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Dave Ramsey, the personal finance guru heard on the radio around the country and well known popular author, is pretty well known for two main concepts. The debt snowball, and Dave Ramsey’s 7 baby steps. I’ve talked about the debt snowball before, but have not discussed the baby steps plan to get out of debt and build wealth. Here is Dave Ramsey’s 7 Baby Steps Plan, with some of my own thoughts as well.
1.) Save $1000 for an emergency fund- If you don’t have any money saved for an emergency fund, start here by saving at least $1000. Dave says save $1000, but if you feel you need more, like $1500 or $2000, do what makes you feel comfortable. The important thing is to get some sort of financial cushion going so you don’t have to use credit cards to pay for unexpected expenses or minor emergencies.
2.) Pay off all debt using the debt snowball -According to Ramsey, you should pay the minimum on all of your debts (including credit cards, auto loans, etc.) and make extra payments on the one with the lowest balance every month until it is eliminated. You would then take those extra payments and add them to the debt with the next lowest balance, and so on, until you are debt free -except for your home mortgage. As I’ve mentioned regarding the debt snowball before, if you want to pay the debt with the highest interest rate first, go ahead and do what feels right to you, as long as you continue to reduce your total debt.
3.) Save 3 to 6 months of expenses in savings- This is the “real” emergency fund. While the first $1000 you save in step one is designed to keep emergency expenses from having to get put on a credit card or keep you from getting behind on your bills, saving 3 to 6 months expenses can help you get through major emergencies, such as losing your job, a medical emergency, a major repair to your home, or having to buy a new car because your old one died on you.
4.) Invest 15% of household income into Roth IRAs and pre-tax retirement- After you have a comfortable safety net for just about anything life can throw at you, it is time to start investing. It’s probably a good idea to at least the company match to your 401k if one is offered before you reach this step, but now is the time to ratchet it up on the 401k and Roth IRA contributions.
5.) College funding for children -This is another somewhat debatable one, at least on the order you do it in, after funding your retirement. But if you think about it, it does make sense. If you have not saved up enough to pay for your children’s college, there are other options, such as loans, grants, scholarships, or even you child working part time to help pay for college. But if you hit retirement age and you don’t have enough saved, you only have one choice-keep working.
6.) Pay off home early- Now is the time to eliminate your last debt, the home mortgage. If you can knock this one out, you will probably be in pretty good financial shape. While some people prefer not to pay off their mortgage, it does offer a very large sense of security, I would imagine.
7.) Build wealth and give! Invest in mutual funds and real estate- If you have your primary mortgage paid off, Dave advocates investing in mutual funds and real estate, i.e., diversify your portfolio and continue investing. While if you had invested in either of these a year or two ago, you might not feel so confident, if you have gone through the other 6 steps and have no other debt, and are in it for the long haul, you probably shouldn’t worry about it too much. Don’t forget to help others with your new found wealth!
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Great advice above. On paying off debt using the snowball method, most advice says to pay off the debt with the highest interest rate first. But sometimes, If you credit card debt across many cards, and you have one credit card with a small outstanding balance, pay it off first even if it is a lesser interst rate. Having one less card on the list does wonders for your mental state.
@San Fran- Thanks! I think you are right, for some people knocking out one debt first can be a great mental boost, even though the math might tell you to pay off the highest interest one first.
Wow, I’d never heard of Dave Ramsey before. Some good pointers re getting debt bustered once and for all.
RC importantly identifies the debate about whether it’s better to pay off your highest interest account first of your smallest debt. Ultimately, for most people the long term difference in savings between the two approaches is relatively minor. But it’s critical to create a system that lets the payments be managed. The biggest problem is a charge being made on a credit card that consequently throws off one’s estimated payment schedule. Thus, identifying an approach that allows one to execute constant payments is key.
@DebtGoal- You make a good point, you definitively need to have an approach to paying off debt and stick to it in order to succeed. Thanks for visiting!