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Over the past 20-25 years, Dave Ramsey has always stood as a powerful voice against debt. Using his radio show and consistent teachings, he has helped millions of people gain control of their money and stay out of debt. To me, he is a financial hero because of all the people that he has helped. Even this humble blogger and my family have traveled down to the Dave Ramsey Show studios in Nashville, Tennessee to scream, “I’M DEBT FREE,” after we paid off all of our consumer debt.
We certainly are fans of Dave Ramsey.
One of the things that I love the most about Dave Ramsey is that he teaches a very simple way to get out of debt and build wealth, called “The Baby Steps.”
The Baby Steps
- Save $1,000 to start an emergency fund
- Pay off all debt using the debt snowball method
- Save 3 to 6 months of expenses for emergencies
- Invest 15% of your household income into ROTH IRA’s and pre-tax retirement funds
- Save for your children’s college fund
- Pay off your home early
- Build wealth and give
Small Critiques to Dave Ramsey’s Plan
No matter which expert we listen to and respect, I feel that it is very important to take their message and teachings and think about why it works for you. After thinking critically about their message, we should then ask ourselves which parts of their teachings we want to adopt completely, which parts we want to adopt partially, and which parts do not work for us at all. For instance, I am a big fan of Mr. Money Mustache’s strong anti-consumption mentality, but I also live 45 miles away from my work (which is really stupid, I know). So some parts of each expert’s teaching will completely work for us, while others may not.
The same is true with Dave Ramsey. Even if I agree with most of the stuff that he teaches, I can’t just blindly follow him without thinking about how his plan will work in my situation.
Baby Step 1: Save $1,000 to start an emergency fund
This is probably the baby step that I like the most. This is a quick and relatively pain-free step for people who have decided that they want to actually retire one day and figure out what is going on with their money. I love the Dave Ramsey quote of “sell so much stuff that the kids think they’re next,” when referring to this step.
The main concept behind this step is that bad things happen to us, which can cost us money. We have all had a water heater go out in the middle of winter, a car muffler fall off, or an unexpected visit to the doctor’s office. Without an emergency fund, these minor inconveniences can turn into credit card expenses that last for 6 months or more. Therefore, a small ($500-$2,000) emergency fund is needed to prevent us from having to borrow money at an interest rate of 19.9%.
Once we decide to actually start Dave Ramsey’s plan, this step can be the most satisfying, because it shouldn’t take too long to save up this money. By selling a bunch of stuff, working an extra job, or just turning in a bunch of rolls of coin to the bank, most of us can get $1,000 together pretty quickly.
Baby Step 2: Pay off all debt using the debt snowball method
The debt snowball method tells us to list all of our debts from the smallest one to the largest one, attack the smallest one with a vengeance, and pay minimums on the rest. After the smallest debt is paid off, then we attack the next one to pay it off quickly.
The thing that I really love about this baby step is the focus and heart that Dave Ramsey uses to attack this baby step. He uses imagery of a gazelle running away from a predator to show how intense we have to be when paying off debt.
Although I absolutely love the intensity, I think that we need to pay off our higher interest rate debt first. For instance, if our car loan is $5,000 at 4.9% and our credit card has a balance of $15,000 at 19.9%, we would be doing ourselves a disservice by paying off the car loan first. Over one year, paying off $5,000 of the credit card first can save us $750. So, the intensity in this step is good, but the smart way to pay off our debts should be by listing them out from the largest interest rate to the smallest.
We may even want to transfer our high interest credit card debt to a lower interest credit card to help us pay down our debt a little faster.
Baby Step 3: Save 3 to 6 months of expenses for emergencies
Mathematically, this step may not make a ton of sense, but we still need to do this step for peace of mind.
Saving a larger emergency fund provides an important barrier between emergencies that happen in life and having to go back into debt. Nothing would be tougher than going back into debt immediately after getting out of it, because of a big emergency. Although we are saving money in this step that we could have invested in the stock market, we still will come out ahead in the long run because of the powerful psychology of staying out of debt.
Personally, my wife and I invest enough money for only 3 months of expenses in an online money market account through Capital One 360 that earns 2% on balances over $10,000. There are a lot of other online banks out there that have similar interest rates, but we have been using this one since college, and we have always been happy with it.
Once you are done with the first three baby steps, you won’t have any consumer debt (car loans, student loans, credit card debt) and you will have $10,000 or so in the bank to protect you in case of emergencies.
Baby Step 4: Invest 15% of your household income into ROTH IRA’s and pre-tax retirement funds
To me, this is where Dave Ramsey’s baby steps start to get a little controversial. Dave recommends completing the first three baby steps before starting to save for retirement. He even goes as far as saying that we should stop all retirement savings (including a company match in a 401k) until we have the first three steps complete.
While I appreciate the intensity that Dave Ramsey suggests, I think that stopping our retirement investing will significantly hurt us in the future. Compound interest is such a powerful tool, that we need to invest as much as we can now so that we will be able to retire young and won’t have to catch up on our investments in the future.
Although I know that it is really important to pay down our debt, I feel that we should do this while still investing 15% of our income in the stock market. We simply can’t afford to stop investing, even if it is for a short time!
I also feel that Dave Ramsey’s suggestion to choose good mutual funds could harm us because of their high fees. As I wrote, investing in index funds instead of mutual funds can save us over $200,000 throughout our investing lives.
Baby Step 5: Save for your children’s college fund
Like Dave Ramsey, my wife and I strongly feel that we should help our children pay for college. However, we also feel that it is so important to make sure that we are financially secure, before we pay for our children to go to college. With this in mind, I think that we need to completely pay off our house before saving for college.
The other good thing about paying off our house first is that it frees up a mortgage payment. This money that was once used to pay towards the mortgage can easily be reallocated to invest in a college fund or to cash flow college.
We also want to encourage our children to pay for a bit of their college by themselves. If they know that they have $80,000 or more in a college fund, then it may be difficult to motivate them to apply for a lot of scholarships and save money for college by working.
Baby Step 6: Pay off your home early
Even though most home loans have very low interest rates right now, Dave Ramsey and I both feel that it is very important to pay off the mortgages on our homes early. I know, that we can probably earn a better return on our investment by putting money into the stock market, but when risk is factored in, we probably come out ahead by paying off our home early.
Plus, as Dave Ramsey says, the grass in our backyard would feel a lot better when we actually own it.
Baby Step 7: Build Wealth and Give
This is the step that most people are really looking forward to. Whether we want to increase our retirement savings to 50% of our income and retire early or build wealth so that we have more options with our career, this step provides us with a lot of freedom to do whatever we want.
By this point in our financial journey, we will be completely debt free and on our way to financial independence or a possible early retirement. If we are debt free, we will be able to make a bigger impact with our giving, both financially and perhaps even with our time.
It’s certainly true that people who are able to follow Dave Ramsey’s baby steps will do a great job financially. With a couple of tweaks, we may be able to do an even better job and become financially independent a little bit quicker.
Let us know if you enjoy Dave Ramsey’s teachings and what you would change about them.
And thanks for reading!
~Nathan
Let’s keep living a great life … with the help of money. So what’s next?
- You can travel for free by using rewards credit cards.
- You can get motivated and get out of debt.
- You can check out the next post or the previous post and continue to learn.
But no matter what you decide to do, let’s leave the ordinary behind and take action today!
2 Comments
Chris Roane
I agree with most of what Dave teaches. But some parts of his “my way is always the best way” rubs me wrong. But he has helped so many people. This is a great summary of his steps.
Life Before Budget
Thanks, Chris!
I don’t think we can ever say that one way will be the best for everyone. With any guru, I think that it is always good to find what part of their message works for us in our particular situation. Unfortunately, there is no “one size fits all” answer, which is what Dave is trying to provide.