Dave Ramsey Baby Steps Review: A CFP’s, Pros & Cons

Are Dave Ramsey’s Baby Steps suitable for you?

Dave Ramsey’s Baby Steps is one of the best-known financial planning concepts. 

The framework’s popularity stems from its simplicity. Simply follow the instructions in order, checking off each one before moving on to the next. 

But the major question is whether you should use the Baby Steps formula or if there is a better way to proceed.

In this article, we’ll review Ramsey’s seven baby steps, examine the pros and cons of each step, and provide an alternative plan to Ramsey’s approach.

Overview: The 7 Baby Steps.

Dave Ramsey’s Seven Baby Steps are:

• Baby Step #1: Set aside $1,000 for a basic emergency fund.
• Baby Step #2: Pay off all debt (save for your mortgage, if you have one) utilizing the debt snowball method.
• Baby Step #3: Set aside three to six months of living expenses in a fully filled emergency fund.
• Baby Step #4: Put 15% of your household income into a retirement account.
• Baby Step #5: Save for your children’s college education.
• Baby Step 6: Pay off your mortgage early.
• Baby Step #7: Build money and give.

Baby Step #1: Save $1,000 to Start an Emergency Fund

Summary: Ramsey recommends creating a $1,000 startup emergency fund before investing or beginning to pay off high-interest debt. 

Does this make sense? Yes, and yes! Having a small amount of cash saved is essential. 

In fact, the Federal Reserve conducted studies on low-income families who maintained a $500 emergency fund. They discovered that when faced with a financial hardship, lower-income families fared better than middle-income families that did not set aside $500.

Tips for Success:

• The goal is to complete this phase as rapidly as feasible. 
• Set yourself a deadline. Create a plan to help you save $1,000 as quickly as possible, ideally in 30 days or fewer. This may need some imaginative thinking, and you may miss the mark. That’s fine; you’ll at least be better off than you were a month ago.

Baby Step #2: Using the Debt Snowball Method, Pay Off All Debt (Except Your Mortgage)

Summary: When paying off debt utilizing the debt snowball approach, begin with the lowest balance. For example, if you have two credit cards, you should prioritize paying off the one with the lowest balance first, even if the interest rate is lower.

The concept behind this technique is that paying off the lowest balance first is a more attainable objective and will help you gain momentum.  

Does this make sense? As a CFP® with a passion for statistics, you may be surprised to learn that I am a huge fan of the debt snowball technique. In fact, research show that using the debt snowball helps more people pay off their debt. 

A debt avalanche is an alternative to a debt snowball in which you pay off your debts in order of interest rate, highest to lowest.

While I like the debt snowball method as a debt-reduction strategy, I disagree with Ramsey when he says it should be used to pay off all obligations other than your mortgage.

First and foremost, if you have high-interest credit card debt (defined as an APR of around 18%), you should focus on paying it off as soon as possible. You can’t get ahead while you’re paying so much interest.

But what about student loan debt, which typically carries an annual rate of roughly 6%?

For low-interest personal obligations like these, 7% is an excellent number to remember. That’s the average percentage that the stock market returns (after inflation) each year. 

So, if you want to go by the numbers, it makes sense to pay off any loans with rates higher than 7% while emphasizing investing over paying off those with rates lower than 7%. 

Consider this: if you can earn 7% by investing, you are losing money by paying off debt that is less than 7%.

Important Note: The exact equation is more complex than this. For example, you could lose a deduction for paying off your student loans early or gain one for starting to invest. 

Furthermore, paying off debt provides a guaranteed rate of return, but investing does not. So consider 7% as an approximate guideline, not an exact law. Often, it boils down to what you are more driven to do.

Another instance to consider is when your employer matches your 401(k) payments. In that situation, you could obtain up to a 50% return on your money. I would absolutely invest up to the maximum at that rate of return before paying off my lower-interest loans, because not doing so is like to turning down free money.

Tips for Success:

• Math does not always take precedence over behavior. A research published in the Journal of Consumer Research — which is presented in plain English in this Harvard Business Review article — discovered that it’s best to pay off your smallest debt first, even if it doesn’t save the most money over time.
• Determine your debt repayment date. Use The Ways To Wealth’s debt payoff calculator (instructions are available in our how to pay off debt page) to determine how long it will take you to become debt-free. 

Baby Step #3: Save Three to Six Months’ Expenses

Summary: In Baby Step #1, you established a beginning emergency fund, saving enough money to keep a sudden financial setback, such as an urgent auto repair, from ballooning out of control. But you also need to consider if your finances can endure a longer-term setback, such as losing your job. 

Does this make sense? I have a couple views on this specific Baby Step.

• Six months is a large sum of money for novices to save aside, and it may be more than they require. Analyze your situation and danger, and be certain that you are considering all options.
• For most people, the greatest risk is losing their work. So it’s critical to assess how significant a risk it is in your specific situation. Are you in a field where you can simply find a new job if your business announces layoffs, or will you struggle to replace your current income? If you are low-risk, you may be able to get by with just three months’ costs saved. 
• Building an emergency reserve and investing are not mutually exclusive. It is possible to accomplish both. If your employer matches your 401(k), I would donate up to that amount while still building your emergency fund.

Tips for Success:

• Make it a challenge. Try to accomplish it quickly, as this will assist you avoid giving up. Set an aggressive aim.
• Take on a side hustle with a high potential. These side hustles allow you to achieve significant success in a matter of months. This is one of the most effective strategies to make progress on this baby step, as it is typically easier than attempting to reduce your living expenses.
• Look for a better-paying job. If a side hustle does not work, do not be afraid to move jobs. You can often command a 10% to 20% increase in compensation simply by changing jobs, which means a lot more money flowing toward your financial objectives.

We also recommend:

• How to Make a Financial Plan in 7 Steps

Baby Step #4: Invest 15% of Your Household Income Into a Roth IRA or a Pre-Tax Retirement Fund

Summary: In this Baby Step, you begin saving 15% of your salary for the goal of retirement.

Does this make sense? I believe 15% is an appropriate aim. If you invest 15% for 30 years or more and keep your living expenses under control, you will be able to retire comfortably.

However, if you intend to retire early or are starting later in life, you will need to invest more.

In such a case, it’s more crucial to work backwards, calculating how much money you’ll need to retire and then determining how much you’ll need to invest/save to reach that goal.

Another counter-argument is the sole use of pre-tax retirement assets rather than investing in taxable accounts. While tax-advantaged funds function as advertised, the boost in after-tax return is closer to 1% than if you simply used a taxable account.

This is significantly less than what most people believe. 

So, while I would still take advantage of a 401(k) match, in some instances, it may be prudent not to max out your 401(k) beyond the company match and other pre-tax retirement funds such as an IRA. Instead, put your savings in a taxed investing account.

Early withdrawals from a taxable account are not subject to any fines or fees. While you will face capital gains taxes, this gives you the freedom to access the money whenever you choose, rather of having to wait until you’re 59.5 years old, as with a retirement account. 

For many, the additional liquidity is worthwhile.

Tips for Success:

• Begin with your 401(k) employer match. That’s free money, and you should take advantage of any opportunity to receive it.
• Start where you are. If you can only save a few percent per month, do so. Try to start with enough to get your full business match, so you don’t leave money on the table. Then, every three months, reevaluate your savings percentage and challenge yourself to increase it by another percent. It can take you two, three, or even four years to get to 15%, which is fine.

Baby Step #5: Save for Your Children’s College Fund

Summary: Most parents worry about having enough money to cover their children’s future college fees. With three children of my own, I think about it frequently. 

Does this make sense? A common mistake here is to skip Baby Step #4 and begin saving for schooling fees. 

You must remember to put yourself first. That may appear to be the reverse of what a good parent should do, but it is not. A financially stressed aging parent can be a significant load for an adult child to endure.

Keep this in mind while deciding how much to save for college. Your children can borrow money for education at low interest rates, but this is not true for your retirement.

Tip for Success:

• Check into your state’s 529 college savings scheme. These plans provide a tax advantage while saving for your child’s education.
• Use the $2,000 x Age rule of thumb. Multiply your child’s age by $2,000 to discover how much savings you’ll need or whether you’re on schedule. This sum pays for 50% of the total cost of attending a four-year public college. 

Baby Step #6: Pay Off Your Mortgage Early

Summary: Most people’s largest financial obligation is their housing payment. It can be really liberating to pay that off.

Does this make sense? There is nothing wrong with paying off your mortgage early. However, you must consider the opportunity cost; paying down your mortgage instead of investing more may result in long-term financial loss.

This is particularly true in today’s low-interest rate environment. 

It’s also worth noting that these two behaviors are not mutually exclusive. You do not have to pick between paying off your mortgage early or investing more. Assume you have $500 left over at the end of the month; consider investing $250 of it and allocating $250 to pay off your mortgage.

Tips for Success:

• Gradually increase your paydown. Each month, challenge yourself to see how many months in a row you can increase your payment, even if it’s only by $25.
• Take advantage of the bonus features. When you receive a big quantity of money, such as a tax refund or a bonus from work, put it toward your mortgage.

Velocity banking is a practice that some people use to pay off their mortgage ahead of schedule. It involves taking up a home equity line of credit and using the cash to pay down your mortgage in large chunks. You may learn more in our velocity banking guide, which discusses the approach’s advantages and disadvantages.

Baby Step #7: Build Wealth and Give 

Summary: This step acknowledges that you’ve achieved your major financial goals, allowing you to spend your money anyway you wish.

Ramsey employs statements such as “you can live and give like no one else” and “keep building wealth and become insanely generous.” Ramsey also recommended that you consider leaving an inheritance. 

Does this make sense? This is where we all want to get to. After years of focusing on more fundamental financial goals, the notion is that once you’ve reached this point, there are endless possibilities.

But is it truly that simple?

I’d like additional advise on how much one should save. Many individuals don’t start their debt-free journey — and more crucially, get through it — until their 30s or 40s. In Baby Step #4, Ramsey recommends saving and investing 15% of your income. Is this enough? I’d certainly run the math myself to make sure. 

Overall, though, the concept is solid. This is undoubtedly the point you want to reach – the one at which opportunities emerge and leaving a greater legacy or giving generously becomes an option.

An Alternative to Dave Ramsey’s Baby Steps

One of the guiding principles at The Ways To Wealth is that personal finance is personal. In other words, there is no one-size-fits-all financial plan.  

That being said, there’s no denying how much the Dave Ramsey Baby Steps have helped people improve their financial situation. According to Derek Tharp, CFP® and lead researcher at Kitces.com, Ramsey’s approach has some ingenuity that financial planners might benefit from.

Dave Ramsey’s counsel and strategies for behavioral transformation offer valuable insights for advisors to consider when assisting clients in making positive changes.

So, if given the opportunity to recreate Ramsey’s Baby Steps based on the most recent studies, this is my best effort.

• Step #1: Save at least $500 for unforeseen expenses while you’re going through Step #2.
• Step 2: Pay off all of your high-interest consumer debt (mostly credit card debt).
• Step 3: Take full use of your company’s 401(k) match.
• Step #4: Establish a fully established emergency fund to cover three months of living expenses.
• Step #5: Invest at least 15% of your household income for the long term, recognizing the benefits and drawbacks of taxable versus tax-advantaged accounts.
• Step 6: Set up a 529 plan to save for your children’s college education.
• Step 7: Build wealth, spend more on things that make you happy, and give.

Personally, given such low interest rates, I would not pay off my mortgage and instead invest in index funds over the long run. Or, if I’m on track to meet my financial objectives, spend money in a way that makes me happy. 

Dave Ramsey Baby Steps: Final Thoughts

The Dave Ramsey Baby Step framework’s main benefit is the structure it gives. You may work your way through each Baby Step one by one, knowing exactly what to focus on. Finally, if you stick to the strategy, you’ll be in a terrific position in the next years. 

However, this rigid structure can lead to complications because every financial decision has an opportunity cost. Focusing on getting completely debt-free requires committing additional dollars to your debt repayment activities, which may not be the most efficient use of those funds. 

It’s crucial to understand that Ramsey is generally anti-debt, and his advice reflect that. 

Furthermore, personal money is not always so black and white. Life changes quickly. So, from time to time, it’s vital to step back and assess your situation to ensure you’re on the correct track.

Often, there is a better way to achieve your goals.