Why Dave Ramsey Believes You Should Do These Three Things Before Investing a Cent

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  • Dave Ramsey provides a money management plan called the 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 completed a few other financial priorities.

Investing is important, but Dave Ramsey has three steps he recommends completing first.

Most financial experts recommend investing money to build wealth and save toward retirement. If you've recently started working on improving your financial situation, you might think that you should invest right away.

While Dave Ramsey recommends investing, he believes it's better to handle a few other things first. In his popular system, the 7 Baby Steps, you don't start investing until step No. 4. Here are the first three steps and why they take priority.

1. Save $1,000 for your starter emergency fund

The very first thing Ramsey advises people to do is save $1,000 as fast as they can. This becomes your starter emergency fund to cover any unexpected life events that come your way. If your car breaks down, or you get sick and need to miss a few days of work, you can dip into your emergency savings and avoid borrowing money.

Why should your emergency fund come before any investing? An emergency expense could happen at any time, and if it does, the safest way to pay for it is with cash.

Let's say you decide to invest first and handle the emergency fund later. Before you can do that, your dog gets injured, and you end up with a $500 vet bill. Maybe you can sell some of your investments to cover that. But if they've decreased in value, then you'll lose money in the process, hence why an investment account shouldn't be your emergency fund.

2. Pay off all debt (except the house) using the debt snowball

Next up, Ramsey recommends paying off all non-mortgage debt. That includes credit cards, auto loans, and any other types of debt you have. Ramsey likes the debt snowball method for this, where you pay debts in order from the smallest balance to the largest. Here's what you do in this debt repayment method:

  • Make minimum payments on all your debt to stay current and avoid late fees.
  • Put all your extra money toward the debt with the smallest balance.
  • Once that debt is paid off, repeat the process with the next smallest balance.
  • Continue until all your debts are paid off.

The logic here is to pay off accounts that are costing you money in monthly interest before you work on making money through investing.

Although Ramsey's advice works for lots of people, you don't need to follow it to the letter. This step is a great example of one you might want to modify. It is a good idea to pay off high-interest debt before investing. If you're paying an 18% APR on your credit cards, that's much more than most investors can expect to earn. In that case, you get the best return for your money by paying off credit card debt.

You may not need to knock out all your non-mortgage debt, though. If you have loans with APRs of around 6% or less, there's nothing wrong with investing while you repay those.

3. Save three to six months of expenses in a fully funded emergency fund

The third baby step has you looping back to that emergency fund. Now, you're going from a starter emergency fund with $1,000 to a full-fledged emergency fund with what most experts recommend -- three to six months of living expenses.

If your living expenses cost $3,000 per month, then your target would be $9,000 to $18,000 in savings. This better prepares you for big emergencies, like a job loss where it takes you several months to find work.

Once again, it's okay to be flexible about when you start investing. Definitely save until you have a three-to-six-month emergency fund. But if you want to start investing and save toward that emergency fund simultaneously, there's nothing wrong with that.

Next up: Invest

After you've done those three things, then Ramsey recommends moving on to the fourth step, which is investing 15% of your household income in retirement. That's a habit to follow for the rest of your career. There are plenty of different options to save toward retirement, including accounts with online stock brokers and/or an employer-sponsored retirement plan.

Ramsey's system is designed to put you on good financial footing first, and then start building wealth. That's why it starts with setting up your emergency savings and getting free of non-mortgage debt.

The 7 Baby Steps are just one system that works, and as mentioned earlier, you don't need to wait quite so long before investing. But at a minimum, it's best to have a solid emergency fund and get rid of high-interest debt before you invest.

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