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Dave Ramsey's
"Baby Steps"

Sometimes, "simple" is the best answer. And Dave Ramsey's "Baby Steps" plan is nothing if not simple.

Dave Ramsey, financial author and host of a popular nationwide radio show, created the following "Baby Steps" for getting yourself out of debt and putting your financial house on a solid foundation.

Honestly, there are a lot of methods for trying to dig yourself out of financial problems, and the "Baby Steps" may not necessarily be the best one for you.

(I preferred, for example, to pay off my debts according to their interest rates, from highest rate to lowest. But I'm just a "rebel with a spreadsheet" that way.)

Despite that, I feel that Dave's "Baby Steps" plan is THE very most workable for most folks, and more importantly, the most likely to bring about debt freedom. The Baby Steps are simple, straightforward, and just crazy enough to work.

"The bottom line?" asks Ramsey. "It's easy to become wealthy if you don't have any payments."

The best and most-detailed version available of these Baby Steps can be found in Ramsey's 2003 (updated in 2007) book The Total Money Makeover. I've reviewed Total Money Makeover, and recommend it highly if you are serious about following this plan. The book addresses many intricacies which space here restricts me from covering.

For anyone interested in a nice synopsis of Dave Ramsey and his motivations, CBS News told his story in a November, 2004 episode of its 60 Minutes program.

So is Dave's plan better than all the test?

Yes, I believe so.

In my opinion, you can spend a lot of time researching and kicking around various authors' financial fix-it plans ... but you'll not find a more realistic or effective one than what's right here. Just listen to a few sessions of Ramsey's radio show. What you'll discover — as I did — is that the "WE'RE DEBT FREE!" chorus, presented time after joyous time by Ramsey's callers, is perhaps the best indication of what can happen when simple planning meets goal-oriented motivation.

Life-changing? You bet it is.

So here we go. Here is Dave Ramsey's "Baby Steps" Plan:

Make minimum payments on all bills. Squeeze your budget until you accumulate $1,000 cash. This is your beginner Emergency Fund.

You'll never make headway in your quest to get out of debt if you don't have some savings — at least a little something to fall back on. That "little something" is called an Emergency Fund, and that's what this first $1,000 is for (or $500, if you make less than $20,000 per year). Put everything else on hold. Make only minimum payments on all your debts; take on a second job if necessary; forego retirement-plan contributions (temporarily) if you can. Get your "beginner" emergency fund together first. Get it together fast.

If you already have more than $1,000 in savings, and in anything other than a retirement account, withdraw everything except the $1,000. Use these proceeds for Baby Step #2, regardless of penalty (if the money were in CDs, for instance, there would likely be a penalty for early withdrawal).

Once you have accumulated the $1,000 (or $500), keep it someplace where you cannot easily get at it.

It must be available, but not easily available.

It must be spendable, but not easily spendable.

Why? Because for most folks, if the money's right there in front of you, you're going to find a way to spend it. And that's the last thing we want.

"Sometimes," Ramsey instructs, "you have to protect yourself from you."

Pay off your debts in order of smallest balance to largest. "Snowball" the payments as you go.

Grab a sheet of paper or a spreadsheet. Write down all your debts except your home. (If you're into spreadsheets, something like my DebtTracker spreadsheet will come in really handy here!) Arrange them in order from smallest balance to largest. Do everything you can to pay off the smallest debt listed (take on a second job, or sell stuff if you have to!) while making minimum payments on everything else.

I'm convinced of the unstoppable potential of people when they get on fire for something.
— Dave Ramsey

Once that first debt is paid and gone, then "snowball" its monthly payment: Add it to the normal payment you're making on the next-smallest debt, and focus your efforts on that debt. When that one is paid off, take that monthly payment amount and apply it toward your next debt.

Get the picture? The more debts you clear off, the more your "snowballed" payments increase. And the more headway you'll make — faster — on your larger balances.

Check my Debt Snowball page for a more thorough discussion, as well as a walk-thru example, of this part of the Baby Steps. And take a look at ExcelGeek's Debt Snowball / Rapid Payoff Calculator spreadsheet if you want a turbocharged way to set up and track your Snowball.

What's the rationale behind paying off your debts in this manner? Ramsey writes: "The reason we list the debts from smallest balance to largest is to have some quick wins. sometimes behavior modification is more important than math. This is one of those times." He goes on to add:

When you pay off a nagging $52 medical bill or that $122 cell-phone bill from eight months ago, your life is not changed that much mathemetically yet. You have, however, begun a process that works, and you have seen it work, and you will keep doing it because you will be fired up about the fact that it works.

One important caveat:   If you're working on this second Baby Step and some emergency arises which forces you to spend any part of your emergency fund, then immediately stop this step and return to Baby Step #1. Stay there until you've refunded your Emergency Fund in full.

In Dave's world, if Baby Step #1 (beginner Emergency Fund) isn't in place, then all the steps after it are in serious jeopardy. (And I very much agree!)

Create a full-fledged Emergency Fund containing 3 to 6 months' worth of expenses.

Bad luck and rainy days are a part of life.

Expect them.

Prepare for them.

Do this by maintaining three to six months' worth of bills and living expenses in a savings or money-market account. You'll then have gone a long way toward erasing the "What if?" stresses from your life.

This fully-funded Emergency Fund allows your family to always be ready for whatever life hurls at you. Sure — that Murphy guy might still stop by your residence every so often, but he won't be able to run roughshod over your financial life the way he used to. Ramsey, in fact, takes the analogy a step further: "Don't forget that the emergency fund actually acts as Murphy repellant."

You must also flip a mental switch regarding your e-fund:   It is there for true emergencies. Nothing else.

Ramsey elaborates: "Beware not to rationalize the use of your emergency fund for something that you should save for and purchase. Something on sale that you 'need' is NOT an emergency. Prom dresses and college tuition are NOT emergencies," he says. (This, of course, is where Mary Hunt's Freedom Account concept enters the picture.)

In any event, get your full e-fund together, and you'll be in a financially-elite class. You won't need your credit cards any longer ... even for emergencies. And the next time your car's alternator detonates?

"What used to be a huge, life-altering event," Ramsey says, "will now become a mere inconvenience."

Direct 15% of your annual pre-tax income into your retirement plans. Utilize tax-advantaged accounts such as 401ks and Roth IRAs, if eligible.

Now it's time to get your retirement funds in shape. Contribute the maximum amount you can, your target being contributions of a full 15 percent of your household's gross (pre-tax) income. If you have tax-advantaged plans (401k or Roth IRA, for example) available to you, then exploit them to their fullest extent. If your company matches any part of your contributions, do not consider this as part of your 15 percent. Additionally, do not include expected Social Security benefits in your retirement calculations. "I don't count on an inept government for my dignity at retirement, and you shouldn't either," Ramsey says.

At this point, if you haven't already done so, it is time to begin seriously educating yourself about mutual funds, stocks, and the financial markets.

"Getting older is going to happen," Ramsey says. "You must invest now if you want to spend your golden years in dignity."

Take care of college funding. Fully fund Educational Savings Accounts and/or utilize 529 plans.

If you have kids, then you'll have college to worry about. The earlier you start, and the more attention and funding you're able to give to it, the better off you and your kids will be. Since college tuition inflation averages around 7 to 8 percent per year, your investments will need to (hopefully) do better than that. Always use tax-advantaged accounts (such as 529 plans or Education Savings Accounts) to their fullest extent to assist with this. These plans do have certain income limits and other restrictions and/or fees, so be sure to check the fine print before diving in.

Regardless of how you save for college, do it. Saving for college ensures that a legacy of debt is not passed down your family tree. Sadly, most people graduating from college right now are deeply in debt before they start. If you start early or save aggressively, your child will not be one of them.— Dave Ramsey

Become financially "ultrafit" and 100% debt-free: Pay off your home early.

For most people, the mortgage payment is the single largest monthly payment they will ever have. Just imagine what you can do with that money when you've paid it off. Imagine how you'll feel when you make that last payment.

At this point in the Baby Steps, you'll want to round up every spare dollar you can find and put it toward your mortgage, regardless of all the oft-quoted benefits of mortgage-interest tax deductibility. (How wise is it to continually pay, say, $5,000 in interest to a bank each year, just so that you won't have to pay $1,500 in taxes to the government? The small minority of folks who own their homes debt-free probably don't mind paying that $1,500 a bit.)

For more comments regarding home, home loans, and their affordability, you might refer to my "Home, Expensive Home" article from Aug. 30, 2002.

Get to the point where your money works harder than you do: Build wealth (mutual funds, real estate, etc.), have fun, and give!

With every bit of your debt zeroed-out and your savings tanks on the full mark, you can finally reach for the "pinnacle point" — that moment in your life where your money works harder than you do. What would it be like to exit the Rat Race and live entirely off the returns of your savings and investments? Find out: Invest more, and more, and more. Invest more to continue to grow your wealth. Give more so that you can continue to grow your soul. Article End