Do I pay the high interest loan before the student loans? What if I owe the IRS? Should I get the car repaired or pay the credit card? Should I take advantage of my employer’s 401K match or pay cash for graduate school? How much do I need to save for retirement? How do I balance long-term goals and short-term savings?
Life doesn’t fit into a neat little box, no matter how hard we try, and to make matters more complicated, it seems there are twenty different answers on the internet for every one financial scenario. It’s like trying to find the best cheesecake recipe when you’ve never made a cheesecake. There’s no reference point. And this a little more important than a cheesecake.
So instead of prescribing an intricate scheme that looks nice on Pinterest but doesn’t translate to real life, I want to take you through the Seven Baby Steps. Designed by Dave Ramsey, the Seven Baby Steps is your surest, fastest way to building (and keeping) wealth. Keep in mind, this is not a get-rich-quick kind of deal, but a principles-based plan that—if you follow it without skipping steps—will allow you to build wealth over time.
Baby Step 1: Save $1000 as a starter emergency fund. Save up $1000 as quickly as humanly possible and put it into a separate savings account, preferably a money market account where you’ll get a little interest. Order some checks, and your starter emergency fund is all set. This must be complete before moving to step two, or you will almost certainly get stuck in a debt cycle whenever a minor emergency pops up.
Baby Step 2: Pay off all non-mortgage debt. Make a list of debts, starting with the smallest balance and ending with the highest balance, regardless of interest rate. Pay the minimum payments on everything except for the smallest debt. As you cross off each debt on the list, add the payment from the previous debt onto the payment for the next one.
Baby Step 3: Complete your emergency fund, which consists of three to six months of living expenses. Whether three, six, or somewhere in-between, you’ll want to have several months of living expenses set aside (not your whole paycheck, just what will cover basic expenses). This is like an insurance policy that creates a buffer between you and any life events or significant financial emergencies.
Baby Step 4: Contribute 15% of your gross income to retirement accounts. This one can be painful to wait for, especially if your employer offers a 401K match and you’re still in Step 2, but trying to manage debt and invest is counterproductive to wealth-building. It’s like trying to plant a garden over a mess of weeds. You won’t be able to harness the power of your biggest wealth-building tool—your income—when you’re strapped with debt. Clean up the debt first, then focus on investing.
Note: Steps 4, 5, and 6 are done concurrently.
Baby Step 5: Save for college. If you have little ones, they will most likely go to college or trade school, and that takes a lot of money. The earlier you can start saving, the better. Even if you aren’t able or do not plan cover your child’s entire tuition bill, there are some excellent (and some terrible) tax-deferred investment options to help your future scholar. Take caution: don’t become overwhelmed by rising tuition costs and sacrifice Step 4. Retirement is going to happen and there are only so many ways to pay for it. However, there are several ways to fund college that don’t involve going broke.
Baby Step 6: Pay off the house early. Can you imagine what it would be like not to have a house payment? Amazing hardly begins to describe it. That’s so much money! Better yet, it is possible to accomplish: those who follow this plan pay off their house in an average of seven years.
Baby Step 7: Build wealth and give generously! Because at this point, there’s nothing else to do! I love the focus on giving here, because building wealth isn’t the same as wealth hoarding. What we do with what we have matters more than how much we have.
Life will always be complicated, but having a plan will help you stay focused and on-track. The Seven Baby Steps is a tried-and-true process for staying out of debt and building wealth.