My analysis of Dave Ramsey’s baby step plan. (hint: It rocks!)
Posted on April 22, 2020
Tried and true. Before we start, I want to give full kudos to Dave Ramsey. I have researched so many financial strategies and plans over the years, and his plan is the one we follow. So it is not a theory for us. I can testify! You can find all of his information on Daveramsey.com. Here is my analysis and take on his plan. Baby Step 0 Before you start your plan, work out how much it costs you to live (have a Budget). Check bank and credit card statements. Food, clothing, loan payments, housing, electricity, gas, phone, giving, sending money overseas. Income should be more than expenses, if not, need to either increase income or reduce expenses. Have a GAP between Income and Expenses! Even if it is just $1 to begin with. Apply the GAP to the following steps. *Note* The greater the gap, the faster you will move through the steps. Baby Step 1 Apply the GAP to Save $1,000 in an Emergency Fund. Put this money in a different place than your day to day banking. Set up a new account, or just keep it in cash. This money is to cover small unexpected debts. *Note* Pizza is not an emergency! Neither are shoes. Advantage – You will be able to cover a small emergency without charging it on your credit card, putting you further into debt. Baby Step 2 Apply the GAP to Pay off all debt (apart from your mortgage) using the Debt Snowball (ie list all debts in smallest to largest**). Pay the minimum repayment on all debts (including mortgage), but throw all extra income (ie the apply GAP), toward the smallest debt, then move to the next biggest debt, until all debts (apart from mortgage) are paid off. **Note -debts to government agencies should be prioritised as there may be further ramifications if not paid (ie unpaid fines may hinder rego renewal). Advantage – As you pay off each debt, your expenses will reduce, because he minimum repayment is eliminated, this leads to a bigger GAP, that you can apply to the other debts, hence the name Debt Snowball. Once all debts have been paid off, your GAP is now the sum total of all the repayments you were paying off. Baby Step 3 Apply the GAP to Continue to build emergency fund until you have 3 to 6 months of expenses in savings. Remember, because you have paid off all your debts (Step 2), your expenses are now significantly lower than when you started this process. Keep this money in the bank, don’t worry about interest rates or returns too much, the purpose of this account is that you need to get access to this money immediately if required. Advantage – With 3 to 6 months in the bank and no debts, your stress level plummet. Think about your stress levels if you lost your job with nothing in the bank, compared with having 6 months cushion to fall back on. Baby Step 3a Ok, this step was clearly an afterthought from the original 7 steps, but I am glad it is there. It works. Apply the GAP to Save up for a house deposit, purchase your first home. You ideally want to have a 20% deposit, as this eliminates the need for Lenders Mortgage Insurance. Advantage – By setting a goal to save the deposit before buying, you will have a chance to research exactly what type of house you want to buy. Knowing the numbers helps to not make an emotional decision when buying. A higher deposit means a lower mortgage, therefore lower mortgage repayment. You may find that your repayments are not much more than rent plus regular saving for deposit. Now we come to Steps 4, 5 and 6, which are done concurrently (ie do all three steps at the same time). Divide up your GAP (which should by now be a lot larger than when you first started out because you no longer have debt repayments), and Apply it across Steps 4,5 and 6. Baby Step 4 Apply the GAP to Invest 15% of household income into a retirement fund. Advantage – This will boost your retirement next egg when you retire. The earlier you start investing, the more time the magic of compounding interest has to work. Caution – make sure you educate yourself about how the investments inside your super fund, and other investments, because retirement accounts, such as superannuation, can have wild swings, which are totally normal and common, but can be a shock if you are not prepared. A great resource is https://jlcollinsnh.com/stock-series/ . Although it is US based, and terminology will be different from Australia, the fundamentals are still the same, especially the first 7 parts. Read the entire thing. The more knowledge you have, the more peace you will have about your financial future, especially regarding your retirement. In Australia, every employer must pay 9.5% of their Employees’ gross salary into Superannution. So you can incorporate this into your 15% (ie pay only another 6.5%) or pay the entire 15% in yourself (ignore the employers contributions, treating them as a bonus). Baby Step 5 Apply the GAP to Education funding for children. Similar to investing for your retirement, the sooner you start saving for your kids’ further education, the more will be available when they complete secondary school. Advantage – Your children will start off their working life without no, or significantly lower Higher Education Debt. In Australia, higher education loans are automatically deducted (as long as you tick the right box on the Tax Declaration form with your employer) from your salary at a percentage of income, depending on your level of income. The lower the debt, the quicker it will be eliminated, and the sooner they can start saving for a home. You can put your kids years ahead by investing for their education while they are young. Baby Step 6 Apply the GAP to Pay off home early. The sooner you pay off the mortgage the more money you will have for investing and giving. Dave Ramsey recommends a total of 15 years to pay off your mortgage. In that case, even if it took until age 40 to purchase a home, you will have it paid off by the age of 55. The sooner the better, but do the calculations to allow for steps 4 and 5 when considering step 6. Aim to balance out the scale between wealth building and debt repayment. Advantage – Having a paid-off home reduces your cost of living by 20% to 30%, depending on your mortgage repayments and your income. The mortgage repayment is probably the single largest expense in your budget. Baby Step 7 Apply the GAP to Build wealth and give! This is self-explanatory. Investing and giving will grow exponentially from this point on because you have no other major expenses, such as debt repayments. Your GAP will now be at least the size of your now non-existent mortgage repayments. Spend a few seconds calculating how much you could give away to needy people if you didn’t have that mortgage payment. Advantage – Maybe a spouse could stay home now? You now have the choice. Lifestyle now becomes a primary driver in your decisions, rather than debt repayments. Who was it that said that a “borrower is slave to the lender”? Is it time to apply these steps, so this verse does not apply to (someone) you (know)?