There is no doubt that if you have done a little Google searching for minimalism and saving money, you have probably come across the name “Dave Ramsey.” Dave is a veteran in the personal finance industry and has helped thousands turn their lives around through his Financial Peace University courses. He has sold countless books and still runs a weekly radio show to this day.
I have always admired his no-nonsense and sometimes sarcastic take on the common financial practices of us Americans. He does a very good job of getting you to realize that the person in the mirror is the cause of your money woes and that you are not powerless to start making necessary changes.
So just how has Dave Ramsey helped so many people, and what is a “Financial Peace” university? At its most basic level, it is a seven step program with very straightforward rules and guidelines. Let’s take a look at the 7 baby steps:
Baby Step 1: Start a $1000 Emergency Fund
There are some things in life that we simply cannot plan for. The car breaks down, your bank account gets hacked, you need to hire a lawyer for whatever reason. What would you do in this situation? Would you have the cash to cover one of these occurrences? Dave advises you to make this your top priority before you even touch any debt.
Now most people would think “Wait a minute! Wouldn’t that $1000 be better put towards paying down debt to speed up the process?” And you would be right to think that, but there is a more important factor to be considered. The emergency fund will provide a cushion for you when you go into debt-destruction mode. You don’t want to make to take on more debt to fix an emergency while you are trying to work your way out. The first step is meant to provide you with a contingency plan.
Baby Step 2: Pay Off Debt
Step 2 is where the fun begins. It becomes time to tackle that head head-on and say goodbye to it forever. I have personally struggled with debt myself and let me tell you, paying it off is very liberating. No longer seeing that monthly bill for an amount you owe gives you peace of mind and more room to breathe.
So how do you prioritize which debt to tackle? You’ll use the debt snowball to knock out your debts one by one, from SMALLEST to largest. Pay off the first one. Then add what you were paying on it to the next debt and start attacking it. When you start knocking off the easier debts, you’ll see results and stay motivated to dump your debt. As each debt is paid off, your cash flow will increase and the bigger debts will be gone sooner than you think. Before you know it, you’re debt-free!
Baby Step 3: Save 3-6 Months Expenses
Wow look at you! You’ve paid off all that nasty debt and owe nothing to no one. It’s probably the best you have felt in a long time, but you want to know what’s next. Remember that whole “contingency” idea mentioned in baby step 1? The next step aims to provide you with an even larger cushion.
Unfortunately in this modern age of outsourcing and hungry grad students willing to take whatever salary they are offered, jobs have a much higher turnover rate. It is not completely foreign for a loyal 20-year employee to be let go without so much as a “Thank you for your service.” Completing step 3 will allow you to pay the bills and survive in the event of a layoff or injury that compromises your income.
Baby Step 4: Invest 15% of Income for Retirement
When you make it to step 4, you’ll be one of those people who others say “have it all together.” You have the emergency fund, no debt, and months of expenses in the bank. Now is the time to focus on the future. We were not meant to work forever, nor may our bodies allow us to. You’re likely going to retire one day, which requires a substantial amount of money to do so.
This step is all about building long-term wealth. Take 15% of your gross household income and invest it first into 401(k) plans and then Roth IRAs. If your company doesn’t offer a retirement plan or match your contributions, then go straight to the Roth. Spread the money across four types of mutual funds: growth, aggressive growth, growth and income, and international. Even a couple hundred dollars a month invested now can make you a multi-millionaire.
**Disclaimer: I am not a financial adviser and this is only a review of the program. Always consult with a financial advisor before investing.**
Baby Step 5: College Fund for Your Kids
If you have read my blog, you can probably guess I was conflicted on this baby step. College no longer holds the value it once did, but certain degrees are worthwhile for gainful employment. This step is meant to provide future financial assistance (if you have children) for that purpose. One thing I liked is that Dave explains in his book that college is not a guaranteed path to success, and that pursuit must be evaluated before the fund is used towards it.
Two smart ways to save for your kids’ college are 529 college savings funds or Coverdell ESAs (Education Savings Accounts). These are both tax-advantaged savings vehicles that let you save money for your kids’ education expenses. Both 529 plans and ESAs allow you to save money in an individual investment account. But do your homework first!
Baby Step 6: Pay Off Home
When we talked about paying off all your debt in baby step 2, it was not including your home mortgage. But what if that monthly expense could be done away with as well? Any extra money you can put toward the mortgage will result in tens of thousands of dollars of interest saved and months (or even years) of not having a payment hanging over your head.
As soon as that mortgage is gone, you’re going to have a much bigger gap between your income and your bills. With such a big gap, you can easily take on life changes of all kinds. Things are looking pretty damn good by now, huh?
Baby Step 7: Build Wealth and Give!
Most people want to be wealthy, it’s just a fact of life. Wealth provides mobility and security beyond what the middle class life will. How you will build your wealth, is entirely up to you. There is a plethora of information at your disposal these days if you are more of a DIY kind of person, or you can find a reputable financial advisor to assist you.
Charity is another difficult topic. Giving your money away is hard to justify strictly in terms of one’s net worth. The reasons for it are non-financial. It remains one of those things that has to come from your heart. I do encourage everyone in this situation to find a charity that speaks to them in some way and try to get involved.
Summary of the 7 Baby Steps
The “7 baby steps” make up a pretty sensible personal finance plan. It’s not perfect and it doesn’t match everyone’s needs, but it does provide a roadmap that works for the financial situations of most people.
The challenge comes from the self-discipline that it takes to actually follow the steps. I view self-discipline, bad habit breaking, and good habit building as the greatest challenges of personal finance. Once you master those things and reach a higher level of self-control, not only does personal finance become easier, so do many other aspects of your life, including the ability to earn more money.
The baby steps are a good guidebook, but the real project is improving yourself.
You can get Dave’s book – “The Total Money Makeover” for a more in-depth guide to the plan!