Dave Ramsey is one of the more polarizing figures in the personal finance space. Love him or hate him, he has encouraged millions of people to pay off debt. Dave Ramsey’s baby steps are the foundation of his approach to helping individuals and families become debt-free.
The baby steps provide a standard process for digging out of debt and eventually building wealth. However, like any traditional process, it will not connect with everyone. Personal finance is personal, after all. At the same time, these baby steps have proven to be successful for many over the years.
People say the baby steps’ beauty is the overly simplified approach. Many individuals shy away from the personal finance space because it’s difficult to understand the concepts. Sometimes, those in the personal finance space talk over the heads of new individuals, which scares people away. We spend too much time on the technical aspects instead of the behavioral characteristics.
Our family’s introduction to the personal finance world started with Dave Ramsey’s baby steps and Financial Peace University. The remainder of this post will cover the pros and cons of each step.
Dave Ramsey Baby Step 1: Save $1,000 For Your Starter Emergency Fund
The concept here is relatively simple – save $1,000 as fast as you can, any way you can. If tracking your expenses or zero-based budgeting isn’t enough to find extra money for savings, you may have to get creative. Making extra money on the side may include driving for Uber or Instacart, selling items from around the house on eBay, or getting a temporary job delivering pizzas. The whole purpose of this baby step is to be laser-focused on saving up that first thousand dollars.
Pros of Baby Step 1
We live in an era where many Americans cannot cover a $400 emergency. Having a $1,000 emergency fund in the bank can keep a family from getting deterred when they need to replace a flat tire or fix an HVAC issue. Expenses like that can throw a family off-course relatively quickly as they work through the baby steps.
More than anything, this step is about getting a quick win early. This baby step allows you to check the box to say you were able to complete one of the baby steps in a short period of time. In addition, this first step builds the momentum for the next few steps, which can take much longer to complete.
Cons of Baby Step 1
The Dave Ramsey baby steps rolled out in the 1990s. Back then, the purchasing power of $1,000 was much different than today. You’d need about twice the money today to have the same purchasing power.
It’s no secret that it takes more money to cover those unexpected expenses. While saving $1,000 still checks that first box, you could more easily get derailed if an emergency comes in at more than $1,000. To keep up with the cost of inflation, you’d need to save about $2,000 to have the same impact today as in the 1990s.
Dave Ramsey Baby Step 2: Pay Off All Debt (Except the House) Using the Debt Snowball
The debt snowball method involves listing all your debt on paper and organizing it from the lowest dollar amount to the highest. Then, you’ll continue to make minimum payments on all debt obligations except for the debt with the lowest dollar amount.
The goal is to put as much money as possible towards the lowest dollar amount and pay it off as fast as possible. Paying the lowest dollar debt will then snowball that debt payment into the next lowest debt, and so on. So baby step 2 is all about paying off your consumer debt, except the mortgage.
Pros of Baby Step 2
The debt snowball method is another method where the behavioral aspects trump the mathematical approach. The debt avalanche method, which involves paying off the highest interest-rate debts first, would be more beneficial from a mathematical standpoint. However, getting those small early wins by paying down small debts can help propel you to become completely debt-free.
This step is the bread and butter of the Dave Ramsey baby steps. Of course, many people will tell you that low-interest-rate debt is perfectly fine to own as long as you’re investing the extra money in assets with a higher rate of return. However, you’ll rarely find anyone who regrets being completely debt-free.
Cons of Baby Step 2
Dave recommends an all-in approach to becoming debt-free as quickly as possible. This recommendation can be extreme, depending on your financial situation.
For example, if you have $100,000 in student loans, paying off that debt could take many years. That would mean going years without investing in your 401(k), potentially missing out on years of free money from a company match.
It can also be tough to make it that long without building an emergency fund of more than $1,000. So the chances of something costing more than $1,000 is high. Overall, it’s tough for me to argue with this approach of becoming debt-free as fast as possible.
Dave Ramsey Baby Step 3: Save 3 – 6 Months of Expenses in an Emergency Fund
Now that you’ve completed the long journey of paying off your debt, it’s time to build an even stronger financial foundation. A 3-to-6-month emergency fund will protect you from more significant life events that can set you back. An emergency fund and debt freedom will allow you to survive almost any financial situation.
This step involves taking all the money you used to pay down debt and putting it in an emergency fund. Hopefully, this step doesn’t take as long as step 2 since there should already be a lot of momentum built up. Once you have your emergency fund saved up, ensure it’s kept in a savings account or other safe asset so you don’t risk losing it. The whole point of an emergency fund is for it to be there when you need it.
Pros of Baby Step 3
Peace of mind comes with having several months of expenses saved. In addition, an emergency fund will allow you to stay afloat if you lose your job or incur an unexpectedly high cost.
It would help if you had a good idea of your monthly expenses from your budget at this point in your journey. The amount to target for your emergency fund is simply multiplying that budget by the number of months of expenses you plan to save. You’ll also want to take into consideration any significant annual expenses.
Cons of Baby Step 3
There aren’t many cons to having a fully-funded emergency fund. Like baby step 2, the biggest downside is the missed opportunity to start investing. You should save your emergency fund in a low-risk account, so you would miss out on potential returns if invested in a higher-risk asset.
One big issue I have with the Dave Ramsey baby steps is eliminating a credit score once you get to this point. Dave recommends never taking out more debt once you reach baby step 3. Maintaining a high credit score once free from consumer debt is not difficult. You have to charge a couple of credit cards occasionally and then pay them off at the end of the month.
Having a high credit score can help you get a lower interest rate on a mortgage or borrow from a lender in an emergency. However, more employers are also doing credit checks, and the absence of a credit score can raise questions. So while it’s possible to get by without a credit score, several things in life are more manageable when you have one.
Dave Ramsey Baby Step 4: Invest 15% of Your Household Income in Retirement
Now that you are debt-free and have a fully-funded emergency fund, it’s time to start investing for retirement. Dave suggests investing 15% of your household income into a pretax retirement account. Traditional ways to invest in retirement include an employer 401(k) or equivalent account or a self-directed individual retirement account (IRA). However, the 15% goal does not have an employer match on your investments.
You should be able to move through this step quickly. For example, if you’ve been paying down debt and building an emergency fund, many can shift those dollars immediately to their pretax retirement account.
Pros of Baby Step 4
Finally, you’re able to start investing in the market. Investing in retirement accounts is one of the best ways for the average American to build wealth. The earlier you can get to this stage, the better. Compound interest is powerful, and there is a significant difference in growth if you start investing at 25 years old compared to 35 years old.
Target-date funds are becoming more popular if you put 15% of your household income into a 401(k) or similar account. Target-date funds automatically invest your dollars in more aggressive, higher-risk funds when you are younger. Then, as you get closer to retirement, those assets shift to lower-risk assets such as bonds.
Cons of Baby Step 4
There isn’t much of a downside to starting to invest 15% of your household income in a tax-advantaged retirement account. What pains me at this stage is all the free money you might have missed out on by not starting earlier.
The baby steps are very specific; you should not invest for retirement until you have paid off all debt and built an emergency fund. It sounds great in practice, but what if you’re someone with $100,000 in student loan debt and don’t make a high income? It could take you a decade or more to get to this step.
At that point, you have missed out on your best investing years. You can never get that time back. I understand the power of going all-in to reach a goal, but not investing five or so percent of your income in retirement right away can result in thousands of dollars in tax savings, company matches, and compound interest.
Dave Ramsey Baby Step 5: Save for Your Children’s College Fund
Now that you’ve started caring for yourself in retirement, it’s time to consider your children. Unfortunately, the price of college continues to rise at an unsustainable rate. Yet, a college degree is still the best path to an upper-middle-class life.
One difference with this baby step is it’s the least definitive of all the steps. Therefore, there’s no exact amount that you have to save to move through this baby step. However, to graduate from this baby step, you need to start saving an amount that will add to what your kid(s) may need when ready for college.
There are a few ways to invest in your children’s college fund. The most common is a 529 college savings account. We are using this option to save for our children’s college fund. Other options exist if your kids have earned income, such as Roth IRAs.
Pros of Baby Step 5
As important as it is to take care of our financial situation, leaving a legacy behind for your family is also essential. How you approach that looks different for everyone. However, we believe that saving for your children’s college is a crucial step in a family’s financial journey.
If you don’t have children or don’t plan to pay for their college, you can immediately move past this step onto the next. However, if you have kids or plan to in the future, it would be a good idea to strongly consider saving for college. Starting your children off in life debt-free is a great way to set them up for success.
Cons of Baby Step 5
The most frequent questions related to this baby step are around if your children do not go to college or if they take advantage of the situation. We’ve all known someone who was forced into going to college, did not take it seriously, and dropped out.
Some will say if you raise your kids right, you won’t have to worry about anything. Unfortunately, this advice usually comes from people who haven’t had college-aged children. The reality is that every kid is different, and not everyone is a good fit for college. For example, going into the trades is a great way to make a living without college.
Even if you save up a bunch of money for college and your kid decides not to go, there are still ways to use that money elsewhere. Minor penalties or taxes may be required if the money is used for something other than college, but you would still have access to most of the capital. Instead, you could give your child a downpayment for a house or something else to get their lives started on the right foot.
Dave Ramsey Baby Step 6: Pay Off Your Home Early
Paying off your home early may be the most controversial baby step. There is a wide-ranging debate in personal finance about becoming mortgage-free early.
Most people that have paid off their mortgage say it’s one of the best decisions they’ve ever made. Others argue the downsides associated with the opportunity cost of paying down a low-interest rate mortgage instead of investing that money in an asset with a higher return.
Both sides have valid arguments. It’s what makes personal finance personal. Unfortunately, after likely moving quickly through baby steps 4 and 5, this one will probably take a while. Even if your mortgage debt is only $100,000, it will take more than $3,000 a year for three years to pay it off.
Pros of Baby Step 6
Paying off your mortgage can give you peace of mind that is difficult to understand otherwise. However, when it comes to the debate of investing more or striving to pay off your mortgage, we are firmly in the pay off your mortgage camp. Becoming completely debt-free is the final block in setting your financial foundation.
Benefits from paying off your mortgage early include a near-guaranteed rate of return, better protect you in a recession, and reducing your monthly expenses. In addition, once you pay off this final debt, you’ll have a lot of money to play catch up.
Cons of Baby Step 6
Most people will tell you the downside of paying off your mortgage early are the higher returns you’d miss out on in the market. While that will likely be true, this assumption also assumes that money would all go towards investments and not elsewhere. It also assumes the market will continue to increase at a higher rate than a mortgage rate, which is likely to be true in the long run but not in the short term.
My biggest issue with this baby step, similar to many others, is the lack of flexibility. With high housing prices, paying off your mortgage could take a very long time. Maybe a decade or longer, depending on your household income and mortgage total. That’s a long time before you start to build wealth in anything besides 15% into a retirement account.
Dave Ramsey Baby Step 7: Build Wealth and Give
Once you’ve made it this far, it’s time for a huge party! Paying off all debt, including your mortgage, is a big deal. Now it’s time for the real wealth building and giving to begin. Without debt, you’ll have a large income shovel to start building wealth. Alternatively, you may be able to downshift a career into a single-family income or a less stressful job situation.
Dave recommends giving away 10% of your income throughout this entire process. If you don’t give when you have little, you’ll never give when you have much. I certainly understand this point of view, though I also think it can be too inflexible. Either way, this step is where the real fun begins.
Pros of Baby Step 7
I love the fact that wealth-building and giving are tied together. But, of course, some would argue that true wealth is built through charitable endeavors. Regardless, you’ll be set up to focus on building wealth and being generous for the rest of your life.
Once you get to this point, you’ll have many options to give and build wealth. Generally, the best ways to build wealth are by purchasing assets. Building wealth may include stocks or bonds, real estate, or a business. For those with higher risk tolerance, this could even mean crypto. Regardless, with a high savings rate and smart investments, you will be well on your way to building generational wealth for your family.
Cons of Baby Step 7
I’m generally on board with Dave Ramsey’s advice on paying down debt and building your financial foundation. However, the more I learn about his suggestions for building wealth, the more I hate it.
Yes, hate is a strong word. However, Dave often promises high-fee mutual funds with promises of unrealistically high returns. For example, Dave suggests that mutual funds will provide an average return of 12% when the S&P 500 historically returns about 8%.
Combined with paying a 1 or 2% mutual fund fee, his investing advice leaves much to be desired. In general, passively managed funds outperform actively managed funds. A passively managed fund is a Vanguard index fund to the total US stock market or the S&P 500.
Summary of the Dave Ramsey Baby Steps
Like any financial advice, you often have to take the good with the bad. Dave Ramsey effectively gets people who don’t care about personal finance to care about personal finance. His baby steps have resulted in millions of families becoming debt-free and building wealth for their families.
With any “one-size-fits-all” approach to personal finance, there are downsides. Generally, if you can make it to baby step 7, hopefully, you can graduate to learn about personal finance from others.
Mark is the founder of Financial Pilgrimage, a blog dedicated to helping young families pay down debt and live financially free. Mark has a Bachelor’s degree in financial management and a Master’s degree in economics and finance. He is a husband of one and father of two and calls St. Louis, MO, home. He also loves playing in old man baseball leagues, working out, and being anywhere near the water. Mark has been featured in Yahoo! Finance, NerdWallet, and the Plutus Awards Showcase.