The “seven baby steps” have become fairly well known thanks to Dave Ramsey’s rising popularity and common sense financial approach. They are at the core of his philosophy and provide an excellent framework to guide you in your financial endeavors. They lay out a path toward financial independence that applies to everyone, regardless of their level of wealth.
The standard baby steps:
- $1,000 Emergency Fund
- Pay off Debt
- 3 to 6 month emergency fund
- Invest 15% for retirement
- College funding for kids
- Pay off home early
- Build wealth and give
The baby steps are generally an excellent starting point, but some customization may be necessary depending on your financial and personal goals. If you don’t plan to have kids, you’re obviously not going to worry about a college fund. If you don’t have a mortgage, you not going to worry about paying it off early. You may find it necessary to customize the order, the amounts, or the steps themselves.
Given what we want to accomplish over the next few years, here are our updated and customized baby steps.
My Baby Steps
- Tithing: 10%
- Pay off Debt: $50,000
- Emergency Fund: $30,000
- Retirement: Invest 15%
- Spend Fund: $10,000
- College: Invest 8%
- Foreign fund: $30,000
- Pay off mortgage early
- Build Wealth
A tithe is 10 percent of something. Tithing is usually paid to show gratitude to God for one’s blessings and to further His work. Tithing is generally our family’s biggest expense. I don’t feel totally comfortable putting it out there for everyone to see, but that’s what I signed up for when I created this site. I am comfortable, however, with putting aside what others think in order to provide the type of financial transparency upon which BareBudgetGuy.com was founded.
Tithing is my family’s Baby Step #1. It is the first thing we set aside with any income we earn. Faith is a central principle of tithing, which is why for us it comes before any other expense or baby step, including debt. We continued to pay tithing on the income we earned during the 4 years we were in debt. At times, it’s easy to feel like we can’t afford to pay it, but we do believe in Malachi 3, and feel we have seen the “windows of heaven” open when we most needed it.
Stephanie has a great post on giving while in debt which is in right in line with my thoughts on tithing as a priority.
2. Pay off debt
We went $45,000 into debt when I went back to school for an MBA and added another $5,000 for a minivan upon graduation. We worked hard to be very frugal and were able to pay off the $50K within 18 months. We had a very small cushion of cash but we didn’t skip to step 3 before cleaning up the debt.
3. $30K emergency fund
We finally hit our emergency fund goal last month! It’s known (by me) as our “peace of mind” fund. It seems that some people can enjoy life regardless of being financially strapped, but I am not one of those people. A 3-6 month emergency fund is probably plenty to hold a family over in most situations, but I wanted to feel just a little bit more security.
Our emergency fund is probably more like a 7-8 month fund. I know a lot of people who opt for a whole year’s worth of expenses. Some think large emergency funds are excessive and that the money could be earning a greater return invested elsewhere, but only you can determine how much you need to invest in your emergency fund to give yourself that peace of mind.
4. 15% retirement contribution
Now that we’ve hit our emergency fund goal, it’s time to crank up the retirement contributions, which we will be doing this month. Generally, you shouldn’t move to the next baby step until you have achieved the one you are currently working on, but part of tailoring the baby steps to your situation is determining if its okay for you to work on certain steps simultaneously.
One exception I made was to contribute 5% to my 401K (Baby Step #4)-just enough to get the full company match-even when we were still in debt working on Baby Step #2. It didn’t take us that much longer to pay off the debt, and we came out of it with a few thousand extra dollars more than we would have otherwise.
5. $10K spend fund
I have mentioned a spend fund before, but I’m not sure that I’ve explained it’s purpose. A spend fund differs from an emergency fund in that its purpose is to cover expenses that you can reasonably foresee. If you think you’ll probably need a new roof in a few years, there’s no reason that the expense should come out of your emergency fund. Our goal is not to touch the emergency fund unless we find ourselves in a true and unforeseen emergency.
We chose a somewhat arbitrary amount of $10,000 for the spend fund. This should cover any car or house repairs that come up in the short term. The spend fund is just a more general approach to the sinking fund.
You create a sinking fund simply by saving each month to cover a specific purchase for a certain point in time. For example, if I think I’ll need a new roof in 2 years that will cost me $10,000, I’ll start saving about $400 each month for the next two years. Rather than keep track of a bunch of sinking funds, I just opted for the lump sum spend fund approach.
6. College for the kiddos
I’m leaning toward contributing about 8% of what I earn each month to a few 529 education plans. I’ve still got to nail this one down, and I need to do it soon, because we are quickly approaching our Baby Step #6.
How much you need to save now for your kids’ college education is the classic finance problem. Here’s how I came up with the 8%.
We have 3 kids-ages 7, 5, and 3. Assuming they go to college when they are 18, I can easily estimate how much I should be saving each month for their education. How much you want to give your kids for college is a whole different topic. Here I’m just discussing how to calculate what you should be saving in order to hit your chosen number.
I like the number $50,000. My undergrad alma matter tuition rates have been consistently increasing at rate of 3 percent. So if I give my oldest $50,000, child 2 would get $53,000, and child 3 would get $56,000.
Using the PMT function in excel, I calculated about how much I need to contribute annually for each kid to hit my goal. You can download it here if you want to see the formula. I assumed a 5% interest rate in this case, which I think is reasonable. I added together the number I calculated for each kid and divided by 12 to give me my monthly college fund contribution, which happens to be about 8% of my monthly income.
7. Foreign fund
This is the one I am most excited about. We are serious about taking a one year sabbatical to South America. There are a whole host of reasons we’d love to do this, but I’ll talk about the “why” another time. I figure we’ll need about $3o,000, which is how much I’d need to feel comfortable if neither of us is working. I do plan on doing some work, but I want to be prepared so we don’t have to stress.
8. Early mortgage payments
Depending on how and when Baby Step #7 plays out, paying off the mortgage early may or may not be applicable for us. But if it is the right thing to do at the time, making early payments is a powerful tool because everything you pay above your normal payment is applied directly to the principal. And the more you can chip away at the mortgage, the closer you are to being truly debt free and in control of your money.
9. Build wealth
Once every other baby step is complete, then real momentum begins. With no debt payments or baby step buckets eating up your resources, it’s amazing how fast your money starts to exponentially build on itself. I know from experience. Well… not me personally, but a guy I know…
Here’s where we’re at. We should hit our spend fund within the next month or two, and then we’ll start packing money away for the kids and for our sabbatical/mini-retirement/service trip/midlife crisis/family adventure and bonding experience (or just Baby Step #7).
Own your baby steps!
And that’s it! To make personal finance truly personal, you need to make the basic principles your own by applying them to your own personal situation. I love helping people do that. I am just finishing up a tax season of making people pay me for it, but I’ll do it for you for free.
What custom baby steps do you have?