Especially when times get tough, being financially sound becomes a key player. The businesses and individuals that really struggle are those who are living paycheck to paycheck. The ones who thrive are those that have been planning for the future the whole time.
And when I say “plan for the future,” most people assume that I mean investing. While investing is important, there are some things that should happen first. We need to walk before we can run.
Dave Ramsey has a famous process he calls the “Baby Steps” that walks us through the basics of laying our financial foundation. And while the baby steps aren’t perfect for everyone, it is a great framework to work from.
Here are Dave Ramsey’s 7 Baby Steps with my commentary.
• Save $1,000 for a starter emergency fund
This step shouldn’t be skipped. Life is great at keeping us on our toes and having a little saved can take some of the pressure off when something unexpected happens. This not only makes it easier to sleep at night, but it could stop you from resorting back to your credit cards to cover unexpected expenses.
• Pay off all debt (except mortgage) with the debt snowball method
This includes your car, credit cards, student loans, and anything else other than your mortgage. This may seem overwhelming for some but Ramsey’s snowball method can help break it down. He counsels to write all debts out smallest to biggest, and at which point you’d pay only the minimums for all but the smallest. You’d allocate every extra dollar towards the smallest debt until it is paid off. Then you move to the next smallest until all debts are paid off. This method can help break a large task down into manageable pieces.
• Build a 3-6 month emergency fund
While a $1,000 emergency fund is a great to start, 3-6 months of living expenses is the next step to protect from larger life events, such as losing a job. This is a key element to have a strong foundation to fall back on if needed.
• Invest 15% of your income for retirement
Now is the time that you put all the money that you were putting into debts and your emergency fund towards retirement. The first place to look is your employer’s retirement plan (401(k), TSP, ect) especially if they have a match (the match may even be a reason to invest early in these baby steps because it is hard to beat free money). You can also use an IRA or Roth IRA. 15% may seem like a hefty percentage but since retirement can easily be a ⅓ of your life, it should be taken seriously.
• Save for your kid’s college
Some people don’t have kids or don’t believe in paying for their kids’ college so you’ll have to tweak this step for your personal situation. 529 Plans or Education Savings Accounts can make saving for college expenses easier and more tax efficient.
• Pay off your home early
At this point, your home will be the last thing that stands between you and being completely debt free. Paying your home off early can easily save you ten of thousands of dollars in interest, if not more.
• Build wealth and give
If you make it this far, you are in a great spot. You are debt free and your monthly expenses are probably lower than ever (no mortgage or debt payments). This allows you to heavily invest, build wealth, as well as give generously to others. You will feel more financially free through all the baby steps but this step will feel incredible.
ConclusionAs I said before, these steps aren’t perfect for everyone but they do offer an incredible framework to become more financially free. And you don’t have to wait until step 7 to be happy either. Even step 1 helps to provide more peace of mind and security. Wherever you are at in the process, enjoy the journey and look back occasionally to see how far you’ve come.