One of my favorite finance writers, Dave Ramsey, created a “system” that he calls the 7 Baby Steps towards getting out of debt and building wealth.
Each of these steps should be followed in order – starting at step 1, and then proceeding in succession. Don’t jump from Step 1 to Step 5, he says. You should move from one step to the next, in the same way that a baby needs to crawl before they can walk.
If you’re in debt, you may find this helpful. Here are Dave’s seven baby steps:
#1. Start a £1,000 Emergency Fund Known as a “rainy day fund”, this is something you should only tap into in emergencies. An emergency like you lose your job, but need to pay your rent, or your car breaks downs and you have to repair it to get to work. Don’t use the money in here for emergencies like you need to purchase the latest gaming system or a new outfit to wear on vacation.
#2. Pay Off Debt From Smallest to Largest The second baby step can take awhile, especially if you have a large amount of debt. Dave Ramsey recommends paying off debt using the “debt snowball” tactic. This method advocates making a list of all current debts, and then focus on paying off the smallest one first regardless of the interest rate. Once you pay off the smallest debt, then you move on to the second smallest and so on until it is all gone.
#3. Make a Long-Term Emergency Fund Concentrate on taking that £1,000 emergency fund and turn it into a long-term emergency fund. It should have enough money to cover all your expenses for 3 to 6 months. This way, if the unexpected happens and you get sick or you lose your job, you can draw from your emergency fund instead of going back into debt again.
#4. Save For Retirement You don’t want to spend your golden years working. Once your debt is paid off and you have a hefty emergency fund in place, take some of that extra cash and save at least 15 percent of your paycheck towards retirement. Investing this money into a 401(k) plan where employers match employee contributions up to 50 percent, for example, allows you to maximize your retirement.
#5. Save For College Maybe you never got to go to college. Maybe you have kids you want to send to college. Either way, once you are living debt-free, set aside some of your paycheck towards a college savings plan. You won’t have to pay taxes on many of these plans provided you withdraw the money for educational expenses.
#6. Pay Off Your Mortgage Early By now, you are clear of all your debt except for one outstanding loan: your mortgage. Take the extra money you saved by no longer making debt payments and instead throw it towards paying off your mortgage early. Paying off a 30 year mortgage in 20 years instead of 30, for example, ends up saving you thousands in interest fees.
#7.Build Wealth Rich people don’t get rich by stuffing their money under a mattress. They take that money and invest it in the stock market or use it to start a business. Some even give to charities. Either way investing money to get back more money in return allows you to build up real wealth.
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