The goal of Dave Ramsey’s Baby Steps is to help you work towards financial stability and eventually freedom. It all starts with putting a little money aside, then starting to attack your debt.
Dave Ramsey teaches this plan on his website, his radio show, in his books, and Financial Peace University. Overall, he’s helped millions of Americans get out of debt and create a better financial life.
The Baby Steps are pretty solid, but at times, they’re too simplistic for some in the personal finance community.
If you’ve never heard of his steps or are thinking about using them to pay off your debt, I’m going to explain what the Baby Steps are and how they can help.
And while I don’t want to pick a fight… Dave has a cult-like following of superfans… I am going to talk about where they fall short for some people.
What are Dave Ramsey’s Baby Steps?
Step 1: Start and build an emergency fund of $1,000
This is a “starter” emergency fund that will help you with any what-if scenarios. It’s meant to help you get out of debt by no longer adding to your debt. If your car breaks down or your fridge goes out, you pull cash out of your emergency fund instead of using a credit card to cover the cost.
To fund your emergency savings, Ramsey recommends creating a zero-based budget and setting a monthly savings goal. If you’re struggling to find money in your budget to save, then sell stuff online, find a side hustle, and cut any extra spending.
This money is not meant to be spent on extras, like going out to eat or a new gold club – an emergency fund is for emergencies only.
Not sure if your expense qualifies, Dave Ramsey tells you to ask yourself these three questions:
- Is it unexpected?
- Is it necessary?
- Is it urgent?
The more you answer “yes” to those questions, then you’ve justified using your emergency fund.
He recommends that your emergency fund is easy to access, but not too easy. You could put it in a high-yield online savings account, a money market account at a neighboring bank, etc.
What happens if you pull money from your emergency fund? You need to revisit this step and replenish your fund.
Learn about EveryDollar, the budgeting app built to work with the Dave Ramsey Baby Steps, in EveryDollar vs. Mint Comparison: Which Budget App is Best?
Step 2: Use the snowball method to pay off all of your debt (except for your house)
The snowball method is an integral part of the Dave Ramsey Baby Steps. The way it works is:
- Line up all of your debts (except your mortgage) from smallest balance to largest balance.
- Make the minimum payments on everything except the debt with the smallest balance. On that one, pay as much extra as you can.
- When you’ve finished paying off the smallest debt, you move on to the next debt.
You repeat the last two steps until you’ve completely wiped out your debt. As you start to knock out debts, you’ll have more and more money to put towards the ones with higher balances. This is where the snowball idea comes in.
When you’re working the debt snowball, you’re not paying attention to interest rates unless you have two debts with the same balance. In that case, he recommends paying off the one with the highest interest rate first.
Ramsey recommends the debt snowball over the debt avalanche because the snowball method gives you the motivation to keep going. You may be able to pay off debts with smaller balances in just a couple of months, and it feels really good to have those off your back.
But, Step 2 is where Dave Ramsey’s advice starts to break down for some people.
The debt avalanche is a more mathematically sound method because you focus on debts with the highest interest rates first. If you took the exact same debts, the avalanche is always going to save you some money.
Also, Ramsey doesn’t give a ton of actionable advice for how you’re going to find extra money to pay off your debt. Well, at least not much free advice… Dave Ramsey is a businessman who sells books and classes to people who want help working through his Baby Steps program.
If he’s not going to give you much free advice, here are a few tips:
- Negotiate for lower rates on your bills (insurance, phone, etc.)
- Get rid of cable for something cheaper like Netflix or Hulu
- If you have a new car payment, there are a lot of great used cars that cost a fraction of what you’re paying (here’s how to ditch your payment)
- Start flipping furniture
- Find a good side hustle
Step 3: Save 3-6 months worth of expenses in an emergency fund
After you’ve paid off all of your debt, Ramsey recommends that you really stock your emergency fund. $1,000 honestly isn’t a lot of money if something serious happens, and having 3-6 months' worth of expenses set aside is a much safer cushion.
The way the Dave Ramsey Baby Steps work is that one steps make it possible for the next one, so all of the money you were throwing at your debt can go towards your emergency fund
Is 3-6 months worth of expenses enough?
Most personal finance experts will agree on 3-6 months. If you’re self-employed, you should save more because your income can fluctuate. Really, the amount you keep in your emergency fund is up to you, and I’d say play it safe but don’t let it keep you from the next step.
Step 4: Invest 15% of your income for retirement savings
The Dave Ramsey Baby Steps recommend two different investment vehicles for your retirement savings:
- If your employer has a 401(k), start here and take advantage of the employer match
- Anything else goes into a Roth IRA (one for you and your spouse if you’re married)
This is pretty solid advice, and Ramsey goes on to suggest that you shouldn’t invest less than 15%, even if it means you can’t help your kids through college.
People who want to retire early or get a later start will need to save at a higher rate if possible. This is another reason why finding a side hustle can help you with your financial goals.
How and where to invest your retirement savings?
While I’m not a financial advisor, I really like ETFs. Because they’re inherently diverse and have low expense ratios, ETFs are an overall more affordable option that gives you broad market exposure.
No matter what kind of assets you choose, Personal Capital can help you keep track of your investments, how much you're paying in fees, and help you plan for retirement. This is the free investment and net worth tracking tool my wife and I use.
Learn about Personal Capital at: Personal Capital Review 2019 | Free Investment and Net Worth Tracking
Step 5: Save for your children’s college fund
After you’ve got a good start on your retirement savings, Dave Ramsey tells you to start putting money aside for your kids to go to college. He recommends a 529 college savings plan or ESAs (Education Savings Accounts).
Ramsey wants your children’s college education to be paid for in cash and without student loans. We all know how freaking expensive college is, and he wants you and your kids to think about whether college is a necessity.
That’s very personal stuff, and I’m not one to tell you what you and your kids should do.
I know I’m happy that I got my college degree, but I also know how hard it was to pay off my student loan debt.
If you’re able to help your kids with college, that’s awesome, but don’t let it get in the way of your retirement savings.
Step 6: Pay off your mortgage early
The Dave Ramsey Baby Steps are set up to leave you completely debt-free. No student loans, credit card debt, unpaid medical bills, and now mortgage. You work this step by putting as much extra as you can towards your mortgage payment, which then reduces the amount you pay in interest charges.
Not a bad idea in theory, and I know many people who have prioritized paying off their mortgage and are very happy they did.
There are also lots of people who look at their mortgage as good debt because it will raise your net worth as it increases in value and is eventually paid off.
Step 7: Build your wealth and give
The final step – you’re 100% debt-free, have a cushion for emergencies, and are building a healthy retirement savings. Nice work!
Dave Ramsey encourages you to leave a legacy that involves an inheritance for your kids and their kids and giving generously. If you follow Step 7 as he recommends, it’s possible that your children won’t struggle with debt in the way many Americans do.
I’m all for building your wealth and giving, but I really think that you should focus on what financial independence means to you. Maybe it’s travel or early retirement.
The point is, you’ve worked really freaking hard to get to Step 7, and I feel like you’ve earned the freedom to do what makes you happy.
Pros and cons of Dave Ramsey’s Baby Steps
Dave Ramsey’s site says his program has helped millions of people their financial lives. Over 4 million alone have completed his Financial Peace University. But, not everyone agrees with his advice. Here are a few points to consider if you’re thinking about following the Dave Ramsey Baby Steps.
Having an emergency fund is important
The math doesn’t always add up
The Dave Ramsey Baby Steps are motivating
Ramsey says “No” to all credit cards
The Dave Ramsey Baby Steps are simple, straightforward, and have helped lots of people
The Baby Steps can feel too strict
Pro: Having an emergency fund is important
I don’t think any personal finance expert anywhere will argue against having an emergency fund. That’s because it’s one of the most useful tools for getting and staying out of debt.
Now, some will argue where to put that money, how much it should be, etc. Still, having an emergency fund is one of the smartest and most basic personal finance principles to follow.
Con: The math doesn’t always add up
I talked about this a little already, but it’s a big enough issue for some to bring up again. When you follow Dave Ramsey’s advice and use the debt snowball over the debt avalanche, you could be spending hundreds or thousands of dollars more in interest charges.
But first, let me explain the debt avalanche. Instead of lining your debts up by balance, you line them up by interest rate, the highest interest rate debt is attacked first. You’re still making the minimum payments on everything, but you’re throwing as much as you can at debt with the highest rate first.
This is really effective if you have high-interest rate debt, like credit cards.
With the snowball method, theoretically, you could have $20,000 in credit card debt sitting with an interest rate of ~20% while you spend months paying off zero-interest medical bills or car loans with rates that are well under 10%.
While you’re building your snowball, your high-interest rate debt is also growing, and faster than you might expect.
The avalanche is just better math, but it’s less motivating because if your high-interest rate debt also has a large balance, you can go a while before experiencing any wins.
Some people do a hybrid method where they start using the avalanche and then take care of a small balance debt if they’re losing motivation.
Pro: The Dave Ramsey Baby Steps are motivating
Ramsey’s plan is backed by psychology – small wins encourage you to work towards bigger goals.
Paying off debt is exhausting and those wins motivate you to keep going. It’ just that simple.
Con: Ramsey says “No” to all credit cards
This is one that gets to me because I love my credit cards. I don’t carry a balance month to month, and I use them to hack the cost of travel. What does that mean? I use them strategically to earn sign-on bonuses that let me drastically cut the cost of airfare and hotels.
Credit cards essentially save me thousands of dollars every year.
However, not everyone has a healthy relationship with credit cards, and that’s who Ramsey is talking to. You shouldn’t try travel hacking or churning cards if you know you’ll overspend and add debt.
Pro: The Dave Ramsey Baby Steps are simple, straightforward, and have helped lots of people
No matter what you think about Dave, he’s helped millions of Americans get out of debt. That’s no easy feat.
His plan is so effective for some people because it teaches personal finance on a basic level. It’s not confusing high-level financial advice. His steps are meant to help real people dig themselves out of debt and stay debt-free.
Con: The Baby Steps can feel too strict
Because his Baby Steps are so simple, they can feel too strict. Here’s what I mean:
- No credit cards ever
- You must pay off your mortgage
- You need to save for your kid’s college fund
Turning those into black and white issues doesn’t leave much room for people who want to do something a little different. I’ve actually heard from a lot of people in my M$M Facebook community that they started the Baby Steps but didn’t agree with all of his advice.
Remember, personal finance is personal.
If you follow the essential ideas of living below your means, saving for emergencies and your future, and reducing your consumer debt, you’ll be a lot better off than many people. The way you get there should be up to you.
Final word on the Dave Ramsey Baby Steps
These steps are basic personal finance. IMHO, it’s the kind of stuff that should be taught in high school… we’re fortunately seeing more and more schools require personal finance.
That doesn’t mean it’s bad or not worth following, but there is a lot more to personal finance.
The Baby Steps can lay the groundwork for a better financial life, and you can learn and implement even more if you’re willing to put in the work. Reading personal finance blogs like this one are a great place to start.