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Let’s face it –there is no shortage of money-management advice floating around the internet these days. But one plan in particular, the Dave Ramsey Baby Steps, has withstood criticism and grown in popularity since its introduction to the mainstream public in the 1990s.
Beginning with his 1993 book Financial Peace and continuing with the 2003 follow-up The Total Money Makeover: A Proven Plan for Financial Fitness, Dave Ramsey has helped millions of people get out of debt and onto a path toward financial freedom. His 7 Baby Steps are by far his most popular advice.
But do the 7 Baby Steps really work? Is Dave Ramsey still a financial authority worth trusting and following in 2019?
Our take: Yes and yes.
But don’t just take our word for it. Keep reading to see exactly why you can trust Dave Ramsey and how the Baby Steps continue to be an effective money management solution.
Who is Dave Ramsey?
Much like you wouldn’t visit a new mechanic without reading at least a few reviews on Yelp, it is important to understand Dave Ramsey’s background and life story to best evaluate his credentials and trustworthiness.
The good news is we’ve done the research for you, and Ramsey passes the litmus test with flying colors. Ramsey’s journey toward becoming a financial expert is a complicated one, but it can be distilled down into a few main points:
- Ramsey graduated in 1982 from the College of Business Administration at University of Tennessee, Knoxville with a degree in Finance and Real Estate. He started Ramsey Investments in 1986 and quickly built a real estate investment portfolio valued at more than $4 million. At this time, he consistently earned over $20,000 per month in net income. However, he built this company by leveraging short-term debt, and when the notes (i.e. loans) were sold and the new lender demanded immediate repayment, Ramsey was forced to declare bankruptcy
- While recovering from bankruptcy, Dave Ramsey began to re-evaluate his philosophies on all things related to personal finance. He began taking a closer look at what the Bible had to say about money, studied several different financial curricula and workshops, and eventually developed his own set of lessons and materials based on his own personal experiences and the teachings of other financial experts.
- Starting with a small local radio show called “The Money Game,” Dave Ramsey built his show, now called “The Dave Ramsey Show,” into a nationally-syndicated radio show heard on over 575 radio stations with a combined weekly audience of over 10 million listeners.
- Ramsey is well-known for repaying all of his debt after recovering from bankruptcy, including the debts that were cast off in bankruptcy. It is noteworthy that he was under no legal obligation to pay back these debts. Said Dave, “A bankruptcy clears your name of debt. However, God clearly told me in prayer to pay my debts.”
After getting out of debt, Dave Ramsey formed Ramsey Solutions in 1992, and the accolades have rolled in steadily ever since. With six New York Times best-selling books, a team of more than 550 employees, and an unwavering mission to give hope to those hurting financially, Ramsey’s message has made an impact.
Our conclusion: Dave Ramsey walks the walk, provides solid money management advice, and is an authority who can be trusted by those seeking financial advice.
What Are the Dave Ramsey Baby Steps?
In a nutshell, the 7 Baby Steps are a step-by-step plan designed to help people save money, get out of debt, and build wealth in an organized manner.
The steps are to be followed in order:
Baby Step 1: Save $1,000 to start an emergency fund
Baby Step 2: Pay off all debt using the debt snowball method
Baby Step 3: Save 3 to 6 months of expenses for emergencies
Baby Step 4: Invest 15% of your household income into Roth IRAs and pre-tax retirement funds
Baby Step 5: Save for your kids’ college funds
Baby Step 6: Pay off your home early
Baby Step 7: Build wealth and give
Do the Baby Steps Really Work?
Though there are no guarantees in the area of money management, our opinion is strong: Dave Ramsey’s Baby Steps work very well for people who are willing to follow them carefully and enthusiastically.
First, the Baby Steps work because they are heavily-focused on helping people change their behavior. Just like Dave Ramsey took a long look in the mirror and decided to make lasting changes while declaring bankruptcy, the Baby Steps help people get beyond the symptoms of their money problems and dig out the root cause.
Second, the Baby Steps work because they break down a complicated course of action into an easy-to-follow plan. The steps are not left open to interpretation or re-arranging, which makes it very easy for people to “go all in” and put their energy and effort into taking action rather than making plans.
Third, the Baby Steps work because they are built upon the understanding that quick wins are motivating and encouraging. For example, many people begin the 7 Baby Steps and immediately jump to Baby Step 2 upon realizing that they’ve already saved $1,000. Another example: Many people become what Ramsey calls “gazelle-intense” after paying off 1 or 2 small debts using the debt snowball and ride that wave of momentum to pay off their debts much faster than they thought would be possible.
In our experience, the Baby Steps work if you are willing to do the work. They are designed for people who are tired of being stuck in debt, living paycheck to paycheck with no hope of change, or just drifting along without a dream for their financial future.
When implemented correctly, the 7 Baby Steps are a powerful tool for better money management habits that last a lifetime.
The Dave Ramsey Baby Steps: In Detail
The 7 Baby Steps are a proven, step-by-step plan designed to educate, encourage, and empower anyone who is willing to follow them.
Here is a closer look at each Baby Step:
Baby Step 1: Save $1,000 to start an emergency fund
In this step, the goal is to save exactly $1,000 as quickly as possible to build an emergency fund. What’s an emergency fund? Think of it as a savings account designed to cover the unexpected expenses life may throw your way. It is meant to help you avoid going deeper into debt when things like car trouble, leaky pipes, or a dead furnace come up unexpectedly.
Ramsey recommends keeping your emergency fund money in a separate savings account to avoid the temptation to spend the money on non-emergency items.
Why doesn’t Dave recommend building an immediate emergency fund of 3-6 months of expenses? His plan is all about becoming “gazelle-intense” and paying off debt as quickly as possible.
Our recommendation: Park your emergency fund in a high yield savings account that is both easily accessible and poised to help you earn a bit of interest.
Baby Step 2: Pay off your debts using the debt snowball method
With your emergency fund in place, the next step is paying off debt, starting with your current non-mortgage debt.
You’ll want to gather an accurate list of all of your debts to start, which you can easily do by gathering all of your recent statements or creating a quick, free account with Credit Sesame. Next, you’ll list your debts in order based on the total balances, not interest rates, from smallest to largest. You will work to pay them off starting with the smallest balance first. This is called the debt snowball method.
Using your list of debts and your monthly budget, you will take any remaining money in your budget each month and use it to pay down the balance on your smallest debt. You’ll continue to make minimum monthly payments on all of your other debts, and when each debt is paid off, you’ll “roll over” that monthly payment into your “snowball” and use it to pay down the next smallest debt as quickly as possible.
Results will obviously vary based on factors such as debt totals and income levels, but on average, many people are able to pay off all of their non-mortgage related debt in 6 to 24 months.
Why doesn’t the Debt Snowball Method take interest rates and monthly payment amounts into account?
The Debt Snowball Method is built to keep you motivated and give you the powerful experience of quick wins. It recognizes that personal finance and debt can be very emotional, and by paying off small debts quickly when you’re just starting out, you will feel the emotional highs of paying off debt and keep going.
Doesn’t it make more mathematical sense to pay off high-interest debt first?
Yes, but personal finance is not strictly based upon mathematics. And if most people were really good with math, they probably wouldn’t end up deeply in debt in the first place!
In all but the most extreme cases, the differences in total interest paid over time is very small when using the Debt Snowball Method. That’s because most people get so motivated when they see their debts start to disappear that they start looking for ways to make extra money, save money on groceries, etc.
Baby Step 3: Save 3-6 Months of Expenses for Emergencies
Once you are debt free, Baby Step 3 is intensely-focused on making sure you never fall back into debt by building a larger emergency fund to to protect against life’s surprises. Saving 3-6 months of expenses will provide a larger buffer to protect against temporary job loss, illness, or other major expenses which may pop up.
Calculating how much you should save in an emergency fund may sound overwhelming, but it doesn’t have to be hard! Here a couple simple strategies:
- Simply calculate your average monthly expenses and multiply them by the desired number of months. If you’re in great health and have a very stable job, three months of expenses may be just what you need in your emergency fund. If you have health or job security concerns, you may need six months worth of expenses or more in savings.
- If there are expenses that are regularly in your current budget that you could easily and instantly cut in the event of a financial emergency, take them into consideration. For example, if your budget includes discretionary spending on clothing, restaurants, and an expensive cable TV package, you might consider cutting those when planning your minimum expenses if you were to start drawing from your emergency fund. After all, your emergency fund is meant to cover your basic living expenses for as long as possible until you get back on your feet, not cover unnecessary spending.
- If you prefer to be extremely conservative, you may choose to calculate your emergency fund needs based on a multiplier of your net monthly income.
Baby Step 4: Invest 15% of Your Household Income into Roth IRAs and Pre-Tax Investment Funds
In Baby Step 4, the focus is squarely on retirement –whether you are 22 or 62!
The primary goal is to invest 15% of your household income into pre-tax investment opportunities, such as your 401(k) or Roth IRA. Logically, you should always take advantage of any company-sponsored match opportunities before investing in anything else. This is your time to take advantage of the tax benefits of investing for your future!
Once you cover the amount your employer will match, Ramsey recommends (and we agree with them) that it is wise to invest the rest of your 15% in a Roth IRA. Why a Roth IRA? Dave has several reasons:
- You have greater control and more mutual fund options within a Roth IRA than you likely have in your 401(k).
- With a Roth IRA, your contributions have already been taxed. When you eventually withdraw from your Roth IRA, your distributions will be tax free! That means your earnings also grow tax free.
- Compared to a traditional IRA, Roth IRAs do not require minimum distributions. A traditional IRA requires that minimum distributions begin when the account holder reaches age 70.5.
One important thing to note about Baby Step 4: It is an ongoing step that will demand your attention each month until you retire and no longer need to contribute to your retirement plans.
Baby Step 5: Save for Your Children’s College Fund
With all of your non-mortgage debt paid, an emergency fund in place, and a growing retirement portfolio, it’s time to move on to Baby Step 5 and start saving for your children’s college fund.
Dave Ramsey recommends two options for saving for college: the ESA (Education Savings Accounts) and the 529 college saving plan. Each option is a bit different and nuanced in its own way, and plan options often vary state by state, so it’s important to review your options and choose the one that is best-suited for your individual circumstances.
Baby Step 6: Pay Off Your Home Early
At this point, the only debt you have left is the mortgage, and you’re going to wipe it out in Baby Step 6!
Yes, you may not have a ton of wiggle room in your budget at this stage, especially if you’re actively saving for college for multiple children and fully-funding your retirement. But it has been proven that any extra money you can put toward your mortgage principal can help you save tens of thousands of dollars in interest over the long haul.
The average family who chooses to follow the Baby Steps typically pays off their home in under 10 years following the date they started their first Baby Step. Just imagine a life with no mortgage, a rapidly growing retirement account, and funded kids’ college accounts!
Baby Step 7: Build Wealth and Give (Like No One Else!)
Imagine for a moment that you have no outgoing payments (except regular utilities, of course). Not a penny of debt owed to anyone.
How would that change the rest of your life?
Imagine being able to give with reckless generosity. Imagine going out to dinner and leaving a $500 tip. Imagine taking your entire family on a paid-for trip to Disney World.
That’s the power of following the Baby Steps and getting to Baby Step 7. When you have no obligations, you have complete and total freedom to continue building wealth and blessing others through charitable giving and other gifts.
Baby Step 7 is all about having fun with money and enjoying financial independence. As Dave Ramsey is famous for saying, you’ll never have more fun with money than you will by giving it away.
Common Criticisms of the Dave Ramsey Baby Steps
It may be easy to assume Dave Ramsey and his recommended money management methods are without criticism. But just like most experts with strong opinions, Dave has his haters, too.
Conveniently, many of the sharper criticisms tend to center around the 7 Baby Steps. Here are some of the popular criticisms, along with our opinions:
Criticism: $1,000 is NOT an adequate sum of money for an emergency fund.
Our take: While it’s true that $1,000 isn’t enough money to stave off all money-related emergencies, it’s definitely enough money to pay for many of them. High price tagged emergencies, like a new transmission for a car or a new furnace, aren’t likely to be covered by just $1,000.
But the point of a small emergency fund is to quickly push you into an intense rush through Baby Step 2.
Criticism: Paying off your debts smallest to largest with the debt snowball doesn’t make sense mathematically. It would be better to pay them off first by highest interest rate (a plan called the avalanche method).
Our take: At face value, this logic is hard to argue against. However, money management isn’t just about math. If it were so simple, people wouldn’t borrow money in the first place!
Paying off debt with the debt snowball makes sense, even when it isn’t necessarily the most mathematically-sound way of repaying debt, because it also takes into account the behavioral and emotional benefits of quick wins.
In our opinion and experience, people are far more likely to give up early on their debt repayment journey using the avalanche method than if they are using the debt snowball. The thrill of paying off a couple small department store credit cards is way more powerful than saving a few bucks in interest.
Criticism: An emergency fund of 3-6 months of living expenses is horribly wasteful when that money could easily be earning a strong return if invested in index funds or other mutual funds.
Our take: Yes, this is true, mathematically-speaking. This is a classic case of risk vs. reward. And these types of arguments always play out a bit differently depending on who is involved.
For example, a tenured public school teacher at the top of her pay scale may not see much value in a robust emergency fund. On the other hand, a young couple with a child on the way and plans to have one spouse become a stay-at-home parent would likely be terrified without an emergency fund.
A 3-6 month emergency fund is a very secure way of avoiding financial disaster in the event of job loss or extended illness. It provides more peace than a credit card, home equity line of credit, or a plan to sell off assets could ever provide.
That said, the value of an emergency fund is primarily emotional, which means the value is ultimately derived based on the holder’s personal preferences.
How to Get Started With the Baby Steps
The 7 Baby Steps aren’t a magical solution to all of life’s money problems. But no matter where you are on financial journey, Dave Ramsey’s Baby Steps offer the kind of step-by-step guidance to help you build a better life. If you follow them faithfully and take massive action to move from step to step in a timely manner, it’s nearly a guarantee that you will become a millionaire.
Ready to get started with the Baby Steps yourself?