If you haven’t heard of Dave Ramsey, you are probably in excellent financial shape. For many, he represents a financial savior for those with too much debt and who want to improve their money management through Dave Ramsey’s seven baby steps.
In this post, we review Dave Ramsey’s iconic seven baby steps, provide the pros & cons, and our take. Dave has a huge audience when you consider these scary financial statistics in the US:
- Only 43% of Americans have enough money to set aside an unexpected emergency.
- The average American carries a debt balance of $92,727, including a mortgage.
- Among all US adults, the median retirement savings are $65,000.
- According to Sofi, 87% of parents are paying a portion of their children’s college education.
Who Is Dave Ramsey?
Dave Ramsey is a well-known personal finance guru and coach, helping millions through his top-rated nationally syndicated weekly radio program, books, Financial Peace University, and more. According to sources, Ramsey’s net worth is about $200 million.
He has strong convictions about personal finance, backed by his experience, making his own mistakes, research, and religious beliefs. Testimonies shared by many of those who succeed in becoming debt-free demonstrate the value of Dave Ramsey’s significant contribution over the decades.
Ramsey’s money management philosophy is to focus on one priority at a time and chalk up wins to gain a sense of accomplishment. He is notable for disliking credit cards or any kind of debt except for home mortgages, and his preference is that homebuyers should pay all cash.
Ramsey Is Wealthy But He Made Mistakes
According to sources, Ramsey’s net worth is about $200 million from his empire. Dave has done a great deal for many households dealing with challenging financial situations. He shares his own story about losing everything.
When Dave was a millionaire at age 26 in the early 1980s, he lost money when he became overleveraged, and banks pulled his credit. He spent years recovering from his losses and barely looked back except to preach and counsel others about better financial management. I admire his passion for helping people, reading his books, and listening to some of his shows. Dave became an early proponent of personal finance when many of us were making mistakes and working hard for our money.
The Ramsey Show is the third largest nationally syndicated weekly talk radio program.
Ramsey Solutions is the primary website for his shows, offering his products.
Ramsey+ provides an annual membership bundle of $129.99, including Financial Peace University, EveryDollar premium budget tool version, Trackers, exclusive live stream events, 1:1 coaching calls, and more.
EveryDollar – the free version of the budget tool
The Total Money Makeover– We recommend this New York Times bestseller.
Dave Ramsey’s 7 Baby Steps At Quick Glance
- Save $1,000 For Your Starter Emergency Fund
- Pay Off All Debt (except your home loan) Using The Debt Snowball
- Save 3-6 Months of Expenses for a Fully Funded Emergency Fund
- Invest 15% of Your Income in Retirement
- Save For Your Children’s College Fund
- Pay off Mortgage Early
- Build Wealth And Give
These seven steps are complex rules that encompass a personal finance blueprint that has worked for many Ramsey followers, but they are not easy and not without some criticism. Dave’s steps are rigid with a one-size-fits-all approach that may not be appropriate for everyone. Like diet plans, he prefers behavior modification over specifics, like math.
While we believe these are smart moves for most people, we will point out where we differ or raise questions. We will explain each step in turn and provide our thoughts.
How do the seven baby steps work? You must complete each step completely before moving on to the next step. If you are on Step 2, which focuses on debt payoffs, and you were hit with an emergency and needed money from the emergency account, you must go back to Step 1 and refill the fund to $1,000. There are rare exceptions to this rule.
Our Pros & Cons of Dave Ramsey’s 7 Baby Steps
The seven baby steps provide an excellent roadmap to achieving financial access by managing your money and setting financial goals.
Saving for emergencies and being debt-free are significant early accomplishments.
His steps include guidance for retirement and college investing.
Wealth building and giving go hand-in-hand is a strong message.
Readers can feel Ramsey’s passion for helping people with wonderful proverbs that say more.
The seven steps are a one-size-fits-all approach with little flexibility.
You need to take steps in consecutive order somewhat rigidly, which may delay your investing retirement and college years.
The steps rely on behavioral modifications and changing habits but are not necessarily efficient from a numbers point of view.
I agree with the concepts, but completing each step before moving on may cause significant delays, particularly in retirement and college contributions.
Dave Ramsey’s 7 Baby Steps
Are you ready to dive in? Let’s start with the first step.
Step 1 Baby Step Save $1,000 For Your Starter Emergency Fund
Dave wants you to do two things before dealing with the emergency fund. If you are behind with payments, you need a budget and get current with your creditors. Pay your basic living necessities first, and pay what is due on your credit cards and student loans.
Creating a monthly budget is imperative for starting on the seven baby steps. He mandates the zero-based budget where you spend each dollar of your income (e.g., savings, living costs). Each cost reduces income until your budget equals zero at the end of the month.
Budgeting scares many people, especially those with problematic finances because you can’t hide from the truth of doing an honest review of outgoing money.
Establishing an emergency fund is essential for unexpected events that happen to us, like losing a job, necessary surgery for your pet, car damage, or a boiler blowing up.
Rather than relying on putting these expenses on your credit cards, you should have money in a savings account without overdraft protection or money market accounts. Dave prefers these accounts for their liquidity and is readily accessible for only emergencies rather than CDs. CDs often come with penalties, making money less available.
An emergency fund helps reduce your risk when these unwanted surprises happen.
Dave’s guidance is to accumulate $1,000 quickly for this starter emergency fund, recognizing this is not nearly enough but a good way to put this essential tool in place. If you don’t have $1,000 in savings, you should sell something, work extra hours, or both. You should be willing to forgo dining out or other “wants” before this small fund is in place.
Remember, this is just a start for emergency funds, and in step 3, you will fully fund your emergency savings account according to your circumstances.
The sooner you complete this step, you can move on to Step 2, a challenging area for most households.
The emergency fund is by far the most crucial account to establish before you do any investing. Starting with an amount of $1,000 puts you ahead of the game. You should put the fund in liquid assets that are easily accessible. We wouldn’t rule out CDs necessarily, but we would consider putting the money in a high-yield savings account or a money market account first.
Budgeting is key to managing your finances, and the zero-budget is worthwhile. We happen to find the 50/20/30 budget easier for most people.
Step 2 Baby Step Pay Off All Debt (except the mortgage) Using The Debt Snowball
Dave Ramsey is well-known for his preference for the debt snowball method over the avalanche method. He dislikes debt, as a rule, and wants those who are going through this step to avoid taking on any new borrowing.
The debt snowball requires you to list all your debts from the smallest payoff balance to largest, excluding your home mortgage, irrespective of the loan’s individual interest rate. All loans are put on the list, even if they are loans from a family member with zero interest. The one exception to going with the smallest debt first is that if you have a larger debt to the IRS or are facing a foreclosure, pay that earlier.
To get started, take your money from nonretirement savings and investments. Pay off your smallest debt in dollars and go on to the next smallest one, and so on. Your debt list should include your required monthly minimum amounts, be it on your credit cards or any other loans.
The point is to get small but quick wins to further your motivation by paying off small amounts first. Dave acknowledges this method favors the behavioral impact over the math. This motivational approach works for many who see immediate benefits in checking off their debt list. The problem for many is overwhelming credit card debt balances that proliferate from high-interest costs if not paid off aggressively. The snowball method won’t work well on that debt, and you can’t just pay minimum payments.
You may run out of cash before paying off all your debts based on your budget. You could sell something you don’t need or the car if you have a loan when that happens. You can work a side hustle or extra hours to get money to pay that month’s bills. Typically, it should not be your home unless your monthly payment exceeds 45% of your take-home pay or you can’t be debt-free within 18-20 months.
While it is easy to follow this particular step, it is pretty challenging. Dave sanctions three loans not part of the snowball method: your home mortgage, business loans, and rental costs.
However, it is also confusing as to how to handle a home equity loan (also known as the second mortgage). Dave offers a rule that if your second mortgage is more than 50% of your gross annual income, it doesn’t belong on the snowball list. On the other hand, a small business loan is a personal loan and belongs to the debt using the snowball method unless it is more than 50% of your gross annual income.
As a rule of thumb, Dave suggests that steps 1 and 2 could take two to two and half years, with this step a more lengthy time.
We agree with Dave that getting rid of debt and becoming debt-free is a significant financial goal. There is validity to having instant gratification and wins under your belt. The snowball method for eliminating debt that Dave favors has merits in motivating those in a predicament to tackle the easy stuff first.
The Cents of Money favors the avalanche method, which prioritizes your highest interest rate first and lists all your debt in that order rather than the smallest amount first. We prefer tackling a credit card debt balance of $8,000 with a 16% interest rate, which grows far more rapidly than other debt types.
Yes, it will take you longer to pay that debt off, but by delaying your payoff in this category, you will ensure your balance swells to more significant proportions. The Avalanche method makes more sense when dealing with large credit card balances.
Matt, A Radio Caller
It could take years to achieve success in steps one and two. So, I strongly disagree with Dave’s advice to a caller named Matt on his radio show. Matt inquired whether he should stop making his 401K contributions, mainly because the first 3% earns a generous 100% match.
Dave encouraged Matt to stop his contributions until he accomplishes his debt payoffs, which can take years. Matt would have to wait until step four when the focus is on retirement investing. I strongly disagree with this move not only because it could take years, but it interferes with Matt’s habit of making monthly pretax contributions of about $150 (median salary of $60,000 x 3%) that may already be in Matt’s budget.
Step 3 Baby Step Save 3-6 Months of Expenses for a Fully Funded Emergency Fund
The starter emergency fund of $1,000 was just a first step and kicked off the baby steps program. It is time to build a fund to cover three to six months of your essential living costs in step three. That cushion will help you financially face losing a job, a death in the family, or paying deductibles on your insurance when there is an accident.
Households’ essential living costs differ broadly. According to Dave, a fully-funded emergency fund ranges from $5,000 to $25,000, with a typical family having $10,000. Like in Step 1, the savings should be in a liquid account and quickly withdrawn without penalties. CDs are less desirable because they typically carry penalties.
However, it is usually better to pay the penalty on the CD if that is where your emergency money is than to take a personal loan at a higher interest rate.
Establishing an emergency fund of three or six months depends on your circumstances. Do you earn a steady or irregular income, have better job security because you are a tenured teacher, or work for a new start-up company? Those who make lumpy compensation or risk losing their job should seek more extended funding to feel financially secure.
Dave advises families that don’t yet own their home to hold off buying one until they finish this step. I agree with this advice as new homeowners rarely understand the responsibilities and the cost structure of having their place. Fund your emergency fund ahead of significant purchases.
This step can take quite some time, postponing your retirement contributions and potential employer matches.
All households should aspire to have six months in their fully-funded emergency fund, as things get challenging during financial crises.
Step 4 Baby Step: Invest 15% of Your Income in Retirement
Tackling wealth building comes up in step four is retirement investing. The plan is to invest 15% of your gross income annually, not counting the company match or social security benefits. As a rule of thumb, Dave offers some flexibility of 12% to 17% of retirement contributions.
Where should you be investing this money? He favors mutual funds over ETFs with more than five-year track records of “winning” and supporting evenly or 25% across four types of funds:
- Growth and Income (Large Cap/Blue Chip funds
- Mid Cap or Equity Growth funds
- International (Foreign or Overseas) funds
- Aggressive Growth (Small Cap or Emerging* ) funds
(*Emerging means from countries with emerging economies with higher risk and returns.)
In The Total Makeover, Dave doesn’t explain why mutual funds (as opposed to ETFs) or this particular mix and suggests readers go to his website for further explanations.
Investing 15% of your income should take full advantage of tax benefits and the company match of the sponsored 401K plan. Typically, you must allocate a minimum percentage to earn the company’s contribution, “free money,” but part of your compensation package.
After the 401K plan, you must set up and fund a Roth IRA. Both plans have annual contributions and income limits that you should check out annually. He uses several examples using dual incomes for spouses but only the husband’s 401K.
Readers should know that he uses 12% returns for the stock market and 4% for inflation in his calculations to build the retirement nest egg. Dave’s calculation pulls out 8% annually to live on during your retirement years.
My most significant criticisms and questions come up in this section.
Why a 12% return? Dave refers to a 12% average stock market return, probably a simple average but the compound annual growth return (CAGR) of 10% (about 10.2%) used by many market experts. We explain the difference between the two rates and use an average market return of 10% based on CAGR. Additionally, that rate is before adjusting inflation, bringing you down to 7% returns unless you hold stocks that better pace inflation.
Why is Dave suggesting you can live off of 8% of your retirement money annually? Sure, you can live off that rate, but does that math work? To us, it seems way too high and should be closer to 4% to live on, while other researchers have pointed to 3%.
Dave wants you to maximize your earnings, but be careful using his 8% withdrawal rate. The 4% rule comes from William Bengen’s study in 1994 when he found that retirees withdrawing 4% of assets, adjusted annually, would provide a decent cushion to live on. Last year, Bengen updated his research, allowing for a 4.5%.
Finally, we question why retirement contributions come up more than halfway through his seven baby steps. I think of people like Matt, who suspended their retirement contributions on Dave’s advice in My Take in Step Two.
Dave doesn’t discuss fees, passive versus active funds, or why he favors mutual funds over ETFs. Fees are costs that bring down your returns, so they do matter. The use of passively managed low-cost funds works for most people rather than paying higher fees for active management of your portfolio. We recommend Personal Capital for its free financial management tools, including its retirement analyzer and our company review.
Why not ETFs? Dave doesn’t endorse ETFs, but they tend to have lower fees and are good choices. For large-cap growth, QQQ is a terrific choice.
His call is for you to invest now, which we argue is delayed. Dave says to invest, even if you are older (and I agree), but he doesn’t discuss how people catch up.
In one testimonial in this step, a couple in their twenties have become entirely debt-free except for their house. They pay double their monthly mortgage bills to own their home in five years. They are virtually free and clear of debt, including their cars, and likely have a bright future.
However, they mention they can retire with $12 million! Yet, they don’t offer specifics: what they earn or do for a living or how they get to a pot of $12 million. This testimony left me scratching my head and in wonderment.
Step 5: Save For Your Children’s College Fund
According to Dave, going to college is a want, not a need, and a luxury. For many, that may be so. College prices rise faster than inflation, and having a college degree doesn’t guarantee success or wealth. However, paying your college costs fully with loans is a financial drag on your young adult life.
Think carefully about whether college suits you or your children, and if so, expand your search at public schools. Dave recommends Educational Savings Accounts (ESAs) and 529 college savings plans for funding at least the first step of college.
Both plans are similar in tax benefits. However, the ESAs have less flexibility, with a cap of $2,000 in annual contribution per child and lower-income limitations, and parents can choose the investments. Dave recommends a growth-stock mutual fund, though some people choose target-date funds, which are most aggressive in the earlier years and get more conservative as you move toward the college start date.
There is more flexibility with state-sponsored 529 plans. You can contribute up to $75,000 annually and invest in options provided, typically from Vanguard, Fidelity, and other major mutual fund companies.
Work-Study Programs and Scholarships
If you have not saved for college for your kids or not nearly enough, Dave suggests looking at work-study programs where companies may pay your tuition for your part-time labor. Additionally, depending on what and where you study, you may receive full or partial help on college costs doing service with the military, National Guard, or specific programs. Inner cities or rural programs for law, medicine, nursing, and teaching are often generous with tuition.
Scholarship funding depends on merit, your background, or organizations like The Rotary Club. Dave suggests software programs you can purchase online as another means of attaining money.
We would encourage a young couple with a newborn baby to consider opening up a 529 college savings plan as early as the child has a name and a social security number. Student loan debt is such an impediment for young adults just starting out, so setting up some education savings account is essential.
Start with small amounts, but get started to avoid having your child pay for college on loans they will be carrying into their adult life. Retirement savings come first, but saving for your little one is a priority to ensure the next generation doesn’t have financial problems.
When looking at colleges, I would look at four-year public colleges but consider the community or two-year colleges as a cheaper but viable alternative.
Step 6 Pay off Your Home Early
Dave dislikes most types of loans, except for the home mortgage. In this step, he wants families to eliminate this mortgage quickly. He recommends finding any money in your budget outside of living retirement and investing in college. If you can pay cash for your home, all the better.
Dave dispels myths throughout The Total Makeover, and this step is no exception. He wants to blow away the myth of people keeping their home mortgage to get the tax deduction he calls “no bargain.” He also pushes back on having a low interest rate on a $100,000 loan to invest in higher return investing like stocks. The difference between a 12% stock return, or $12,000, and an 8% loan, or $8,000 in annual interest, for a 4% gain or $4,000 pretax income. You will either pay taxes at ordinary income or the lower capital gains.
Dave makes a good point that house values sometimes go way down when economic risk increases, most notably during the Great Recession of 2008-2009. When people lose their jobs, paying a mortgage is more challenging than living debt-free during increased risk. That is true, but that is not the entire argument about whether a homeowner should pay down a low-interest mortgage or use the money to invest in higher returns.
When comparing a 30-year fixed-rate mortgage versus a 15-year fixed-rate mortgage, your monthly amount will be higher than the shorter-term loan. However, the total cost of your home, including interest, will be significantly lower. If you have a 30-year mortgage, Dave wants you to pay it faster by doubling your monthly payments. Presumably, he wants you to save on origination, points, and other fees rather than refinancing your mortgage.
Outside of fixed loans, your borrowing choices worsen with adjustable-rate mortgages or ARMs, balloon loans, and home equity loans. You don’t have to go far to find horror stories when using these mortgages.
Dispelling myths, Dave wants you to use your available means to pay down your loan faster, irrespective of your loan rates. This approach may work for many people, and it feels great to be debt-free entirely.
However, math sometimes wins out when you benefit from a low interest-rate loan (say 4%) that you can afford in your budget and take advantage of savings to invest in higher stock returns to build up your portfolio. If you chose to use your savings bucket to pay off your mortgage in March 2020 that you could have refinanced at historically low rates rather than investing in a beaten-down market, you might be kicking yourself (or Dave) now.
Each household’s mortgage and overall financial situation may differ radically. If you have a 30-year loan with a high interest rate and many years left to pay, it may be worthwhile to refinance your loan if rates drop substantially. Today, interest rates are soaring, making it more challenging for prospective home buyers.
Additionally, your credit score may be higher since you originated the loan and didn’t have much of a credit file, meaning you may see a reduction in your loan’s interest rate. Those two factors can reduce your monthly payments and are worth paying those fees. You can then afford to double your payments. Dave doesn’t discuss credit scores in Total Makeover.
Step 7 Build Wealth and Give
Dave wisely tells his readers that wealth is not “an escape mechanism” and is in line with our sentiments. As I remember my grandmother’s words, “Poor or rich, money is good to have,” money is not everything.
When you are debt-free, have gotten to this step, and still earn a good income, you can have more leeway to buy your wants. Dave endorsed a caller into his program who asked if he could buy a Harley only after the caller shared he had a six-figure income and $20 million in investments. Nice example! Dave finds three good uses for money: fun, investing, and giving.
This step is relatively short and lacks guidance for investing outside retirement and college planning. Dave wants you to bow at this “Pinnacle Point” when you successfully get to this step and maybe thank him for the well-deserved roadmap he set for readers.
After having fun and investing, which should continue, giving is an important message everyone should adhere to and not ignore. As an Evangelical Christian, Dave shares many helpful proverbs throughout his writing and has said, “Pay God First.” He doesn’t provide a specific percentage of how much to give, implying to share if and when you can.
Regarding why Dave doesn’t speak to percentages on giving could be in recognition that we may all have different spiritual beliefs, which underly many charitable donations. When you succeed so that you are debt-free, have a steady income, and your investments are in good shape, giving should be about 10% of your income, a good benchmark in your budget.
Overall, we admire and respect Dave Ramsey and his seven baby steps, but we raise some criticisms along the way.
It is hard to estimate how long it takes the average household to reach this point. However, it is a roadmap with many winners.
We put building wealth in the minds of those even overburdened with debt much earlier with small amounts of contributions to emergency funds as a priority, retirement, college, and investing outside of retirement in this order. Debt payoffs through the avalanche method will get rid of your toxic balances faster than other than the snowball.
Dave Ramsey’s personal finance empire has captured the attention of millions of people that have too much debt, and need help resolving this significant problem and have an opportunity to build wealth. Dave deserves much of the praise he gets. We differ in many ways and give our takes on this post. There are controversies surrounding him in his dealings with employees, and we purposely stayed clear of that.
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With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.