Dave Ramsey is a personal finance expert and is most well known for his 7 baby steps to help you get out of debt and take control of your money. While these steps have helped millions of people, they are not perfect. Below I’ll walk through the pros and cons of Dave Ramsey’s Baby Steps and provide some alternative options along the way.
Before diving in, I want to put on the record that I agree with most of what Dave Ramsey has to say when it comes to personal finance, and I think he’s helped a ton of people throughout his career. I even included his book, The Total Money Makeover, in my list of the best budgeting books.
Getting out of debt, investing for retirement, and having a handle on your finances are all great things, and all are things that Ramsey recommends.
Who is Dave Ramsey?
As mentioned, Dave Ramsey is a personal finance guru and the founder of Ramsey Solutions – the company behind his website (daveramsey.com) and personal finance empire.
This empire now includes:
- The Dave Ramsey Show – Dave’s popular radio show where listeners typically call in with their money problems and questions
- The Total Money Makeover – His best selling book
- Ramsey+ – The ultimate membership bundle of Ramsey products and services, including Financial Peace University, EveryDollar, and more
- EveryDollar – A budgeting app
- The Website – Which hosts everything above and much more
Dave didn’t build this empire overnight, though. And the main reason he got into the business of personal finance was because of mistakes he made.
Ramsey struggled with debt when he was young and eventually overcame it. He then decided he wanted to help others avoid paying the “stupid tax” (mistakes that cost you money) as he did. Those are his words, not mine!
Today, Dave is arguably most well known for his 7 baby steps to help people get out of debt, seen below.
Dave Ramsey’s 7 Baby Steps:
- Baby Step 1: Save $1,000 in an emergency fund
- Baby Step 2: Pay off all debt (except your mortgage) using the debt snowball method
- Baby Step 3: Save 3-6 months of expenses in an emergency fund
- Baby Step 4: Invest 15% of your household income for retirement
- Baby Step 5: Save for your children’s college fund
- Baby Step 6: Pay off your home early
- Baby Step 7: Build wealth and give
These steps serve as a blueprint for anyone trying to get on track with their finances. Below, we’ll break down the details of each step and the pros and cons of this process overall.
Breaking Down the Dave Ramsey 7 Baby Steps
Baby Step 1: Save $1,000 in an Emergency Fund
The first step in Ramsey’s plan is to save $1,000 in a “starter” emergency fund.
An emergency fund consists of money you set aside to cover unexpected expenses that might pop up. These expenses could include things like a surprise medical bill or necessary house repair. An emergency fund is typically stored in a liquid account, like a high yield savings account, so that you have immediate access to it when needed.
Emergency Fund Definition: Money stored in a liquid account (like a savings account) to cover unexpected expenses.
This first baby step serves two primary purposes.
For one, if a minor repair or accident comes up, you can handle it without going into debt. That’s a win.
Second, it gets the ball rolling on your financial journey. One thousand dollars is a lot of money, but not an insurmountable amount. Ideally, you can accomplish this first step in less than a year (by saving $20/week), if not much faster.
Now, will a $1,000 emergency fund pay for a new roof that needs to be replaced? Or cover you for a few months if you lose a job?
No, and I don’t think that’s the point of this “starter” fund. I’ve heard Dave say on his show that only having $1,000 is supposed to scare you a little. It’s a small win, and it protects you against small expenses, but it doesn’t make you feel comfortable. That comes in step three.
One last thing to note before moving on – the backbone of the entire baby step process is to have a sound budget. If you are spending more than you are making, you won’t save any money, let alone $20 a month. Part of this first step needs to be devising a budget and identifying ways to either increase income or decrease expenses as you move through the baby steps.
Just Start Investing Thoughts:
Generally speaking, I like this first baby step and think it’s a great place to start for most people.
I like that the initial emergency fund is small on purpose to allow someone to get a quick win, but also because there are better ways to use your money outside of just putting it in a savings account. For example, paying off debt or getting your full employer match in a 401(k).
Baby Step 2: Pay Off All Debt (Except Your Mortgage) Using the Debt Snowball Method
In step two, the recommendation is to pay off all of your debt (except for your house), including credit card debt, student loan debt, car loans, and personal loan debt, using the debt snowball method.
With the debt snowball method, you pay off your smallest debts first, ignoring each loan’s interest rate (while always making minimum payments on each loan). For example, let’s say you had three forms of debt:
- Credit Card Debt: $10,000 with a 20% interest rate
- Car Loan: $5,000 with a 3% interest rate
- Student Loan: $25,000 with a 7% interest rate
Using the debt snowball payoff method, you would first completely pay off your car loan. Then, you would tackle the high-interest credit card, and last would be the student loan.
Similar to step one, you use your budget to accomplish this goal. Saving more and earning more until you have paid off all of your debt.
The main idea behind the debt snowball method is that the psychological benefit of completely eliminating a loan or type of debt outweighs the money saved by paying off high-interest debt first. A study by Northwestern in 2012 substantiated this theory.
In the example above, going from three types of debt to just two types is, in theory, more important than going from $40,000 in debt to $35,000 in debt.
Just Start Investing Thoughts:
It’s hard to argue with the phycology behind this approach. It might work for most people, but my mathematical brain would make me take a different approach on two fronts.
For one, I would employ the debt avalanche method of paying down debt, which involves tackling your debt with the highest interest rate first. In the example above, that would mean starting with the high-interest credit card debt, then moving on to the student loan debt, and finishing with the car loan.
In the end, as long as you pay the same amount of money towards the debt, this approach will save you money in the long run by lowering the total amount of interest paid.
Second, I don’t think that every form of debt outside of your mortgage is “bad debt.” I can see an argument for not aggressively paying down any debt with an interest rate of 5% or below. That is because every additional debt payment has an opportunity cost, and you could invest your money instead. If you can capture a 7% return, you would be better off investing!
That said, it’s hard to argue with becoming debt-free. So while I agree with eliminating debt in principle, I don’t think it’s your only option.
Baby Step 3: Save 3-6 Months of Expenses in an Emergency Fund
The third baby step involves revisiting step one.
Now that you have all of your debt paid off (besides your house), it’s time to build up a more comfortable, fully funded emergency fund. One that could cover more considerable unexpected expenses that pop up and prevent you from ever needing to go into debt again.
Of course, there are exceptions. You might decide to go back to school, or maybe you haven’t purchased your house yet, but the idea of baby step 3 is to stop you from needing to take on “bad debt” (i.e., maxing out credit cards) to solve a short-term problem.
Just Start Investing Thoughts:
Again, while this is not necessarily bad advice, it is not advice that I would follow.
First, I would get my 401(k) employer match if offered to me. This is free money that should be taken advantage of sooner than later.
Second, I don’t think there is a one-size-fits-all recommendation with emergency funds, as outlined in this article. For a young, single person with a relatively stable job, having a one-month emergency fund might be enough. However, a family of five living on one income that has a mortgage might feel more comfortable with a year saved up.
Aiming to save three to six months is fine and a good rule of thumb, but it is not the requirement before you can start investing, which brings us to step four.
Baby Step 4: Invest 15% of Your Household Income for Retirement
Step four is a big one – it involves saving and investing for retirement.
Specifically, Dave recommends investing 15% of your gross household income in a 401(k) and Roth IRA (or other pre-tax retirement accounts). He also recommends investing in mutual funds (specifically, growth mutual funds) as the investment vehicle of choice.
A general rule of thumb is that you need 25x your annual expenses saved up to comfortably retire (read more on the 4% rule here). If you save 15% of your gross annual income as Dave recommends (and spend the other 85%), it will take you about 35 years to save enough for retirement.
This is holding a few basic assumptions constant:
- Your spending level does not change in retirement
- Your income level does not change
- You realize a +7% annual return
It’s important to run the numbers to understand if waiting 35 years is acceptable or if you plan to retire sooner or later. You can then adjust your assumptions and savings rate from there to meet your goals.
Just Start Investing Thoughts:
My first comment builds on that last point – 15% is a rule of thumb. It will not fit the needs of everyone.
For some people, savings 15% might be impossible, and saving 10% (and waiting closer to 40 years to retire) will have to do.
For others, perhaps those that are chasing financial independence and early retirement (FIRE), their goal might be to save 60% of their income so that they can retire in under 20 years.
Either way, you need to figure out your retirement goals and prioritize them before moving on to step 5.
I’ll also add that I agree that both 401(k)s and Roth IRAs are great places to save for retirement. Health Savings Accounts are another phenomenal account if available to you.
The one aspect of Step 4 that I will build on is that low-cost index funds might be a better choice than traditional mutual funds, which typically come with a higher fee that can add up over time. Betterment, Charles Schwab, and Vanguard are all places where you will find low-cost funds to invest in (there are many other good online brokers, those are just three great ones).
Here is some more reading on index funds and investing costs if you are interested:
Baby Step 5: Save for Your Children’s College Fund
Once you have paid off all of your debt (again, except the house), built up a stable emergency fund, and started actively saving for retirement, Dave recommends saving for your children’s future education.
Specifically, it’s recommended that you open a 529 College Savings Plan or Education Savings Account (ESA). These are both tax-advantaged accounts, similar to a 401(k) or Roth IRA, but explicitly designed to be used for education expenses.
Just Start Investing Thoughts:
If you have kids and are financially stable (which you would be if you made it through steps 1-4), saving for their future education is a great gift to give them.
However, I think there are some “risks” to consider regarding saving for your kids’ college education.
Your kid might get a scholarship or decide college isn’t for them. And while with most tax-advantaged college savings accounts, you can change the beneficiary to someone else (or pass it onto their kids), it does add a wrinkle to things.
So I think this is a good step, but not a mandatory one.
Baby Step 6: Pay Off Your Home Early
Step six is probably the most controversial on the list.
Dave recommends paying off your mortgage early and getting to 100% debt-free, no matter the interest rate on your loan.
It’s hard to argue with… “100% debt-free” has a nice ring to it, doesn’t it?
Of course, you have to make sure you can make additional payments against your mortgage principal without facing penalties. And if you can, you should, according to the seven baby steps.
Just Start Investing Thoughts:
Listen, as I said, it’s hard to argue with eliminating all your debt. Just look at the state of consumer debt in the US – Americans currently owe $14.3 trillion! That means the average household carries over $100,000 worth of debt (assuming 122 million households).
Plus, this is the main purpose of the baby steps – helping you get out of debt!
So, yes, in general, I agree that debt is bad and should be eliminated when it makes sense to do so mathematically. However, with a mortgage, it usually does not make sense to do so mathematically.
With an average real return of +7%, technically, your money would be better off in the stock market (assuming your mortgage interest rate is below 7%, and most are below 5%) over a long period of time.
This assumes a few things, though:
- You are far from retirement – otherwise, the guarantee of a 3-4% return (the mortgage interest) is likely better than a gamble in the stock market for a short period of time.
- You will actually invest the difference – not paying down your mortgage and buying a new pair of jeans instead of investing the money does not leave you financially better off.
- You have the stomach for it – some folks might want the guaranteed return that comes with paying down a mortgage, and that’s fine; it’s still a solid return on your money!
Baby Step 7: Build Wealth and Give
Last, step 7 is a celebratory step. It’s the step where I imagine Dave finally says, “congrats, you did it.”
With your debt paid off, retirement on track, kid’s college paid for, and no mortgage, you are free to do with your money as you please. Some common suggestions include:
- Max out your 401(k) and Roth IRA, ensuring a full and happy retirement
- Continue building wealth in a brokerage account
- Invest in real estate
- Give money to charities that mean something to you
- Spend money on things you enjoy without guilt
Just Start Investing Thoughts:
This step is the vaguest, but I mostly agree with it. At this point, I think maxing out retirement accounts and investing in low-cost index funds and ETFs in a brokerage account are both great options.
I would also call out here that using a credit card would be a wise thing to do. You could do it earlier on as well; the key to using a credit card is to spend within your budget and not spend just because it’s easy.
Especially in step 7, when you allow yourself to spend on things you enjoy, using a credit card to rack up rewards points is another added perk.
Pros and Cons of Dave Ramsey’s Baby Steps Plan
Dave Ramsey Baby Steps Pros:
Ownership: Dave Ramsey puts the ownership on you to take control of your finances, rather than finding outside factors to blame (which could be right or wrong). The baby steps emphasize that the most productive thing to do is take ownership and take action.
Bias for Action: Like the pro above, the baby steps encourage you to act now, not later. There is no reason to start next month or next year; everyone can start working through the baby steps today.
Keeps You Focused: The steps are simple and designed to be tackled one at a time, making it easier for you to succeed and gives you a reason to celebrate along the journey!
It Works: there are plenty of success stories out there, from Brittany to Bob and Tammy.
Dave Ramsey Baby Steps Cons:
Not Always Financially Sound: As you saw in the “Just Start Investing Thoughts” in every section above, the baby steps lean on behavior over math. I wrangle with this balance frequently, and even more so since reading misbehaving by Richard Thaler. The rational side of me wants to recommend the mathematically sound action, while the empathic side of me realizes that people can be motivated in different ways.
One-Size-Fits-All: The baby steps are a one-size-fits-all framework, and I think they should be more fluid. Whether you are pursuing FIRE or want to open a credit card, some exceptions should be considered. I realize that a framework such as this one starts to get fuzzy the more exceptions you grant, so this is more of a call-out on how to use the baby steps rather than a con of the baby steps.
Items Left Out: The baby steps are supposed to be simple, but some essential items were left out of the framework, including getting insurance, saving for a house, and tracking your finances. They are implied throughout the process but not explicitly stated with their own step.
Summary: Dave Ramsey Baby Steps
Overall, I am a fan of the Dave Ramsey baby steps and think it’s a solid framework for paying off debt and taking control of your finances.
However, I think it is a framework that should be modified to fit your needs, within reason.
Can you save a smaller emergency fund before you start to invest? Sure.
Can you forego paying off your mortgage and invest instead? Absolutely.
Should you put every dollar you have into Bitcoin and Tesla stock options? Probably not.
The baby steps should bend but not break. Overall, I think the 7 baby steps is a good (not perfect) framework that will work for most people trying to take the first step to improve their financial situation and achieve financial freedom.
