Nathan Lippincott, financial advisor and budgeting expert, reviews David Ramsey's 7 Baby Steps to Financial Peace.
One of the most familiar budgeting approaches is Dave Ramsey’s “7 Baby Steps to Financial Peace.” These steps have been immeasurably helpful to many individuals and families starting their financial journey. Because so many have heard of the steps, it is important to address them in any budgeting discussion. In this blog, I will review and comment on Ramsey’s steps. If this peaks your interest, consider checking out my own 7 Step Plan for comparison and assessment purposes.
Baby Step #1: $1,000 Cash in a Beginner Emergency Fund
A small emergency fund is an important starting point. Start saving! Sell household items, take on a side job or project – do whatever is necessary to build this “safety net.” Murphy’s Law of catastrophes dictates that if something can go wrong it will, and this applies to budgeting as well. It is very common for an emergency to take place at the beginning of a budgeting journey, wrecking even the best laid plans. Having an emergency fund offsets this and gives you some security and comfort regarding future unknowns.
Baby Step #2: Use the Debt Snowball to Pay Off All Your Debt Except for the House
You need a plan in order to work a budget. In order to build wealth, you must eliminate debt. It isn’t until your debt is gone that you will begin to make major strides towards retirement. Ramsey recommends writing down all of your debts, from the smallest to the greatest amounts. Start with the smallest debt and pay that off first. Then, take whatever amount you were paying to this first debt and add it to your payment towards the second until it is paid off. Repeat this with each debt. Before you know it, you will be able to actually see results and debt will be paid off on a consistent basis. This not only moves you towards being debt free, it instills in you a sense of excitement and creates a reward-based system for achievement.
Baby Step #3: Build a Fully Funded Emergency Fund of 3-6 Months’ Expenses
You already have a cushion emergency fund. But it is easy to see that $1,000 will not go far if circumstances result in loss of a job. This requires additional planning. It is important to set aside savings on a regular basis with the goal to ultimately have 3 to 6 months’ worth of expense funds accumulated. This allows you to not have to stress about unexpected unemployment.
Baby Step #4: Invest 15% of Your Household Income Into Retirement
If you are going to be able to retire, you need to be setting money aside for retirement. You should save a minimum of 15%. If you work for a company that matches 3%, then you are only required to put back 12% and you have your retirement plan in place. It is not as difficult as it seems once you are debt free. Make a plan for this so that you can be ahead of the game in coming years.
Baby Step #5: Start Saving for College
Dave Ramsey includes setting aside money for your child’s college fund. I find this step to be controversial. What you should do is discuss all of your options including Uniform Gifts to Minors (UGMA) account, but I do not feel a 529 plan (College Account), may be fore everyone. It will take years for your children to reach college age and many factors will affect the cost that this might entail. College prices could change. Your child could decide to attend an online college or a local community school and save tuition. Previously, textbooks have been a major expense; now there are programs for renting books, or downloading them, which impacts traditional higher education costs. Your child may decide NOT to attend college. In this case, if your money is tied up in a 529 plan, it cannot be used as those accounts stipulate the funds may only be used for college. In contrast, the UGMA account allows the child to use the funds for anything that they need. If they wish to go to college, they can use it for that; if they decide to pursue a trade, it can be used for that; if they decide to start a business, that is also an option. I find that by talking to your financial adviser you can find the best situation for whatever direction your child's life takes.
Baby Step 6: Pay Off Your Home Early Dave Ramsey advocates next paying off your mortgage as quickly as possible. I am not blindly in agreement with this step, either. You should consider your longer term objectives and financial plan before believing you must do this step, do not pass go, do not collect $200 dollars. You should once again sit down with your financial advisor and this time include you CPA to find out if the tax deduction on your mortgage is valuable to you.
Also you should also realize that it is possible for the money that you would be spending on your mortgage payment to be invested and you could possibly achieve greater long term benefits. Living completely debt free is a wonderful thing but understanding how to make your money work in the most beneficial way for your long term goals, I believe is the most important thing, which is why in this scenario just like in step 5, meeting with your financial advisor is important so they can help you draw up a plan that suits you as an individual, a plan that best suits your family. No two people are alike and in as you work your way up the ladder of living debt free, I feel it is vital to get a financial advisor who is willing to get to know you as an individual and helps you understand and educates you about the true value of investing as to make sure to assist you with your journey in the most beneficial way for your present and your future.
Baby Step #7: Build Wealth and Give Generously
I agree with Dave Ramsey that this is the most fun step of all! At this stage, you are building wealth and giving to others. It is so much of a greater joy to give than to receive. When a person has no debt, no payments, and a plan for investment, he or she can do anything – all because a plan was made and he or she was disciplined in keeping it. Now, the benefits and rewards can be reaped without hesitation or regret.