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Dave Ramsey’s 7 Baby Steps

One of the most well-known personal finance gurus is Dave Ramsey. He often talks about how he pulled himself out of debt, and now lives debt-free. He also develops products and sells books designed to help his followers lead debt-free lives.

Among the ideas that Ramsey has developed is The Seven Baby Steps [3]. These are steps that, if used in order, can help you get your financial house in order, and start down the path to financial freedom. The idea is to follow the steps in order so that the steps build on each other.
Here are Ramsey’s 7 baby steps:

1. Start an Emergency Fund with $1,000

The idea is that you can’t get started on your journey to financial success without something to help you pay unexpected expenses. Before you do anything else, Ramsey recommends that you start an emergency fund [4] with $1,000. Before you proceed, you should save up $1,000 in a fund. It might take two or three months to get this point, but it’s a start. One unexpected expense can throw you off the rest of the program, so that $1,000 can be a real help. (Although it’s important to note that eventually you’ll have to expand your fund; $1,000 won’t help that much if you lose your job or suffer some other major catastrophe.

2. Use the Debt Snowball to Pay Off Debt

Ramsey’s debt snowball [5] method is very popular. You list all your debts (except your mortgage), and pay them off one by one. You start with the lowest balance, and work up to the highest balance. Some insist that it’s better to order your balances by interest rate, but Ramsey looks at things in terms of what is likely to have the highest psychological impact — and paying off a balance is encouraging and will keep you on track.

3. Build Your Savings to 3 to 6 Months

Now that your debt is paid off, it’s time to boost your emergency fund. Ramsey suggests that you add to your emergency fund with the money you are no longer spending on debt payments. When you have three to six months’ worth of expenses, it’s time to move on to the next step.

4. Invest 15% of Your Household Income

With no consumer debt payments, and with a solid emergency fund, Ramsey suggests that you start investing in tax-advantaged retirement accounts. He likes Roth IRAs [6] (and I do, too). He suggest 15% of your income should go toward investments that will help you prepare for the future. If 15% overruns the limit for Roths, you can open other accounts to contribute to as well.

5. College for Your Kids

Once you are taken care of, it’s time to help your kids. You can help your children save up up for college [7]. This can be important, since college costs can really put the pressure on later. This can prepare you for the future.

6. Pay Off the Home Early

With regular contributions going to your investment accounts, and to college accounts, it’s time to add extra home payments. You should continue investing, and saving for college, through this period. The idea, once you have a solid emergency fund, is to assign your cash different jobs that it will be doing each month instead of making debt payments. Paying off your home early can free you up later.

7. Build Wealth and Give

Finally, once you are on track to pay off your mortgage early, you should remember to build wealth and give to others. Ramsey believes that giving is an important part of finances, and once you are secure, you should help others as well.

(Photo: marklarson [8])