My “Baby Steps” is a takeoff on the wonderful list Dave Ramsey preaches to his readers/listeners. It’s designed to fit my particular situation and my needs, so it may not be applicable for most people. In fact, I’m fairly certain it won’t be. However, you might be able to take something from my list and apply it to your own situation.
As useful as Ramsey’s steps are, I do not believe there is a “one size fits all” plan for personal finance. Educate yourself, take in lots of different ideas, and come up with a plan that fits you. This is my plan.
1. $1k in emergency fund
This step follows Ramsey’s to the tee. Just like when dieting, you have to avoid at all costs situations that will lead you back to your bad habits. If you don’t want to be tempted with fast food, make sure you have plenty of good food in your house at all times. If you don’t, you’ll find yourself at the McDonald’s drive-thru window at the first sign of hunger.
The same is true with finances. If you are trying to rid yourself of debt and build wealth, you have to prepare yourself for the unexpected expense (car breaks down, you have a plumbing emergency, etc.). If you have an emergency fund saved for such situations, you won’t have to rely on Mr. Credit Card to get you through. He is the enemy.
In short, this step keeps you from stumbling when you are trying to pay off debt.
2a. Invest 6% in 401k (or up to your company’s match)
This is where I deviate from Ramsey’s plan. He advises paying off all debt (except for mortgage) before saving for retirement. My take is, if you can afford to, do both at the same time. Each year you go without saving for retirement is one year of lost compounding interest. Essentially, what I am doing is paying about half of what I would like to contribute to retirement each month. I’ll contribute the other half once I am completely debt free.
(Why am I doing 6%? Well, my company matches 50% of the first 6% I contribute from my paycheck. For example, if 6% of my paycheck was $100, that means my company would chip in $50 every paycheck. This is free money, and my frugality prevents me from turning down free money.)
2b. Pay off all debt (except car)
The “pay off all debt” part is pretty self explanatory. For me, this means three credit cards and one student loan. For others, it likely includes your auto loan. Why do I make an exception for my auto loan? Well, I ran the numbers and I’m better off making only the minimum payments each month. Why?
1. According to Kelley Blue Book, the value of my car is approximately $2k less than what I owe on it. If I sell it, I’d immediately lose that money, plus I’d have to worry about finding another vehicle.
2. Paying off the auto loan early doesn’t make sense because my interest rate on it is only 4.5%. Any “extra” money over the minimum payment I could pay would be better served going into an online savings account that can earn 4.5% interest or better (since an automobile is a depreciating asset).
Ideally, I would have this debt gone as well. But when it pertains to low-interest debts (i.e. debts with interest rates lower than interest I could earn in an online savings account), I believe the “eliminate all debt first” philosophy isn’t prudent.
3a. Begin Roth IRA
At the same time I’m saving for a house, I will begin contributing money to a Roth IRA each month. I can contribute $4,000 per year, so that means setting aside $333 each month.
As I get older and my salary (hopefully) goes up, I will increase the 6% contribution to my 401k plan. But initially anyway, the 6% 401k plus the IRA money will put me right where I want to be for retirement each year (in the 12-15% of gross income range).
3b. Save for house
This is where it gets exciting. For a lot of people, this step would be “pay off mortgage early.” For me, this is the step where I begin saving for my first home. My initial goal is to save 20% for the down payment. My “shoot for the moon” goal is to save enough to pay for my house in cash (just like Dave Ramsey)!
Of course, assuming this “shoot for the moon” goal isn’t feasible, a step will be added: Pay off mortgage early. If I have children, or am expecting to have children in the near future, this will become step 4b (to be done at the same time I am doing step 4, paying for my children’s education). Otherwise, this will be step 3c.
(Note: Ramsey recommends extending your emergency fund to be able to cover 3 to 6 months of expenses after you pay off all debt and before you begin saving for retirement and paying towards your mortgage. I will combine these two steps, 3a and 3b, to serve as my more in-depth emergency fund. Ideally, an emergency never happens and I am able to save for a house and retirement that much quicker. However, if an emergency arises that my original $1k emergency fund cannot cover, I can either tap into my house savings or simply stop contributing money to my Roth IRA for however many months it takes to right the ship.)
4. Children’s College Fund
No, I do not have any children. Only God knows whether or not I’ll have children by the time I reach this step. But whether I do or not, I will begin saving for their education. If they earn scholarships and get to go for college free, great. If not, my saving when they are really young (or not even born) will prevent them from having to take out a student loan and enter the workforce with debt already hanging over their heads.
5. Build wealth and give!
In this step I am debt free (with my auto also long ago paid off), I have bought my house, I am saving for my children’s college education, and my retirement is on autopilot. I will then have numerous options from which to choose.
That’s it. This list could (and likely will) change as my situation changes. What suits my needs today may not suit my needs in five years. The important thing is I have a plan.
Do you have a plan?