It should come as no surprise that I get inspiration from Dave Ramsey’s 7 baby steps to financial freedom.
In addition to his reading his book, I listen to his podcast on YouTube.
One of my main modes of entertainment is listening to him chastise people who made “foolish” financial decisions.
2 of my favorites Dave Ramsey’s quotes
- “You can’t outearn foolishness” – this was said to some guy who made close to 200 k a year but spends a ridiculous amount of money on car payments. He had 3 car payments. He spends more than a grand in car payments per month for one of the cars. Dave took the sentence out of my mouth on that one.
- What’s in your wallet? Do you know what’s in my wallet? Cash! This was one of his rants about credit card debts. He especially detests capital one commercial that says, what’s in your wallet? In fact, I think the best way to elicit a reaction from Dave Ramsey is to tell him you have a huge credit card debt and you want to buy an expensive car.
Baby Step 1 – $1,000 to start an Emergency Fund
Baby Step 2 – Pay off all debt using the Debt Snowball
Baby Step 3 – 3 to 6 months of expenses in savings
Baby Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
Baby Step 5 – College fund for children
Baby Step 6 – Pay off the house early
Baby Step 7 – Build wealth and give!
Don’t get me wrong, this plan works well the way it is. You can do worse than following his advice.
However, I have found that he is extremely debt averse but I am not as extreme.
Therefore, I have made some modifications to my personal financial management.
If you keep an open mind, you might find it useful or at least give you an alternate pathway.
- Pay all credit cards
- Have the minimum required emergency fund >/= 1000 dollars.
- Refinance your loans
- Pay off any loan with interest rate >5%
- Utilize your employer 401 k up to the match and if you have money left, then Invest in Roth IRA.
- Now pay off the rest of your debts
- Maximize your retirement savings
- Boost up your emergency savings to 3-6 months of living expenses
- Invest in your children’s future education
- Build wealth – Save 1/3 of your income or at least strive to. Go a little wild, diversify.
- Give – at any stage above too if able to
- Optional pay off mortgage
Let’s use Dave Ramsey’s 7 baby steps as a framework since he has more authority on the subject matter than I do. Here is an affiliate link to buy the book. I think everyone needs a copy.
The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness
Save a mini emergency fund. Recommended amount = 1000 dollars.
I believe that credit card debt should be prioritized over the emergency fund.
If you pay off credit cards, you are no longer paying interest, and can still use the available balance in the case of an emergency.
If you are really devoted to improving your finance, you are less likely to use the credit card.
There are also many credit card offers nowadays that wave interest rate for up to a year or more for a new card.
When credit cards are paid, it is then important to begin building your emergency fund.
1000 dollars is a good start, but aim for around 5,000 dollars. Why that much? Although not the norm, I do have high miscellaneous expenses as a doctor.
For example, towards the ending of my fellowship training, I wiped out all of my emergency savings.
In one month, I had to pay for my medical license (about 500 dollars), DEA license (~700 dollars) and critical care board exam (2400 dollars).
My wife, kids and I flew down to our new location to look for housing.
The cost of the flight, rental car and hotel were close to 3,000 dollars. It felt like an avalanche of money spending.
I had to dip into my credit card briefly to survive. Thankfully, I picked up a few shifts that helped me catch up.
Baby step 2
This can be divided into 2 parts.
Part 1 – Pay off all debt.
My strategy is to pay off high-interest debt. Pay off your credit cards if you still haven’t paid it off in step 1.
Pay any loans with interest rates greater than 5%. In my case, one of my student loan interest rate is 2.8%.
So, I did not rush to pay it off. See my post on time value of money. There, I explained the opportunity cost of money and why it might be beneficial to invest your money now rather than later or use on other venture like paying off a low-interest debt.
Part 2 – Use the snowball method
The debt-snowball method is a debt reduction strategy in which the debtor pays off the smallest balance first and work their way up to the larger ones.
The problem with this strategy is that you will end up paying more over time.
Why don’t you pay off the one with the highest interest first, and then pay the ones with the lowest interest rate last?
This is known as the avalanche method. In our post on 15 Dave Ramsey tips you wish you knew sooner, we touched base on the two different ways to pay off debt.
Refinance if possible to a lower interest rate.
Even Dave said he knew the mathematics does not make sense but it works. But my mathematics background will not let me agree with this method.
Baby step 3
Step up your emergency savings to an optimum level of 3-6 months.
My take:
- I will invest in a pretax retirement account before this stage. At least up till the employer matching.
- My goal is to have 3 months worth of emergency funds, as I am not a fan of keeping too much cash. I always think of many ways to invest that cash. The wife wants more so I think we would settle at 6 months.
If you are enjoying the read so far, please go ahead and join the Breathe Easy Finance community. We will send you our budget template to get you started on saving that emergency fund.
Baby step 4
Invest 15% of your income into both IRA and pre-tax retirement account.
As said above, this should come before the cushioned emergency funds of 3-6 months.
15% should be the floor. For high earners, I will recommend one-third of your income. Follow the rule of three. Divide your income into three. One part to uncle Sam, save one part and spend the rest.
This may actually mean If you pay a higher tax, then what should suffer is your spending part. You have some choices to make; you can find a legal way to pay less tax, spend less or earn more.
You can also do any of the combination or better still, do the three. Even if you earn more, try not to grow into your income. Remember Dave’s voice yelling at you about trying to out-earn foolishness.
First is to contribute to 401k up till the employer match. Then, max the Roth IRA – 5500 currently.
If you have maxed both retirement account and Roth IRA (backdoor IRA for high-income individuals), pay off the rest of the debts.
I am currently at this level and plan to finish paying off my loan in the next year. I started at about $210,000 in loans for undergraduate and medical school.
Through intensive extra coverage shifts in fellowship, I managed to cut it down to 106,000.
My new job offered to pay some of the rest. The overall payment including interest was around 300k. Yup Ouch. Thank God it is behind us now.
Baby step 5
College fund for children
There are different takes on this subject. Some like their children to get loans, some want to pay with cash.
However, if you want to invest for college tuition, there are multiple options but the one I am choosing is the 529 plan.
Last time I checked, my state allows for up to $500,000 in investments for each child. Obviously, I am not aiming to do the maximum.
Baby step 6
Pay off your house
The decision here is not clear-cut. There are polarizing views on this: to pay off or not to pay off your mortgage.
I am with not paying off the house view. I believe my money can be better used to invest, especially considering the long-term horizon that I have. Perhaps I will change my tune once I am older.
I personally enjoyed this article that talked about the 11 reasons why you should carry a big long mortgage.
The ones I think are interesting and might be helpful are :
A mortgage is the cheapest money you can borrow
Most of the line of credit in the USA will get you for at least 8% interest. Don’t even let us discuss credit cards which start at a whopping 18%. That’s reverse compound interest right there.
A mortgage is tax deductible and the interest is tax favorable
Why give up the tax benefit of having a mortgage?
Baby step 7
Build wealth and give
This is also divided into 2
- Build wealth –You are already building wealth since baby step 4. This is the time to take more risks. Take interesting asset classes like real estate, start a business, buy a business etc.
- Give – You don’t have to wait until the last step to do this. Find a cause that you believe in and give towards it. I am still looking into the donor-advised fund and deciding on whether it is a good option for me.
RECAP OF THE 12 TODDLER STEPS
- Pay all credit cards
- Have the minimum required emergency fund >/= 1000 dollars.
- Refinance your loans
- Pay off any loan with interest rate >5%
- Utilize your employer 401 k up to the match and if you have money left, then Invest in Roth IRA.
- Now pay off the rest of your debts
- Maximize your retirement savings
- Boost up your emergency savings to 3-6 months of living expenses
- Invest in your children’s future education
- Build wealth – Save 1/3 of your income or at least strive to. Go a little wild, diversify.
- Give – at any stage above too if able to
- Optional pay off the mortgage
What do you think? How will you arrange the steps? Don’t forget to share!!
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Adebayo
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I am a pulmonary and critical care doctor by day and personal finance blogger/debt slaying ninja by night.
After paying off close to $300,000 in student loan debt in less than 6 months into my real job, I started on a mission to help others achieve the same. There is no magic to this than to strap up and get it done. Some of the ways we achieved this include side hustle, budgeting, great negotiation skills, and geographical arbitrage.
When I was growing up, common knowledge in Nigeria is that there is one thing you cannot trust anyone else with, and you guessed it – your money.
Being frugal came easily to me based on my background. However, the concept of building wealth did not solidify in my mind until when I finished medical school. I wish I knew what I know now when I was 14. Still, I don’t know enough and I am constantly learning to improve my knowledge.
My goal is to reduce financial illiteracy among young professionals. I am catering to the beginners – babies and toddlers in financial literacy.
