Investing is important, but Dave Ramsey recommends three steps to complete first.
- Dave Ramsey offers a money management plan called 7 Baby Steps.
- The first steps are building an emergency fund and paying off non-mortgage debt.
- He recommends investing, but only after you’ve met a few other financial priorities.
Most financial experts recommend investing to build wealth and save for retirement. If you’ve recently started to improve your financial situation, you might think that you should start investing right away.
While Dave Ramsey recommends investing, he believes it’s better to do a few other things first. In his popular system, the 7 Baby Steps, you don’t start investing until step #4. Here are the first three steps and why they take precedence.
1. Save $1,000 for your starter emergency fund
The very first thing Ramsey advises people to do is start saving $1,000 as soon as possible. This will become your starter emergency fund to cover any unexpected life events that come your way. If your car breaks down or you get sick and have to miss a few days of work, you can use your emergency reserves and avoid borrowing money.
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Why should your emergency fund come before any investment? An emergency expense can occur at any time, and when it does, the safest way to pay for it is with cash.
Suppose you decide to invest first and take care of the emergency fund later. Before you can do that, your dog gets injured and you end up with a $500 vet bill. Perhaps you can sell some of your investments to cover that. But when they’ve gone down in value, you’re losing money in the process, which is why an investment account shouldn’t be your emergency fund.
2. Pay off all debts (except the house) with the Debt Snowball
Next, Ramsey recommends paying off all non-mortgage debt. This includes credit cards, car loans, and any other type of debt you have. Ramsey likes the debt snowball method, where you pay debts in order from smallest to largest balance. Here’s how to go about this debt settlement method:
- Make minimum payments on all your debts to stay current and avoid late fees.
- Put all your extra money on the debt with the smallest balance.
- Once that debt is paid off, repeat the process with the next smaller balance.
- Continue until all your debts are settled.
The logic here is to pay off accounts that are costing you money in the form of monthly interest before They work to make money through investments.
While Ramsey’s advice works for many people, you don’t have to follow it to the letter. This step is a great example of one that you might want to change. It’s a good idea to pay off high-interest debt before investing. When you’re paying an 18% APR on your credit cards, that’s a lot more than most investors can expect. In this case, you’ll get the best return on your money by paying off credit card debt.
However, you may not have to pay off all of your non-mortgage debt. If you have loans with an APR of around 6% or less, there’s nothing wrong with investing while you’re paying them off.
3. Save three to six months of expenses in a fully funded emergency fund
The third small step lets you return to this emergency fund. Now go from a $1,000 starter emergency fund to a full-fledged emergency fund with what most experts recommend — three to six months of living expenses.
If your living expenses are $3,000 a month, your savings goal is $9,000 to $18,000. This will better prepare you for major emergencies such as: B. a job loss that takes you several months to find work.
Again, it’s okay to be flexible when you start investing. By all means save until you have an emergency fund for three to six months. But if you want to start investing while saving for that emergency fund, there’s nothing wrong with that.
Next up: investing
After you’ve done those three things, Ramsey recommends moving on to step four, which is investing 15% of your household income toward retirement. It’s a habit to follow for the rest of your career. There are many different options for saving for retirement, including online stockbroker accounts and/or an employer-sponsored retirement plan.
Ramsey’s system is designed to first put you on a solid financial footing and then start building wealth. That’s why it starts with setting up your emergency savings and getting rid of non-mortgage debt.
The 7 Baby Steps is just a system that works and as mentioned before you don’t have to wait that long before investing. But at the very least, it’s best to have a solid emergency fund and get rid of high-interest debt before investing.
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