It’s true… Dave Ramsey may be the king of the Baby Steps and the Debt Snowball, but his outdated techniques are a disservice to those trying to get out of debt.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….
Dave Ramsey’s Net Worth
Dave Ramsey is obviously doing something right. According to Investopedia, Dave Ramsey and his wife Sharon have a current estimated net worth of $55 million dollars!
That’s a lot of money to make while helping people get out of debt. Don’t get me wrong, I have nothing wrong with how much money he is worth. He works hard for his money but he continues to use an archaic system to help people get out of debt.
One of the key issues with Dave Ramsey is his inability to recognize that personal finance is personal. There is not one size fits all for personal finance and while his way may work for some, it may not be appropriate for others.
The Dave Ramsey Plan
Dave Ramsey created a plan to help people get out of debt. He developed this plan in the 1990s’ and is still touting this as the best way to become debt free. Little has changes in his overall methods despite an increase in income and other personal finance changes.
Dave Ramsey’s debt free plan His plan consists of his 7 baby steps (sometimes referred to as the Total Money Makeover Steps) and the debt snowball method.
In addition, his plan also focuses on purchasing the materials for his Financial Peace University. The Financial Peace University is a 13 week plan designed to connect you with other community members as you all tackle your personal finance issues together.
As we look at why Dave Ramsey’s plan is outdated, lets take a look at his Baby Steps to see where you may run into some issues.
What Are 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
Taking A Closer Look At Dave’s 7 Baby Steps
Before blindly following financial advice, we should always ask “why?” While Dave Ramsey himself has been extremely successful, there is a large amount of controversy surrounding his systematic methods.
Again, Dave’s plan has helped many people get out of debt, but it is certainly not the end all be all for everyone. For some it was the exact method they needed to take control of their finances. For others, Dave just seems to rub them the wrong way.
Baby Step 1: $1,000 Emergency Fund
Dave Ramsey advises that the first step to get out of debt 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.
Updating Dave Ramsey’s Baby Step 1:
I completely agree that you need an emergency fund before you start paying off debt. Without money in the bank to act as a safety net, you’re just asking for trouble. You are your biggest defense against unplanned financial expenses.
To make Dave’s Baby Step 1 more relevant for today, I would advise that your emergency fund be funded at least $1,500, but a much better amount would be $2,000.
For advice on how to actually start saving money even if you’re living paycheck to paycheck, check out my article on budgets here.
Baby Step 2: The Debt Snowball Method
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.
Unfortunately this debt payoff method is only focused on the psychology and motivation of people. This method is perfect for people who like to see immediate results and small wins. However, for detail oriented people, this method will drive them crazy.
Ignoring the highest interest rates will cause you to end up paying more money in interest in the overall debt repayment plan. Dave Ramsey strictly looks at outstanding debt totals rather than the amount of interest you pay each month.
Introducing The Debt Avalanche Method
By ignoring interest rates, other balances can quickly climb while you attack a smaller debt with a small interest rate.
To be fair, 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 first (Debt Avalanche) 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 student loan debt is 5.05% – 6.6%, and the average credit card interest rate is 16.71%, 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%!
Updating Dave Ramsey’s Baby Step 2:
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.
It all comes down to knowing what motivates you and your own personal preferences. If you lose motivation easily and have a problem with quitting, the debt snowball may be perfect for you.
However, if you are detail oriented and are not easily distracted, paying off the highest interest rate first, known as the Debt Avalanche, may be better for you and you will end up saving yourself money in the end.
Check out my related article where I detail the major differences between the Debt Snowball and the Debt Avalanche.
Baby Step 3: 3 – 6 Months Of Living Expenses In Cash
Dave’s 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 only 3 short months.
Updating Dave Ramsey’s Baby Step 3:
Giving yourself only 3 months to find a job that will get you back on your feet may be a bit too close for comfort. In the event it takes you 6 months, those extra 3 months will put you deep in debt.
While he does recommend 3-6 months of expenses, he really should be more firm on the 6 months of living expenses number. Realistically, by the time you reach this point you will be debt free except for your house so saving up 6 months of living expenses should not take you very long at all!
Baby Step 4: Invest 15% Of Household Income Into Roth IRAs And Pre-Tax Retirement
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 you may be giving up a 100% return on your money.
Updating Dave Ramsey’s Baby Step 4:
How can you get a 100% return on your money? 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.
Also, with the increase in inflation and wages not keeping up as they once would, Dave’s advice to put 15% into retirement may not be enough.
While 15% is a good number to shoot for, do you really want to take a chance with your golden years? A more realistic number to live comfortably in retirement is 18%-20% of your income into your retirement. Money doesn’t stretch as far as it did in the 1990’s (the birth of Dave’s Baby Steps) 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.
Baby Step 5: College Funding For Children
Updating Dave Ramsey’s Baby Step 5:
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 should be able to cash flow college without going into debt and my children will also be working when they are in college. If we can’t pay for all of it on our own, our children can help fund their college education. It’s about teaching them responsibility. Also, I find kids value things more when they actually have to pay for it.
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.
Baby Step 6: Pay Off Your Home Early
Pay your house off early.
Updating Dave Ramsey’s Baby Step 6:
No update needed! 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 issue life throws at you.
Baby Step 7: Build Wealth And Give
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:
- Step 1: Build a budget (Get your free budget printables here!)
- Step 2: Save $1,500 – $2,000 for emergencies
- Step 3: Attack your debt (using the Avalanche method)
- Step 4: Cash reserves for 6 months
- Step 5: 18-20% of your income into retirement
- Step 6: Save/Invest for future specific plans – not necessarily college
- Step 7: Get rid of that mortgage
- Step 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!