A Dave Ramsey’s Baby Steps is a financial plan to achieve financial stability and debt-free life. These seven baby steps were helpful for millions of people to pay off the personal loan, invest for retirement and handle their finances.
We want to encourage your financial journey, so in this article, we will cover:
- What are the Dave Ramsey baby steps;
- Guide for each Dave Ramsey’s baby step;
- Who is Dave Ramsey, and what is his backstory;
- How to achieve financial independence with over-funded life insurance.
If your goal is to gain financial freedom and pay off your home or student loan, keep reading this article!
Introduction to Dave Ramsey
Dave Ramsey is a personal finance expert who founded the company and finance empire – Ramsey Solutions.
Dave has a turbulent life. He was born in 1960 in a family that nurtured a strong work ethic. At the age of 26, he earned a quarter of a million dollars a year and had a $4 million real estate portfolio. The situation shortly changed – at the age of 28, he lost everything.
His complex financial case inspired him to help and teach other people about personal finance. This story follows one anecdote Dave Ramsey told in his 20-minute documentary. After his enormous failure, he turned to faith and discovered that “God’s word has a lot to say about money.” One day after church, a man with financial difficulties reached him and asked him how he got through his problems and can he help him. Ramsey’s consulting career started with making a financial plan for this man.
Dave Ramsey established his counseling company called The Lambo Group. His money management class began with 37 students, but after a few years of work, the group grew to more than 350 students.
Ramsey Solutions is a genuine financial empire, and it now includes:
- The Dave Ramsey Show – a radio production where Ramsey helps listeners with their money problems and dilemmas.
- Ramsey + – the ultimate membership of Ramsey product and services
- The Total Money Makeover – his bestseller book
- Every Dollar – an app designed for budgeting
- The Website – where you can find everything we mentioned and much more
The Dave Ramsey Plan
Dave Ramsey created a plan in the 1990s’ to help people become debt-free. This plan expanded to The Total Money Makeover book.
Many financial experts critique Dave Ramsey because his plan didn’t change much over the years. They highlight that household income has increased over the years, requiring larger fully-funded emergency funds. The main idea is good, but it probably needs some reformations.
Let’s dig into the Dave Ramsey Baby Steps, and after that, we will discuss this plan entirely or how we can improve it.
What Are Dave Ramsey’s Baby Steps?
Dave Ramsey’s baby steps are a simple plan designed for anyone who wants to upgrade their financial life and learn more about personal finance.
The most significant advantage of this approach is that everyone can follow these simple baby steps, whatever their starting position is.
The plan is consists of these 7 baby steps:
- Save $1000 for your emergency fund
- Pay off your loans using the debt snowball
- Save 3 – 6 months of expenses in your emergency fund
- Invest 15% of your household income in your retirement fund
- Save for your children’s college fund
- Pay off your home early baby step
- Build wealth and give
The Breakdown of Each Baby Step
Baby Step #1: Save $1,000 for Your Starter Emergency Fund
Many people make mistakes when they spend all of their money on paying off their loans and save nothing. It is wrong because a common situation is that some unexpected expenses come up, and people have no money in the emergency fund, which leads them to borrow more money and go deeper into debt.
Even if you have unpaid loans, you always need to have money in an emergency fund, even if it’s only $1000. When you experience a sudden emergency, you will have at least this initial beginner emergency fund.
This step, also called the emergency fund baby step, should be the first step to building a better financial situation and gaining good emergency funds.
The emergency fund baby step is also the point of disagreement between Dave Ramsey and other financial professionals. Dave thinks that $1000 is enough for the initial emergency fund, while others believe it’s insufficient to cover unexpected expenses.
It won’t be a problem for people whose monthly income is higher to save $3000-$5000 for this first step. Also, many people speculate that it’s not a great option to start saving in dollars due to inflation.
Some critics of Dave Ramsey point out that it is more progressive to contribute to your 401k plan than to save for emergency funds. They are not accurate because the 401k is essentially free money, and since that, it can’t be used for emergencies.
When we say emergencies, by that, we mean major financial emergencies like the repair of your car if its breaks down. Don’t use your emergency fund for living expenses, and don’t try to skip this step because it could set you back even further.
One extra tip: saving this first $1000 shouldn’t be longer than 30 days.
Baby Step #2: Pay Off All Of Your Debt Except Your Mortgage Debt
The 7 Dave Ramsey’s baby steps aren’t just a plan guide for money management but also motivations for people. This baby step uses the debt snowball method, and it is crucial to see the power of motivation.
Along with Baby Step #1, these baby steps give people quick wins from the start. That creates the base for motivation and keeps the people stay on the course.
The Debt Snowball Method of debt reduction requests you to list your debts from the smallest balance to the largest. Only your home debt is out of that list. The next step is making minimum payments on all of the obligations and putting every extra dollar you can spare towards the smallest balance until it’s gone.
When you pay off the smallest debt, you move on to the next lowest debt on your list. With that debt, you add what you were paying on the debt before it + minimum payments you were already paying until it’s paid off. The idea is to continue this process with all your debts until you become debt-free.
A great tip is to write your list on the dry erase board to make it more visual. After you pay off your debt, you erase it from the table and move to the next one.
You can also write the amount of money you are planning to put towards them each month that should be motivational to want to attempt to add more and more.
The brain releases dopamine and serotonin whenever you win something. It occurs after paying off each loan. These chemicals create a will to continue the process more and more.
We think that is why Dave Ramsey set #1000 for the first step. Quickly achieving some goals will be easier and more motivational to keep going. It would be more likely for people to give up this process if the first goal was to save $2500. Many of them never would make it to the second step.
I’m sure this sounds great, but there is always another side of the coin.
If you have a credit card debt of $8,000 with a 19% interest rate and, for example, a student loan of $4000 with a 3% interest rate, The Debt Snowball advises paying off the smallest debt first, the student loan.
When you would be paying off your student loan, your credit card debt would just continue to grow. Following this method, the result will be spending a lot more cash in interest because you paid off your smallest debt first instead of your high-interest debt.
Comparable to the debt snowball method is the debt avalanche method. The debt avalanche is a better option if you are detail-oriented and not easily distracted.
Whether you choose to use the debt snowball method or use the debt avalanche, this step is the most important because it sets the tone for the rest of your financial progress.
This method assumes that paying extra interest is worth the motivation you’ll get. In our opinion, it’s not necessary to spend more money on interest rates, but later in this article, we will present you with another alternative to becoming debt-free.
If your position is different from than one in our example, or you strongly feel that this approach is for you, go for it! A lot of people did it.
Once you’ve completed the second baby step, you have all of your debt paid off! Or, at least, almost all of your debt; you still have your mortgage, but you also have 5 more baby steps to go.
Many people say that this was a crucial step because after getting rid of all the loans, they can see the future and the path of building wealth.
Baby Step #3: Finish The Emergency Fund With 3 To 6 Months Of Savings
You are debt-free after the first two baby steps and probably have enough money to start dispersing elsewhere. Dave’s idea is first to use that money to finish your fully-funded emergency fund, and after that, start investing in a retirement fund or save for kids’ college educations.
This order is not accidental. Dave Ramsey claims that if you skip saving for a fully-funded emergency fund, it’s a much better chance to go back into debt if you experience unexpected situations. Constantly many sudden circumstances come up, and even if we cannot predict them, at least we can have an emergency fund with 3 to 6 months of savings.
We can all agree that people without a savings account went through more challenging times during a pandemic than people with at least a starter emergency fund.
Once you’ve finished this third baby step, you can deem your family is protected, and you’re on the right path to financial stability.
The next baby steps are crucial for gaining financial freedom, so if you want to be financially independent, keep reading!
Baby Step #4: Invest 15% Of Income Into Roth IRAs And Pre-Tax Retirement Accounts
This baby step is when you start building your wealth, which is impossible without investing. So it’s logical that this step is all about creating your investments.
For many people, this step is scary because they connect investing with losing money. That is entirely wrong. If you do enough research and continue to learn more, you will not have to take any risks, and it will be no need for a financial coach because you will do everything on your own.
How to start investing? The first thing, as we mentioned, is to begin research. After you get all of the information and understand how things are working, the great place to start is to get a full employer match in a 401(k). Later, you will want an IRA (Individual Retirement Accounts).
We will explain why retirement investing comes before saving for the children’s future because that’s what people usually find contra-intuitive.
No one wants their kids to go through student loan debt, but we also don’t want our children to take care of us because we don’t have a retirement account.
Thus, Dave advises people to invest 15% in retirement, whether 401k, Roth IRA, 403b, or other. This baby step is also called the retirement step. After that, you can begin doing anything with the excess money left over from paying off the consumer debt.
Some people critique this retirement baby step because high-income professionals should be able to invest at least 20% or more of their gross household income into retirement accounts. We agree with that, but it is not the same if the people have 35 or 55 years.
Younger people will have more time, so it’s not a big deal if they start with 15%. Of course, if you can, that is even better because you will need less time to become financially independent.
This step is different from others because it requires much more time than the first three. This baby step will likely last the majority of your working career, and it will be completed when you save enough money for retirement.
Another difference is that you don’t need to finish this step to move on to step 5. You can move to the next step once you can consistently save and invest 15% of your household income.
Baby Step #5: College Funding For Kids
At this point, you should have a fully-funded emergency fund, no debt except the mortgage debt, and invest 15% (or more) of your gross income. According to Dave Ramsey, it is a perfect time for you to save for the children’s college fund. Dave recommends using 529 plans and Coverdell Education Savings Account (ESA) because it is tax-advantaged and used explicitly for educational expenses.
Even though starting savings for a children’s college fund and their financial security is a personal decision, many people decide to do it because we are witnessing the cost of college growing much faster than wages are.
There is no universal amount set for this step because it will depend on how much income you have leftover each month, how old your kids are, and how many kids you have.
Baby Step 6: Pay Off Your Home Early
At this stage of Dave Ramsey’s plan, you should use all of the extra money you earn (thanks to investing) and throw it towards the mortgage payment.
Paying off your house early is a question of debate because some argue that you should pay off your home before and invest extra money is the way to go, while others are looking at this strictly from a numbers standpoint and advise not to pay off your mortgage.
If you have a chance to pay off your mortgage debt, you should use it. It’s an incredible feeling when you know that you own the house you are living in.
Baby Step 7: Build Wealth And Give Generously
This is the end of Dave Ramsey’s baby steps.
All of the people who make it this far deserve big, loud applause. “Live and give like no one else.” is Dave’s advice for the people that come this far.
Since you achieved no consumer debt, 3-6 months of expenses saved using the debt snowball, 15% of your income going into retirement savings, college accounts being funded, and the mortgage paid off. You are in the perfect position to build your wealth. Also, it is a free space for you to be creative and innovative. There are no instructions for this step – the sky is the limit.
Dave’s preferences are mutual funds and real estate over the stock market when it comes to investing.
We mentioned earlier that Dave Ramsey turned to Christianity after his bankruptcy. This is in connection to the last baby step. Dave suggests giving generously to other people – whether you help your cousin who lives paycheck to paycheck or some charity, some so many people need help daily, and God wants both them and you to prosper.
After completing all the steps, consider living a life of generosity.
Alternatives for Achieving Financial Freedom
The Dave Ramsey baby steps are a great plan to build wealth, but it is not the only one.
What would possibly be better than this approach? It would be better if you wouldn’t depend on the financial institution and if you would be able to build wealth, pay for your home early, save for your children’s future, and much more by borrowing money from yourself. It is achievable with the Infinite Banking Concept.
Over-funded Life Insurance Policy
If you choose to put your money into the whole life insurance, you will be able to do the same you would do with Dave Ramsey’s 7 baby steps and even more.
Here is how it works. Over-funded life insurance, or the infinite banking concept, is a strategic method that trades on your life insurance policy to design an endless banking system. The basic idea is to imitate the banking system but without high fees and interests that aren’t good for you. And just like that, you become your own banker.
With an over-funded life insurance policy, you use the policy’s cash value to borrow money, and you set the deadline when to repay it and also the rate of return. Since you borrow money from yourself and pay it off with the rate of return, you are banking for yourself.
Few steps make the Infinite Banking Concept. The first step is overfunding the cash value of the Whole Life Insurance policy. As time passes by, this cash value is accumulating, and the great advantage is that this cash value is tax-free.
Another convenience is that you earn dividends even when you take out a loan and spend that money elsewhere.
We intended to introduce you to Dave Ramsey and his plan on how to build wealth. Your job is to calculate whether it is a good option for you or not. If you are not satisfied with having only $1000 in a savings account or want to be more wasteful with your money, consider investing in cash value life insurance.
If you are ready to achieve financial freedom, here in Wealth Nation, we will teach you how to manage, make, and multiply your money using your whole life insurance. Sign up for our membership if you want to learn more!