Dave Ramsey Baby Steps Debunked: Time to Rethink His Advice?

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I was recently flipping through YouTube and saw a Dave Ramsey video title that caught my attention. I began to listen and was stunned by the advice I heard. A woman called in and had about $6,000 of student loans and $8,000 of credit card debt. Dave Ramsey insisted that she pay off the student loan before the credit card debt. This is perhaps the worst financial advice I’ve ever heard. Further digging led me to the Dave Ramsey Baby Steps – the approach Dave Ramsey recommends for taking control of your finances. Today I am walking through these baby steps, and I am showing you why it’s time to rethink some of his advice.  

Who is Dave Ramsey?

Dave Ramsey is one of the most famous financial gurus. He is well known for his radio program/podcast, The Ramsey Show, as well as several books, including:

• The Total Money Makeover
• Financial Peace:  Restoring Financial Hope to You and Your Family
• Dave Ramsey’s Complete Guide to Money

Additionally, Dave helped create the popular budgeting app EveryDollar, an excellent budgeting option (even though I prefer You Need a Budget).

Dave Ramsey has been wildly successful. Since declaring bankruptcy at a young age, he’s now built a net worth of approximately $200 million.

However, despite his popularity, much of his advice is controversial, including the Dave Ramsey Baby Steps.

What Are Dave Ramsey’s 7 Baby Steps?

Dave Ramsey’s baby steps are a simple plan for anyone to build a better financial picture for themselves, no matter where they’re starting. Here they are:

1. Save $1,000 for Your Starter Emergency Fund
2. Pay Off All Debt Except Your House Using the Debt Snowball
3. Save 3 – 6 Months of Expenses in Your Emergency Fund
4. Invest 15% of Your Household Income for Retirement
5. Save for Your Children’s College Fund
6. Pay Off Your Home
7. Build Wealth and Give

Now that you know the seven baby steps, let’s break them down in more detail and why I think some of this advice is both dated and dangerous. 

Baby Step 1:  Save $1,000 for Your Starter Emergency Fund

The first baby step is to save $1,000 to start an emergency fund. The logic here is that even if you’re in debt, you need to build a small emergency fund to avoid going deeper into debt should a surprise hit.

For example, if your car breaks down, the idea is that you’ll have at least a little money in the bank to cover the expense rather than putting it on a credit card.

Let me be clear – I think the advice to save at least a little bit of money before paying down debt is sound. However, I am not sure this advice has quite stood the test of time. Why? Inflation.

Let’s talk about a better version of baby step one. 

A Better Baby Step 1:  Save $2,500

Dave Ramsey came up with the baby steps decades ago. In that time, the value of $1,000 has dramatically diminished due to inflation. Said differently, $1,000 ten or twenty years ago doesn’t go as far as it does today.

So, let’s revise this baby step to align with the realities of the world today. Instead of saving $1,000, focus on saving $2,500.

While there is no perfect number, $2,500 can likely cover most major expenses. If your car breaks down, the repair is likely less than $2,500. Or if your phone dies, it costs less than this to replace.

However, the principle here is the same – save some money to cover unexpected expenses before paying down debt.

When you’re saving this first bit of money, open a savings account to earn interest. My favorite savings account right now is CIT Bank. And yes, despite today’s paltry interest rates, you still need a savings account.

Baby Step 2:  Pay Off All Debt Except Your House Using the Debt Snowball

Ramsey and I differ significantly on our approach to debt. Dave Ramsey believes that debt is evil and must be addressed ASAP. While certain debt is bad (such as credit card debt), not all types of debt are the same. 

Debt like your mortgage is often of a low interest rate. Because of this, it often makes sense to invest instead of paying off low-interest-rate debt.

However, putting that aside, Ramsey and I have different beliefs about how to pay down debt. Dave Ramsey proposes an approach that suggests paying off your smallest debt first, no matter the interest rate. For example, if you have $6,000 of student loans at a 5% interest rate and $8,000 of credit card debt at a 25% interest rate, Ramsey suggests paying off the student loans first.

The concept is that by paying off a small debt, you’ll gain momentum and feel motivated to pay off the bigger debts. This is known as the debt snowball method because you gain momentum the further you go along.

However, I disagree with this approach. You will pay more in interest. You will be in debt longer. This advice is just plain wrong. That’s why when I heard Ramsey suggest that someone pay off their student loans before their credit cards, I was in disbelief. 

The fastest way out of debt is to pay debt with the highest interest rate first. This approach is called the debt avalanche. Even if the more expensive debt is bigger, you will pay less in interest overall, meaning you’ll get out of debt sooner. This is just math. 

A Better Baby Step 2:  Pay Off Debt with the Debt Avalanche

So, instead of following Dave Ramsey’s approach to pay off the smallest debt first, use the debt avalanche to pay off the most expensive debt first. It’s called the avalanche because it starts slow but accelerates quickly.

Additionally, while I think it’s great to eliminate debt, consider the interest rates on your debt. For example, if your student loans have a 4% interest rate, consider investing (assuming you can earn more than 4%) before paying off your loans.

Speaking of student loans, interest rates remain near historic lows. Consider refinancing your loans to reduce the interest rate you’re paying and get out of debt sooner. Splash Financial is my top pick for refinancing student loans. They guarantee you’ll get the lowest rate, there are no closing costs, and you can refinance in a matter of days. Everyone I know who has used them has been pleased.

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

Once your debt is under control, start building more in savings. Dave Ramsey suggests keeping three to six months of expenses in the bank. 

This is sound advice. Building an emergency fund creates a financial runway so that life’s financial surprises don’t bring you to your knees.

However, three to six months is just a rule of thumb, and it’s probably not the correct number for everyone.

For example, if you lose your job, do you think you can replace your income within three months? There will always be so-called black swan events. These are the things that no one can predict, and they affect the world in unexpected ways.

Additionally, depending on the type of job you have, you may want to consider saving a bit more. For example, if you’re a freelancer whose income varies month-to-month, you may want to consider building a larger emergency fund.

As you start building an emergency reserve, it makes sense to track your progress. One of the best ways to do this is using a net worth tracker. These free tools can help everyone monitor their progress towards their goals, and they can be a powerful motivator.

A Better Baby Step 3:  Save 6+ Months of Expenses Based on Your Situation

While I generally agree with Dave Ramsey here, I think you’d be better off setting six months as the minimum emergency fund. A larger emergency fund provides more protection in the event of an unexpected financial surprise.

However, feel free to adjust this upwards based on your situation and risk tolerance. Personal finance is personal, and so should be your emergency fund.

If you need help building an emergency fund, one of the best things you can do is reduce your expenses. You can do this through budgeting, but you can also find ways to save on regular expenses. I use Truebill to negotiate my cable, phone, and home security bills. They’ve now saved me well over $1,000, all with no effort from me.

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

Dave Ramsey’s fourth baby step is to invest 15% of your household income. 

If you’ve achieved baby steps 1 – 3, you’ve likely achieved some financial stability, having taken control of your debts and built a safety net using an emergency fund. Now it’s time to start playing offense by investing.

While 15% is a good benchmark, it’s not perfect. In general, I think you should aim to invest at least 20% of your income. Investing 20% increases the likelihood that you’ll meet your financial goals. 

Additionally, the 15% number may work well if you start investing when you’re 25. But if you’re 40 years old and haven’t started investing yet, 15% isn’t going to get you to retirement. You’ll need to invest far more. Again, you need to adapt this baby step to your situation.

A Better Baby Step 4:  Invest at Least 20% of Your Household Income for Retirement

Raise the bar. Invest at least 20% of your income towards retirement. And if you’re starting a little later in life, increase this number based on your situation.

The best way to tell if you’re on track is to use a retirement calculator. My favorite retirement calculator comes from Personal Capital. It’s the one I use, and you’ll also find a host of other features that can help you achieve financial success. 

One other tip is to consider your employer’s 401(k) match. If your employer will match your contributions up to a certain percentage, make sure to take advantage of this – it’s like getting a 100% return on investment. In fact, I suggest doing this even before paying down debt. You can’t beat the return.

If you’re already maxing out your retirement accounts (such as a 401(k) and IRA), consider opening a taxable brokerage account to continue investing. M1 Finance is my favorite taxable brokerage account.

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

Baby step number 5 suggests saving for your children’s education. If you can afford to do so after investing at least 20% of your income, I’m all for this.

However, I think my biggest gripe with this baby step is that it does not apply to everyone. The baby steps are meant to be universal truths about personal finance, but this one is only applicable to a subset of people.

A Better Baby Step 5:  Save for Your Children’s Education If You Can

If you have kids, saving for their education can provide them a huge leg up in life. However, don’t do so to the detriment of your retirement picture. Make sure you’re tackling baby step 4 before this one.

Additionally, tailor the savings based on the time you have until your kids go off to college. How much you need to save will depend on their time horizon.

Baby Step 6:  Pay Off Your Home

Baby step number six suggests paying off your home. Paying off your home is not a bad idea, but I am not sure it should be one of your top financial priorities.

Dave Ramsey’s suggestion to pay off your home centers around his aversion to debt. In general, mortgage debt is not bad (assuming the payments are within your means. It allows you to buy an enormous asset over time that you probably couldn’t afford in cash when you purchased it. 

A Better Baby Step 6:  Pay Off Your Home (Before you Retire)

Given how inexpensive mortgage debt has been in recent years, it may make sense to hold on to your mortgage (paying the minimum payment). Any excess cash can be invested, which may result in a higher return on your money than paying down your mortgage.

Of course, you’ll need the discipline to invest this extra money. If you don’t have this discipline, you’ll be better off paying off your mortgage.

Even though mortgage debt is very cheap, I still recommend aiming to pay off your home before you retire. Why? Because a mortgage, even if inexpensive, is a cash flow drain. In retirement, your goal is to minimize your expenses to create the most flexibility possible with your money. Paying off your mortgage provides downside protection. 

Baby Step 7:  Build Wealth and Give

The final baby step is to continue building wealth and give to charities of your choice. 

Building wealth and giving is the financial end game, so I agree with Dave Ramsey’s approach. However, when you’ve achieved this level of financial stability, there are many options to consider.

A Better Baby Step 7:  Build Your Financial Fortress

When you’ve reached baby step 7, there are all sorts of things to consider, including:

• Building a taxable brokerage account after maxing out retirement accounts
• Diversify your investment portfolio (such as investing in real estate through Fundrise)
• Find charities to support

If you’ve made it to baby step 7, you’ve won with personal finance. 

Pros & Cons of Dave Ramsey’s Baby Steps

I am not here to bash Dave Ramsey. I think he’s helped a lot of people with their finances. But I believe that the Dave Ramsey Baby Steps are imperfect. The baby steps stand to be improved. Here are some of the pros and cons of Dave Ramsey’s baby steps:

Pros of Dave Ramsey’s Baby Steps

• Dave Ramsey emphasizes the importance of emergency funds – they help protect against financial downside
• Dave believes that money choices are psychological, not just math – while this may not always be the correct mathematical answer, it can help you be more successful with money
• The baby steps put structure around your path to financial success – they’re easy to follow, and that may make them easier to achieve

Cons of Dave Ramsey’s Baby Steps

• The one-size-fits-all approach doesn’t always work – personal finance is personal
• Certain advice isn’t financially sound – suggestions like the debt snowball will keep you in debt longer
• Ramsey believes all debt, including mortgage debt, is bad; however, used correctly, debt can help accelerate your path to financial independence

7 Better Baby Steps:  A Summary

To recap, Dave Ramsey’s Baby Steps can help you be successful with money, but I believe the baby steps leave room for improvement. Instead of following the Dave Ramsey Baby Steps, instead, consider the After School Finance Baby Steps to financial success:

• Baby Step 1:  Save $2,500
• Baby Step 2:  Pay Off Debt with the Debt Avalanche
• Baby Step 3:  Save 6+ Months of Expenses Based on Your Situation
• Baby Step 4:  Invest at Least 20% of Your Household Income for Retirement
• Baby Step 5:  Save for Your Children’s Education If You Can
• Baby Step 6:  Pay Off Your Home (Before you Retire)
• Baby Step 7:  Build Your Financial Fortress

So, take small steps to a better financial picture today. Start a budget with You Need a Budget, open a savings account with CIT Bank, or open a brokerage account with M1 Finance. Small victories will lead to immense personal finance results.