It’s true… Dave Ramsey may be the king of the Baby Steps and the Debt Snowball, but his outdated techniques are a disservice to those trying to get out of debt.
Full disclosure – I love Dave Ramsey. He is that brash uncle who doesn’t pull punches and tells you like it is. He started a great movement for people to be debt free and to stop living in chains indebted to the banking industry. Unfortunately – the same steps he created in 1992 are not as applicable today as they once were, yet he continues to profit from and promote them.
Here’s hoping I don’t get sued by Dave Ramsey…. and if you haven’t heard of Dave Ramsey’s Baby Steps, let’s go over them and see where they may cause you some troubles…
Dave Ramsey’s Baby Steps
- Baby Step 1 – $1,000 to start an Emergency Fund
- Baby Step 2 – Pay off all debt using the Debt Snowball
- Baby Step 3 – 3 to 6 months of expenses in savings
- Baby Step 4 – Invest 15% of household income into Roth IRAs and pre-tax retirement
- Baby Step 5 – College funding for children
- Baby Step 6 – Pay off home early
- Baby Step 7 – Build wealth and give
A Closer Look At The Steps
Dave Ramsey advises that the first step should be the start of a $1,000 Emergency Fund. In today’s dollars, $1,000 does not cover many emergencies. 2 months ago, the check engine light came on in my SUV and I took it to a local shop. The problem was a dealer specific specialized issue which ended up costing me $2,200. If I started with only $1,000 in my savings before moving on to my debt snowball, I would have added an additional $1,200 to my total debt and been right back in the hole. I would advise that your emergency fund be funded at least $1,500, but a much better number would be $2,000. For advice on starting this fund, please check out my budget article – Budget Isn’t A Bad Word.
For the second step, Dave recommends using the Debt Snowball method which consists paying off the lowest balance first and moving on down the line to the highest balance debt. I totally understand the psychology of this – people often lose motivation if they don’t see progress. For people like me who are determined and unlikely to quit, paying off the highest interest rate makes more sense for me. For instance, if I have $22,000 in credit card debt and $18,000 in student loan debt, Dave recommends paying the student loans first because that is the lower amount.
If the average interest rate on that student loan debt is 5.05% – 6.6%¹, and the average credit card interest rate is 16.71%², why on earth would I spend any amount of time paying off that lower interest student loan? That credit card continues to rack up more and more debt at a rate of 16.71%! I recommend picking the right debt payoff method that will work for you – but I would strongly recommend paying off the highest interest rate first rather than the lowest balance… For more info on where to start, check my related article: Simple Steps To Start Your Debt Free Life!
The third step states 3-6 months of living expenses should be saved after your debt is paid off. This is for a worst case scenario of you losing your job and needing to live off these funds until you find employment. Do you feel comfortable you will be able to replace your income in 3 months? With my current income level, I would not feel confident I would be able to replace it in 3 short months. That is why I recommend a minimum of 6 months of living expenses. While this may seem like a lot, keep in mind you will be building this up after you are debt free – it will not take as long as you think.
This is where Dave recommends you start saving for retirement at a rate of 15%. He fundamentally disagrees with investing anything until you have all your debt paid off and your savings built up. I understand the thought process behind this, but there are two things I would do differently. The first and most important difference is an employer match retirement account. If your employer matches 3% or more, (which is common) in a pre-tax retirement account, I recommend you contribute the match limit before you start paying off debt. Why? If you pay the match – that is a 100% return on your investment that will grow with compound interest. Immediately taking advantage of an employer match makes much more mathematical sense and that should be your first step.
The second difference of opinion I have with Dave is the percentage to put in retirement. 15% is a good number to shoot for, but a more realistic number to be comfortable in retirement should be 18% – 20%. Money doesn’t stretch as far as it once did in retirement and 15% may not be enough to live off of for the rest of your life. Make the sacrifice of that extra 3-5% in order to have a healthy and secure retirement.
Dave recommends investing in a college fund for your children. I recommend doing what works for you. Honestly, my wife and I are not saving for my children’s college at this point. We have no debt and are 2 years from having our house paid off. My oldest is 8 years away from college, so when the time comes we will have 2 options. We will be able to cash flow college without going into debt and my children will also be working when they are in college. They certainly can help pitch in for their school – it’s about growing up and learning responsibility. Before you call Child Protective Services on me, I can tell you that I worked when I went to college – and I think I turned out pretty good…
Pay your house off early. OK, I completely agree with Dave on this one. Yes, mathematically it may make more sense to invest that money rather than pay the house off early. But just think about this. You’re already investing 18% of your income – what is more important to you? A paid off house and no debt what so ever, or making 8% extra on that money and paying a mortgage for another 15+ years? Mathematically it makes more sense to invest – but life doesn’t always work out mathematically. Having no debt gives you peace and security to tackle just about any financial thing life throws at you.
Build wealth and give. I also do not have an issue with this Baby Step – except for Dave Ramsey’s investment advice. I won’t get into it on this post but there are much better investment vehicles to put your money in than those recommended by Dave Ramsey.
Wrapping It All Up
All in all, I agree with much of what Dave Ramsey preaches. He has the heart of a teacher – unfortunately his material is getting a bit dated. In my Debt Payoff Playbook, I have a similar yet updated set of phases to help you become financially secure:
Phase 1: Build a budget
Phase 2: Save $1,500 – $2,000 for emergencies
Phase 3: Attack your debt (using the interest method)
Phase 4: Cash reserves for 6 months
Phase 5: 18-20% of your income into retirement
Phase 6: Save/Invest for future specific plans – not necessarily college
Phase 7: Get rid of that mortgage
Phase 8: Invest for success
As you start this journey, keep your head up – there are many obstacles that will come your way. You can get through all the steps if you refuse to quit. Keep the goal of a financially secure life in the forefront of your mind. You can do it!! You work too hard to be this broke!
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