For BS1 - BS3, the step is completed and then move on to the next step (exceptions noted below, where one might have to restart BS1 or BS3). For BS4 - BS6 it is at the same time, with the priority toward BS4 first, then BS5, then BS6 as funds allow.
Quick recap of the first steps:
BS1 - Save $1,000 for a starter Emergency Fund
BS2 - Pay off all non-mortgage debt.
BS3 - Save 3 - 6 months’ worth of expenses for a Fully Funded Emergency Fund
The next 3 steps are meant to be done at the same time, but in a priority order:
BS4 - Invest up to 15% of income
BS5 - Save for children’s college fund(s)
BS6 - Pay off the home mortgage
When BS4 is being done with each paycheck, and the BS5 savings are either taken care of (or no kids, or kids done with college) and the BS6 mortgage paid off, then:
BS7 - Build wealth and give
We are racing to get BS4 met. We’re actually investing more like 50% of our income right now since starting BS4 in July after we completed BS3 in June. The reasoning behind this is that there are annual caps and deadlines for US IRS tax-advantaged investment accounts (401k, IRA, etc.). Once those deadlines pass, we cannot invest in “past years”.
The 457b deadline for my employer (and perhaps all 401k-type accounts) is Dec 31st. We’ll max that account with my last paycheck on Dec 24.
The IRA deadline is the US IRS tax filing deadline. For 2019 this deadline was extended to July 15, 2020 and we were able to slip a few thousand into the 2019 tax year in the first two weeks of July. We’ll max out the 2020 IRA accounts by March 2021 (IRS deadline is April 15, 2021).
Next year BS4 goals will be easier. Instead of trying to do it in 6 months, we’ll have the full 12 for the 457b employer account, and 9 months for the 2021 IRA accounts (as Jan - March will be spent finishing up maxing out the 2020 IRAs). 2022 will be even easier as well have a full 12 months to do both the 457b and IRA and we won’t be playing catch-up to max out those accounts.
So, technically we’re completing BS4 already as we’re exceeding 15%/paycheck, but we’re doing a non-Dave Ramsey thing maxing out all of our available tax-advantaged accounts for 2020 before starting the other Baby Steps.
We have adult children beyond college, so we skip BS5. In April 2021 we’ll start BS6 and starting to pay extra towards our mortgage. I’ve already run the amortization numbers, and it’ll take 9 years 2 months to complete, saving us 14 years off of the current loan.
Extra notes and way more detail for those who are curious:
BS1 - BS3 are meant to be done “Gazelle Intense” - like a gazelle outrunning a lion, fighting for its life. Take on extra overtime or side work, sell off anything you don’t need, etc. Live on beans and rice - very frugal meals (but don’t starve or anything), no or minimal eating out, no entertainment expenses, etc. Cancel any and every subscription or membership not part of your “four walls” (basic necessities of life). All investing is paused during this time - this is also a motivator to get through BS1 - BS3 as fast as possible.
BS1 - This is a small amount, but meant to motivate one to get quickly to BS3
BS2 - All non-investment savings beyond $1,000 are put toward debt. Debts are ordered smallest to largest (not based on interest rates) and all available money goes to the smallest debt, while the rest get the minimum payment. This helps psychologically to get faster wins as debt accounts are paid and closed out, and then those parents keep “snowballing” to the next smallest debt.
If one has an emergency that needs BS1 money, then BS2 is paused to help pay for that emergency and then restart BS1.
BS3 - The amount of money needed for expenses of 3 months, 6 months or somewhere in-between depends on job stability, single or dual income family.
There is an optional BS3b step, to save up for a house. This can be saving whatever amount one wants/needs, but of course this depends on many factors. A young single person is encouraged to save up 100%, while the minimum recommended to save is 20%. The home mortgage and related mandatory expenses (Home Owner Association fees, property taxes, home owner’s insurance, etc.) shouldn’t exceed 25% of one’s net take home - actually, that 25% rule applied to renting as well. “Housing” (renting or owning) should be under 30% at the very highest, otherwise move down in housing costs and/or increase the income. Any new mortgage should be a 15 year (or shorter) note with a fixed internet rate.
When BS3 monies are needed for an emergency, then BS4 - BS6 are paused until BS3 is rebuilt.
BS4 - This step is done until retirement and should be done in the most tax-advantaged order until 15% is reached. Not sure what the rules are in the UK, but for the US tax code the optimized tax-advantaged investing order is:
- 401k up to the employer match
- Roth IRA*
- Roth 401k/403b/457b**
- non-tax advantaged investing
*up to $6K/year/person in Individual Retirement Accounts (IRA) (married can do $6K per person, even for a non-earning spouse, so $12K)
**up to $19,500/year maximum
BS5 is influenced by the age and number of children. The big picture idea is that neither parent nor child will take out any student loans. That may mean that a student needs to work full-time while going to only a local “junior college” or “community college” or trade school while living at home. On the opposite side of the spectrum, perhaps if the parents start right away when a child is born and they are higher earner parents such that the child can go to any college they can be accepted to. But for many it is more than likely some mix in-between. BS5 is “completed” when there are no more children needing adult education.
It should be noted that parents aren’t obligated to fund their children’s college if they cannot afford it (say they are still not done with BS1 - BS3 and don’t have enough to fund 15% toward BS4). But, if they can afford it over BS4, and the children are diligent students not squandering their studies, a good parent should do this. College or trade schools are an optional adult-level education, and as adult children, they can earn merit-based scholarships or internships or work outside of college to fund their education, but this is their personal responsibility, not that of the parents.
BS6 paying off the mortgage is where any monies go beyond BS4 investing 15% and whatever the parents decide is needed to be saved for BS5 adult education. Baby Steps 6 is completed when the mortgage is paid off. Note that for some, re-evaluating their budget may mean they downsize in home. A recent guest on Dave’s show doing their “debt-free scream” live on the air had downsized from a $500K+ house to a $300K house and paid off the remaining $150K they owed on their mortgage in the last few years. The point being that they shaved off $200K of mortgage debt by downsizing.
Hah, that’s a really long reply, but that is a pretty thorough explanation of Dave Ramsey’s Baby Steps. He believes very much in trying to educate everyone on how to become and live debt-free and become “every day millionaires”. Second generation Ramsey households will never have debt and start out well ahead of their peers, and can become multi-millionaires.
Then there are other financial schools of thought, like the FIRE movement (Financial Independence Retire Early), but I’ll save that for another post