is the last of the baby steps and one of my favorite. This last step is when you’re wealth is at a level of self-sufficient. You can call this as financial independence, where you apply the 4% rule and you can live off of your investment.

When you’re at this stage, you can think about philanthropy or giving back. There are many different ways to give and its a personal preference but ideas can be educational, community outreach, charities, healthcare, and religious organizations.

Giving back allows you a better member of society. This will not only benefit others but by helping others you will also feel good about yourself.

Dave Ramsey’s Baby Steps Final Thoughts

So to recap.

  1. Save $1,000
  2. Pay off all consumer debts, except mortgage
  3. Save 3 to 6 months of living expenses
  4. Invest 15% or more of household income
  5. Save for children’s college
  6. Pay off mortgage early
  7. Build wealth and give

So does Dave Ramsey’s baby steps work? Yes, they do! Why? It’s because it’s in a step-wise approach. These steps are easy to follow and are sound financial advice.

You don’t have to necessarily follow or adhere to the steps in order. Mainly baby steps 3 and 4. You can choose to save $1,000, complete step 2, and skip step 3, and moved on to step 4.

The reason being, if you have a stable job and income you can take your time to build your 3 to 6 months emergency fund.

That’s the only step that’s interchangeable in my opinion. You don’t want to fund your children’s college before funding your own retirement account, however.

Remember the demonstration on the airplane? You have to put a mask on yourself first before you help others. Therefore, you must sufficiently fund your retirement before you can worry about saving for your child’s college funds.

With some hard work and perseverance, you can progress through the steps and put your financial ducks in a row. Trust me, I did it!

I went from a negative net worth of about $203,000 to now a positive net worth of $374,000. So you too can follow Dave’s baby steps and come out on top. Good luck!

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