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Financial baby steps: save and invest

Last week, we explored the basics of baby steps 1 and 2 — save up $1,000 in a beginning Emergency Fund, and pay off all non-mortgage debt. Today, we’ll explore Dave Ramsey’s baby steps 3, 4, and 5.

To recap, the “baby steps” are:

1.  Quickly save $1,000 as your beginning Emergency Fund.
2.  Pay off all your non-mortgage debt using the Debt Snowball method.
3.  Save 3 to 6 months of expenses, completing the Emergency Fund from step 1.
4.  Invest 15% of your regular household income for retirement.
5.  Create a college fund for your children.
6.  Pay off your house.
7.  Build wealth and give like crazy.

Our steps today are to save 3 to 6 months of expenses, to invest 15 percent in retirement, and to create a college fund for your kids. These steps can be incredibly intimidating, but they don’t have to be — they simply take some research and education.

Again, let me remind you that Dave’s plan isn’t the only plan, but it’s a great one that makes a lot of sense, and has worked beautifully for my family.

And also, even though “give like crazy” isn’t until step 7, he still advocates charitable giving all throughout the plan. The last step implies having enough wealth that you can give tons of it away and still live comfortably.

Baby Step 3

Photo by it’s about life

Remember that $1,000 you socked away in baby step 1? Now that you’re debt-free (baby step 2), it’s time to fully fund that Emergency Fund with 3 to 6 months of living expenses.

It might sound difficult, but now that you’re debt-free, you can simply transfer all the money you were sending to someone else, and now pay yourself. Don’t raise your standard of living, and finishing your Emergency Fund won’t take as long as you think.

We thought ours would take at least nine months, and it only took four.

It really feels good to keep that money you were just recently sending to your debtors. Yes, you can probably go out to eat once a week now, but because it’s so much fun to watch that number grow in your Emergency Fund, you’ll be surprised at how much you’d rather store your cash away for later.

Note that you need to save 3 to 6 months of living expenses, not income. Calculate your magic number by tallying up just what you’d need in an emergency — mortgage, utilities, groceries, and the like.

And I’d recommend veering more to the six months side of things, in today’s economy.

Extra Baby Steps 3

Somewhere between baby steps 3 and 4 is the best time to save for your extra needs. So if you need to sock away for a car replacement fund, a down payment, or even a vacation to celebrate your recent financial milestones, go right ahead. I save up for these sinking funds in a myriad of ING Savings Accounts.  Read more about how we use ING to separate our savings goals.

Baby Step 4

Photo by Alex Proimos

Now that you’ve got a fully funded Emergency Fund, it’s time to bring that retirement savings back up. Dave recommends stopping retirement while you work baby steps 1 through 3, mostly to have as much extra cash as possible to finish the steps. It’ll also light that fire under you, making you as gazelle intense as possible.

Saving for retirement is the most important investment you can make, because no one else can do it for you. If you’d like to live out your golden years with dignity, then you shouldn’t rely on your children, and certainly not the government.

Every specific plan is different, depending on your citizenship. For my fellow Americans, Dave recommends the following:

1. Take part in a pre-tax savings plan if you receive a company match in your 401(k), 403(b), or TSP. Invest up to the match.

2. Once your contribution equals the match, fully fund a tax-free savings plan, such as a Roth 401(k) or Roth IRA.

3. If you max out your tax-free contributions and still have money to invest, put the rest in your pre-tax savings plan.

There are definitely some arguments about why Dave recommends specifically 15 percent. I don’t want to get into them today. But I will say that overall, 15 is a good average — if you’re starting late, you might want to shoot for 20 percent; if you’re still in your teens, you’re probably fine with 10 for now.

Baby Step 5

Photo by Kevin Rawlings

You can start baby steps 4 and 5 at the same time. Step 5 is to save for your kids’ college education. This is an important step (though not as important as baby step 4, in my opinion), and if you’d like to give your children a fighting shot at attending university debt-free, a great gift would be some funds socked away, just for this purpose.


Dave recommends (if you’re American) using a Coverdell Education Savings Account (ESA) for your contributions. You can contribute up to $2,000 per year in each account (one per child), and the ESA grows tax-free until withdrawn.

And then, according to the IRS website, “Distributions are tax-free as long as they are used for qualified education expenses, such as tuition and fees, required books, supplies and equipment and qualified expenses for room and board.”

What about 529 plans?

Saving for college via a 529 plan has its advantages as well, and you can open both a 529 and an ESA. The qualifying statement, however, is that each state has its own 529 plan, and they’re all different. So it’s pretty hard to make a blanket statement declaring all 529s to be problem-free. Do your research before proceeding.

You can chat with an investment professional if you’re interested in a 529 — Dave has a database of his Endorsed Local Providers (ELPs) on his site. Find one in your area.

Also, Cash Money Life has a good post recapping the similarities and differences between ESAs and 529s.

Investment Options

Dave almost always advocates doing all this investing via growth stock mutual funds. This, too, is sometimes controversial, but if you’re in it for the long haul, mutual funds are safe and have a decent return.

Don’t be scared by today’s economy, and don’t make rash decisions. Remember, investing is for the long-haul. Look at returns of at least seven years or longer.

Application Time

If you’re still getting out of debt, finish that snowball before investing or saving more than $1,000 for small emergencies.

• Once you have 3 to 6 months of expenses saved up, actively research and begin your best investment options. It’s never too late (or too early) to invest.

• Stick with low-risk investments in trusted sources, such as those listed above. Don’t trust get rich quick schemes.

• Above all, educate yourself. Don’t blindly assume the advice of anyone — even Dave Ramsey. Acquire financial wisdom and knowledge, and don’t be scared. If you have questions, seek out the answers.

Next Monday, we’ll discuss the last two baby steps — pay off your house, build wealth, and give like crazy.

Any thoughts? Questions? How scary is investing to you?

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  1. steadymom

    Great info, Tsh! I used to be heavily involved in Larry Burkett’s financial resources, and that’s what helped us get out of debt many years ago. A liberating feeling, indeed!

    .-= steadymom´s last blog ..STEADY DAYS – Shine Your Light =-.

  2. Emily

    I’m glad you’re posting about Dave Ramsey on your blog, Tsh! I am financially coaching someone who has serious financial issues, and it’ll be great to be able to tell her, “Look, this family was able to save up an emergency fund much more quickly than they predicted.” Always better when you can provide a real-life experience example.

    RE saving 15%: that sounds like a lot (and even more if you are giving an additional 10%) , but I want to encourage everyone to consider that sacrificing a few material things short-term is totally worth it when you can arrive to retirement age with complete financial independence.
    .-= Emily´s last blog ..Montessori or Moore: The Homeschool Quandry =-.

  3. Lindsey

    I love the Dave Ramsey plan, but we do tweak it a bit. 🙂 We’ve almost completed baby step 3! (woo-hoo) we already doing baby step 4, because my husband just couldn’t pass up the mathcing plan his company does. I think we will side step baby step 5 until we get some major home renovations completed, though. I’ve always had the Ramsey mindset but it’s nice now my husband is on board. It feels great to be out of debt, it feels great to pay with cash, it feels great to know that if an emergency comes up that we have the cash to carry us through for quite awhile.

    If anyone is hesitant about the plan, let me tell you that it’s worth it! 🙂
    .-= Lindsey´s last blog ..a good read =-.

  4. Lauren

    Thank you for including “extra baby step 3”. It’s nice to have someone else’s opinion regarding when to veer off the plan a bit and indulge yourself. My hubby is a present-minded person, so he always wants to enjoy now and worry later. I am the opposite, but I think we can both feel good if we wait until steps 1-3 are complete before “rewarding” ourselves.

    • Tsh

      Yep, it certainly was nice for us to take our long-awaited vacation this fall! It was probably our favorite vacation yet, since it was so celebratory and worth the wait. Though it’s not officially “veering” off the plan, b/c Dave says this same thing about having a baby step 3b.

  5. Sandy

    Scary this year! I’ll talk to you more about it in Nashville (I hope we will get time to visit!) With the ages of my kids – we’re at #5 right now (college!)

    Thanks for the good info, Tsh!
    .-= Sandy´s last blog ..Kid Memory Binders: Organized and Easy! =-.

  6. Aimee

    Great advice simply put, Tsh. You are helping so many people with this series!
    .-= Aimee´s last blog ..Foodie Facebook: Cheri =-.

  7. Laura

    Whew, it is hard to imagine that we’ll ever get to the saving/investing stage. I think the problem has always been for us when we try to do all the steps at once. Like, we’re paying down out debt — a little — while also saving — a bit — for retirement and college, and we feel like we’re doing a pitiful job on all fronts. I love the idea of focusing on one thing at a time and really finally making some progress!
    .-= Laura´s last blog ..You Never Forget Your First Cheese: Mozzarella! =-.

  8. Renee

    My husband and I have listened to Dave Ramsey’s Financial Peace almost in it’s entirety, and we’re working on emplimenting some of his strategies.

    This year we are committed to paying off all of our debt minus the car. To keep us committed and on track, I am documenting every penny we make and spend and the thought process behind our financial decisions in my blog. Actually, today was the launch of the new section, and I can’t wait to see where this honest discussion of money takes us.

    Me, Myself and Money
    .-= Renee´s last blog ..Introducing: Me, Myself and Money =-.

    • april

      you are going to pay off all of your debt minus the car… why not including the car? car payments are the worst.

  9. Stephanie

    What would you recommend for a family who can’t save due to a low income? We have zero debt, but we also have zero savings after a year of unemployment wiped out everything we had. At this point my husband works two jobs, I’m at home with my children during the day and work a bit from home at night, but with all that, we are literally living from paycheck to paycheck. We don’t eat out, we don’t buy anything but the bare necessities. We’ve always been extremely frugal. We’ve cut each area of our budget back so far and there is still nothing left over to save. Our next step, if necessary, is to drop our internet service, but that is almost impossible since both my husband’s second job and my evening job depend on it. Any advice? We would love to rebuild some savings but it seems impossible.

    • Stephanie

      Oops – zero debt other than our house payment!

  10. Laura

    It would be crazy for anyone to pass up a company match on 401k savings in order to stick with this plan. Money invested early on in a retirement plan has more time to grown and has a huge impact on the bottom line. Ramsey’s plan offers a basic structure for debt repayment, but is best modified to a more realistic plan with more of an eye toward the future.

    • april

      the reason dave says to “pass up a company match” and totally focus on paying off debt is because you will be that much more motivated to get rid of the debt !! it’s about behavior…90% of it. and it works. 🙂

  11. Crystal

    I’m really thankful you’re going over this again. It’s such a great reminder & motivator! Thanks.

  12. Meliss

    Doing these baby steps has made our life much more simple and a lot less stressful!
    Thanks for writing about this, it is a great reminder for the new year!

  13. Alissa

    Thanks for doing this series. 🙂 I’ve been reading a lot about Dave Ramsey lately. Did you have any sinking funds in place while you were doing BS1 & BS2? Or did you just put everything toward your debt, and use your BEF for anything that came along?
    .-= Alissa´s last blog ..Mvelopes Referral Update! =-.

  14. Tsoniki Crazy Bull

    I love the ING accounts! I have several set up right now and have money taken out automatically each month. It’s very easy. I need to make sure $1000 emergency fund is fully funded, but I am sort of doing the debt snowball already. We are down to less then $5K credit card debt, but just bought a new car and have mortgages, which I’d like to be able to pay a lot more on. I want to start a ESA too, maybe I should just bite the bullet and do it!
    .-= Tsoniki Crazy Bull´s last blog ..Two Quilt Blocks =-.

  15. Amanda

    I have been doing this all backwards. I got rid of my dept years ago, but I have not been able to save any money. I am scared to put all the expenses and income on paper. What if I do not have enough to do this buget? But, last week we had an emergency and we are stressed-out because we do not have any money. But we always seem to have money for magazines, bottles or wine and chocolate. I think once we see how much we are spending on these extras it will help encourage us to save. And, I agree that it would be exciting to watch our money get bigger and bigger. It was exciting watching my dept get smaller and smaller.

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