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Dave Ramsey’s 7 Baby Steps: Is It the Best Way to Pay Off Debt?

Dave Ramsey’s rise to superstardom started in 1992 with the launch of “The Dave Ramsey Show.” Now syndicated to over 600 affiliate radio stations, Ramsey has the ears of over 14 million listeners every week, according to his website.

In other words, Dave Ramsey is as famous as personal finance gurus get.

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You can trace his success to several factors. First, he keeps personal finance simple. No jargon, no showing off, just an easy-to-follow message for the masses — specifically, the evangelical Christian masses. Another key to his popularity is his Christian-oriented messaging tying faith to finance. However, his financial teachings are applicable to anyone, regardless of faith.

At the heart of those teachings are his seven “Baby Steps” for building wealth. They’re simple, actionable, and easy to understand at a glance.

Do they work? Yes.

Does everyone in the personal finance world support them as a strategy? No, but they’ve earned their place in the canon of the personal finance space.

Before following the gospel of Ramsey’s Baby Steps, review them carefully and decide if their simplicity resonates with you, or whether you’d like to take a more nuanced approach to building financial stability and wealth.

In the Beginning

While Ramsey doesn’t officially propose a Step 0 for his Baby Steps, some of his acolytes have christened Step 0 as “Stop adding new debt.” It’s certainly a worthy addition.

As the proverb goes, if you want to get out of a hole, the first thing you should do is stop digging. Debt only ceases to be a moving target when you stop ringing up new debt.

So take your credit cards and tuck them away in a drawer or, better yet, in a safe deposit box. Erase your saved credit card information from every online shopping site and app. Consider credit cards off-limits until you’ve paid off all unsecured debts, and possibly longer.

Stick to paying your expenses with debit cards, restricting your spending to what you currently have in your account. Or go on an all-cash diet and try the good old-fashioned envelope budgeting system.

Once you’ve stopped digging yourself deeper, you’re ready to start climbing out of the hole.

Baby Step 1: Save a $1,000 Emergency Fund

Woman Inserting Cash Into Piggy Bank Savings

Only 40% of Americans can cover a $1,000 emergency expense with their savings, according to CNBC. That’s a terrifying thought considering unexpected expenses arise all the time. From surprise home repairs to car maintenance,  medical emergencies to family crises, all of us live closer to the financial edge than we like to believe.

Ramsey recognizes that all other financial progress immediately falls by the wayside if you face an emergency you can’t afford to address. If your car needs $1,000 in repairs, and you need your car to get to work, you have no choice but to pay that bill today. So, Baby Step 1 is simply to save $1,000 in your savings account as an emergency fund.

Having an irregular income is no excuse. Quite the opposite in, fact. The less regular your income, the more you need an emergency fund to help you weather the ups and downs in your revenue. Learn how to budget and save even on an irregular income, or you’ll find yourself constantly buffeted about by financial headwinds.

Our Take

Everyone should have at least $1,000 in a liquid checking or savings account, period. Expect to get hit with surprise expenses every single year, even if the exact expenses vary. Put your emergency fund in a high-yield savings account from a bank like CIT Bank, perhaps at a different bank from your checking account so it’s less tempting to access.

Baby Step 2: Pay Off All Debt (Except Your Mortgage)

Erase Debt Pink Eraser

Once you have $1,000 saved in your emergency fund, it’s time to pay off all unsecured debts, plus your auto loans.

The average interest rate on credit card debt is over 17%, according to CreditCards.com. Many people feel completely overwhelmed when they look at their debts and don’t know where to start. So, Ramsey preaches the debt snowball method to pay off your debts in order of size.

It works like this: You start by funneling all disposable income into your smallest debt first while making only the minimum monthly payment on all other debts. Once you’ve paid off the smallest debt, you move on to the next smallest debt, then the next, knocking out each debt one after another.

The debt snowball method is a perfect example of Ramsey’s approach to personal finance, which is simple and behavior-focused. Everyone knows at a glance which of their debts is smallest, and therefore, where to start. It gives them a quick win and an early thrill of victory when they pay off that first debt.

Those victories keep consumers going as they pick off their debts one by one.

Contrast that logic against the debt avalanche method, which involves paying off your highest-interest debt first, rather than the smallest. While this can technically save money on interest, it can confuse borrowers, whose interest rates may fluctuate. Even more importantly, the debt avalanche method might mean consumers attempt to pay off a massive debt first, which can quickly lead to discouragement when they make no tangible progress.

Our Take

For most consumers, the debt snowball method makes sense. It’s clear and simple and delivers the psychological momentum needed to keep plugging away at your debts, month after month and year after year. But for more clinical and disciplined consumers, who can maintain relentless monthly debt payments even without quick wins, the debt avalanche method might save them some interest.

Where Ramsey might be wrong is in his insistence on paying off auto loans this early on the road to financial independence. Currently, a buyer with strong credit pays an average interest rate under 5%, per U.S. News & World Report. Meanwhile, the average return on the S&P 500 since its inception in 1928 is around 10%. I earn 8% to 10% on my investments in crowdfunding websites, for example, and 10% on a private note to a real estate investor friend. If I can borrow money at under 5% and invest it at 10%, I’ll do it all day long, every day of the week.

Baby Step 3: Save 3 – 6 Months’ Expenses in Your Emergency Fund

Growing Emergency Fund Plant Jar Coins

Once you’ve paid off all debts excluding your mortgage, Ramsey urges you to return to your emergency fund and beef it up further.

Measure your emergency fund in terms of how many months of household expenses it can cover by itself. Ramsey recommends having at least three months’ worth of expenses held in cash in your emergency savings account. Six months’ worth is even better.

Our Take

Everyone’s needs are different. People with extremely stable income and expenses don’t need as much cash set aside in an emergency fund as those with irregular incomes or expenses. If either your income or expenses are irregular, aim for the three to six months’ of expenses Ramsey recommends.

If your income and expenses are more stable, you may be able to get away with setting aside three months’ expenses. But the more you know about personal finance and investing, the more flexibility you can exercise with your emergency fund.

For example, I keep one month’s expenses in cash as my first tier of defense against emergencies. My second tier of defense is a low-APR credit card, which I can draw on in moderation if needed. I keep a third tier of defense against emergencies in the form of short-term investments and recession-proof investments, which I have no qualms about liquidating in a flash if needed.

Baby Step 4: Invest 15% of Your Household Income in Retirement Accounts

Old Man Walking Stacked Coins Retirement Growth Fund

Next, Ramsey urges you to start setting aside 15% of your income for tax-sheltered retirement accounts.

The first priority is taking advantage of any full matching contributions your employer offers. Common employer-sponsored retirement accounts include 401(k)s and 403(b)s and SIMPLE IRAs. When an employer offers to match your contributions up to a certain percentage of your paycheck, it amounts to free money: You save money for retirement, and your employer gives you extra money to invest tax-free.

Once you secure the full matching contributions your employer offers, Dave recommends putting the rest of that 15% retirement budget into Roth IRAs. You can open a Roth IRA through a broker like M1 Finance.

Our Take

You should absolutely take full advantage of employer matching. In fact, some would argue for putting this higher up the ladder of financial importance (more on that later).

Roth IRAs are a solid tax-sheltered retirement account choice. But if you’re earning more now than you plan to earn in retirement, you may prefer to take the tax break now with a traditional IRA or contribute more to your 401(k), rather than avoiding taxes in retirement.

Pro tip: If you have a 401(k) or an IRA, make sure you sign up for a free analysis from Blooom. Once you connect your accounts, Blooom will check to make sure you have the proper asset allocation based on your risk tolerance. They will also help make sure you’re diversified and aren’t paying too much in fees.

Baby Step 5: Invest for Your Children’s College Education

Piggy Bank Textbook Chalkboard Education Fund Savings

After you’ve started budgeting 15% of your income for your retirement, Ramsey then recommends putting some money toward your children’s higher education costs.

He doesn’t specify a percentage of income, which makes sense. It ultimately depends on how many children you have and how much you plan to help them with tuition costs.

However, he does recommend you take advantage of tax-sheltered education accounts, including 529 plans and Educational Savings Plans (ESAs). Like retirement accounts, these accounts minimize your tax burden as you save and invest.

Our Take

Saving for your retirement should definitely be a higher priority than saving for your children’s education costs. Even if they don’t find a way to pay for college without student loans, at least they have the option of borrowing money to cover the costs. You don’t have that option to cover your retirement costs, aside from reverse mortgages.

Of course, you may not decide to pay for your children’s college education, and that doesn’t make you a bad parent. Plus, there are creative ways to pay for your kids’ college education aside from saving hundreds of thousands of dollars.

Consider investing money for your kids’ college education in a 529 plan through College Backer or an ESA, but don’t feel obligated to do so.

Baby Step 6: Pay Off Your Mortgage

Mortgage Paid Off Calender

Now, it’s time to turn to your one remaining debt: your home mortgage.

You have several options to pay off your mortgage early. For example, you could switch to biweekly payments, each set at half your normal monthly payment. That’s the equivalent of making one extra monthly payment each year since you make 26 half-month payments, or 13 monthly payments, in a year. Yet you don’t notice the extra expense because it’s spread so evenly.

Ramsey keeps it simple, though, by advising you to simply put all available funds toward your mortgage.

Our Take

This advice may not be the best route for everyone. According to the Federal Reserve, the current average mortgage interest rate is only 3.65%. Again, if I can borrow money at 3.65% and invest it at 10%, I’d just as soon keep my mortgage in place and invest my extra money instead. By doing so, I effectively earn a spread on that money.

Additionally,  you itemize deductions when you file your taxes, you can deduct the interest on your mortgage. You can compound those tax benefits by putting more money toward tax-sheltered accounts like retirement accounts or health savings accounts, rather than putting spare money toward paying down your mortgage.

That said, older adults approaching retirement should consider paying off their mortgage early as a risk-reduction strategy. Retirees have less risk tolerance than working adults, so an extremely conservative strategy makes sense for them.

People with high anxiety should also consider paying off their mortgage early. If your mortgage balance keeps you up at night, and paying it off faster will help you sleep easier, then by all means, do it.

Baby Step 7: Build Wealth & Give to Charity

Give Back Letter Blocks

Once you’re actively doing all of the above, you can put the rest of your disposable income toward a single goal: getting rich and doing some good in the world along the way.

Ramsey doesn’t spend much time on the details of how exactly to build wealth, at least not in his Baby Steps program. He encourages his followers to pump more money into their tax-sheltered retirement accounts. When asked to get more specific, he pushes adherents to invest in one type of investment: actively-managed mutual funds.

According to his stated Investing Philosophy, he “prefers mutual funds because spreading your investment among many companies helps you avoid the risks that come with investing in single stocks.”

In that same Investing Philosophy, Ramsey warns against the following investment types:

While Ramsey’s reasons vary for why he doesn’t recommend these investments, it largely comes down to perceived risk. For example, he doesn’t like ETFs because he feels they “allow you to trade investments easily and often, so a lot of people try to time the market by buying low and selling high.” Likewise, he argues against picking individual stocks due to lack of diversification. See his Investing Philosophy for a complete account of his logic.

Our Take

Giving to charity should be an important part of everyone’s financial plan. But at this point, you’re already putting 15% of your income into tax-sheltered retirement accounts, and Ramsey is proposing adding even more money there. While it’s not an inherently bad idea, by doing so, you restrict your access to this money until you reach the age of 59 ½. Which begs the question: What if you want to retire early or build wealth for reasons beyond retirement?

It’s precisely why everyone should have a taxable brokerage account, not just retirement accounts.

As for actively managed mutual funds, mounting evidence suggests that actively managed funds rarely outperform passive index funds in the long term. Look no further than Morningstar’s 2019 report on active versus passive funds, which shows that only 23% of actively managed funds beat their passive counterparts over the preceding 10-year period.

Also, while Ramsey is correct that the average investor shouldn’t try to pick individual stocks, that doesn’t mean all investors should avoid bonds and REITs. Many retirees seek much-needed stability in government bonds, and I enjoy private REITs such as Fundrise and Streitwise as easy ways to diversify into real estate and generate passive income.

An Alternative to Ramsey’s Baby Steps

I admire Dave Ramsey’s commitment to simplicity. He designed his Baby Steps for the masses, for people not interested in learning anything about personal finance beyond the bare minimum. And the Steps work well for them.

But what if you are interested in becoming savvier with your money?

For intermediate and advanced investors, consider the following alternative financial steps:

  • Step 1: Build a $1,000 emergency fund.
  • Step 2: Capitalize on matching contributions from your employer. You earn an immediate 100% return on investment, not including the tax benefits or the actual returns.
  • Step 3: Pay off all unsecured debts. Leave your home mortgage and auto loans in place if the interest rates are under 5%.
  • Step 4: Save between one and two months’ expenses in a cash emergency fund if you have a stable income and expenses. If your income, expenses, or both are irregular, aim for three to six months’ expenses. Keep a low-APR credit card in reserve for emergencies, and perhaps some money in low-volatility investments like Treasury inflation-protected securities (TIPS).
  • Step 5: Invest 10% to 20% of your income in tax-sheltered retirement accounts. The exact percentage depends on your personal financial goals, such as when you want to retire, and other major goals, such as saving a down payment to buy a home.
  • Step 6: Form a plan for your children’s educational costs. That plan may or may not involve you helping out. If so, it should outline how much you plan to provide. Invest money in a separate 529 or ESA account only if you know for certain your child will use it as needed without incurring penalties. For example, some 529 plans require you to choose a state university system, but your child may decide to attend college in another state or not at all. When in doubt, invest the money in a brokerage account or Roth IRA, where you can withdraw contributions penalty-free.
  • Step 7: Build wealth and give to charity. Start with passive index funds, both U.S. and international, that expose you to a wide range of small-cap, mid-cap, and large-cap stocks. Then diversify even further by investing indirectly in real estate or directly by buying investment properties. Just bear in mind that investment properties come with more hidden expenses and labor than most new investors realize.
  • Step 8: Pay off your auto loan as a defensive move if you don’t like the look of the markets.
  • Step 9: Pay off your home mortgage, particularly as you near retirement. Reducing your living expenses also reduces your sequence of returns risk by easing your dependence on your investment portfolio as a source of income.

Final Word

My favorite quote from Dave Ramsey goes as follows: “Debt is not a math problem. It’s a behavior problem.”

I believe the same applies to most facets of personal finance. Budgeting, saving, and investing too come down to behavior challenges. We all understand basic addition, subtraction, and simple percentages. Yet we continually overspend on the latest gadget, the latest fashion, or the latest trendy restaurant.

Ramsey’s Baby Steps are the perfect formula for the average person who isn’t terribly interested in personal finance. He keeps his advice simple and actionable, with no nuance necessary.

For those looking for a little more nuance and personalization, consider these Baby Steps a starting point rather than holy text carved in stone, and walk your own financial path through life.

Have you tried Dave Ramsey’s Baby Steps? Where do you agree with them, and where do you disagree?

G. Brian Davis
G. Brian Davis is a real estate investor, personal finance writer, and travel addict mildly obsessed with FIRE. He spends nine months of the year in Abu Dhabi, and splits the rest of the year between his hometown of Baltimore and traveling the world.

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