A 2017 Analysis of the Dave Ramsey Baby Steps

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My History With Dave Ramsey

Since the 90's The Dave Ramsey Baby Steps have been synonymous with personal finance for middle-class America. I’ve listened to many podcasts and I've read many blogs. Over all the years, one name stands out to me above most others and that’s Dave Ramsey.  I have been impressed by him for over 15 years. 

Brad and I are a 6th or 7th generation media personalities. I don’t want to say that we are a dime a dozen, but there are a-lot more of us to choose from. But Dave was one of these first-generation personal finance coaches. Nobody was doing this back in the 90s. He had a million dollar real estate portfolio and he crashed hard into bankruptcy. He pivoted and started with a radio show helping people avoid his mistakes. Around the same time, he created a small book called Financial Peace and started offering it as a free resource to his church. The radio show gave him a platform to sell the book and the Dave Ramsey Baby Steps nation wide and he turned it into a multimillion-dollar dynasty.

He created an information based around 7 baby steps and built a tribe of debt free warriors. His product went viral in an era that predated social media and blogging and I have a lot of respect for how much more difficult this was. Dave’s backstory is pretty cool and if you want more information, I’m sure you can find it on his website. But, he gives great “no-nonsense” advice to people that have gotten in over their heads with debt and need help digging their way out.

He was inspirational to me, and even though I ignored a lot of his advice when I was taking out my loans for pharmacy school, his message, that debt carries emotional stress, limits your options, and has the potential to ruin your life, stays with me and is a powerful message. I think everybody would benefit from listening to him and I would not be here today doing this blog and podcast if it were not for Dave. I owe him a debt of gratitude!

One of the things I always found frustrating about Dave Ramsey is his unyielding stance on debt. He lumps all debt together: student debt, real estate, credit card debt, business debt all evil.  Many people would call his show to give their specific situation and try to get him to give them their blessing to take out some form of debt, to achieve their goal and he never bent. I was one of these people. He is locked in, he has built a media empire around saying, “Never take out debt!” He has made millions in the process.

But we have not made millions and we are not locked in! We can change our opinion as we get new and better information. We are crowdsourcing our info. We are sharing what we have learned so far, and hoping this will encourage you to share what you know with us and we all grow together. So now, 15 years later and with this platform we are building, we wanted to review and evaluate Dave’s teaching philosophies. We wanted to see where we line up and where we go our separate ways. 

On his show and in his book Dave Ramsey has 7 baby steps that he walks you through it and they're pretty simple

The Dave Ramsey Baby Steps

Baby Step 1: Get an Emergency Fund of $1000

The 1st baby step is to get $1,000 to start an emergency fund. Dave says that this is to prevent Murphy from knocking on your door.

“ What can go wrong will go wrong

-Murphy's Law

I think that's a great idea. No one disagrees with this. Accidents tend to happen when you can least afford it. I don't take the small stuff for granted. If everyone had some of these basic concepts locked down, then pay-day lenders would be out of business. But I know people that don’t have a checking account and I know people that have been forced to take out a payday loan for an emergency. A pay day loan will typically be a short term loan for $600 or $1200 dollars.. And the interest usually runs $200-400 per month

$1000 can be enough to stave off financial disaster.

And I love how protective Dave is about this.

“Keep your grubby hands off it…. Don't touch it. It's not so you can get your nails done it's for an emergency”

I know people that have made devastating financial mistakes and if you need a baseline to start from the Dave Ramsey baby steps can be a fantastic starting place

For much of the show we're going to assume that you have a-lot of the basics under control:

  • We're going to assume that you have a checking account
  • That you know how to balance a budget
  • That you know how to live within your means

We are really going to open up some advanced techniques to help you game the system. But if you don't understand how all this works and you are starting from scratch. Go buy the book the Total Money Makeover. It will change your life.

Baby Step 2: Pay off all debt Except your Mortgage

In this step, Dave recommends using a debt snowball

  1. Make a list of all your debts.
  2. Rank the list in order from largest to smallest.
  3. Make the minimum payment on all debts.
  4. Throw every spare penny into the smallest debt.
  5. When you have paid off the smallest debt, then throw every spare penny into making extra payments on your second-smallest debt (which is now your smallest debt).
  6. Repeat until finished.

Mathematicians often favor The Debt Avalanche

  1. Make a list of all your debts.
  2. Rank the list in order from highest-interest to lowest-interest.
  3. Make the minimum payment on all debts.
  4. Throw every spare penny into making extra payments on the highest-interest debt.
  5. When you have paid off the debt with the highest interest rate then throw every spare penny into making extra payments on your second-highest-interest debt (which is now your highest-interest debt).
  6. Repeat until finished.

I favor a hybrid

  • Try to tackle the smaller ones first. Group all debts below a $1000 together
  • As long as the interest rates are similar then use the debt snow ball and pay off the smallest then roll into the next 
  • Exception: If you have any payday loans with 200% interest rates pay those off first

Either model will work, but I do realize the emotional power of getting rid of smaller debts and rolling the payment into the next one. Group the remaining debt by interest rate and pay off your any debt that has over a 6% interest rate specifically let's get rid of consumer debt like credit cards anything that's making your life more expensive let's get rid of your car payments.

***never use pay day lenders***

If you are a middle-class American who hasn't spent much time thinking about finances, your life is probably about $10,000 a year more expensive than it needs to be.

Imagine this scenario:

  • Mortgage 1500
  • Two Car Payments 350 and 250
  • Student loans 300
  • Food 500
  • Bills 500
  • Credit card debt – minimum payment 115


Total Annual Cost of Living  $42,180

If you were to follow baby step 1 and 2 and pay off all debt with the exception of the mortgage, your cost of living decreases to 30,000. Pay off those credits cards ( get those credit cards to zero then put them in the drawer or cut them up). Pay off those cars or sell. Crush those student loans. This is an easy way to decrease the expense of your life

Get a Tax Free Raise

Do you realize the implications of reducing the cost of your life by $10,000? These are post-tax dollars! It’s like getting a massive raise. That is free from Medicare, FICA, State tax, Medicaid. Alternatively, it means you will hit financial independence faster.

The Devil's in the Details

I have noticed that Dave really doesn't try to give you many actionable tips to help to decrease the cost of your life. Maybe its because he was trying not to get buried in the weeds. But the entirety of his decreasing expenses plan can be summed up as:

  1. Have a yard sale
  2. Sell your car
  3. Work a second job (deliver pizzas)

This may have been enough advice back in the 90’s but I think its a shame that he doesn’t go any deeper on how to actually decrease expenses. I think we can do better.  

  • What if you could cut your food bill in half? I’ve been writing an article series called the Ultimate Costco Meal Plan where you can serve a family of four for around $300 per month
  • Slash the cable and cell phone bill
  • Slash the electric bill
  • Become the CFO of your own life. Become a hawk looking at every recurring expense
  • Go to our Crushing Expenses 101 page  for more ideas

Other Points of Contention in Baby Step 2

Dave Ramsey tells you to hold off on the match with your 401K while you are paying off debt. I can’t recommend this. I have no problem with not maxing out your 401K,  but we don’t walk away from free money. You always do the match. He makes the case that you are being chased by the cheetah and it's short term, usually less than 2 years. Maybe for some very specific situations where someone is close to the edge, like a payday lending situation, this would be good advice. But I think the audience is important. He is focusing on people dangerously close to the edge. You can’t apply that to everyone! If you have some debt at 5% you don’t pass up doubling your money (100%) to pay down 5% . That's dumb math! My wife and I have always taken advantage of match programs and we have some significant savings based on that alone.

See the article Congratulations! Your Broke

Here's question for readers I would like to work out.

If you were financially able to max out your 401K and still have money left over to pay down debt but it would take you 4 years instead of 2 would you? What would be the deciding factor?

I decided that the psychology of paying down my student loans early, far outweighed any benefit I would receive from maxing out my 401K. As a result, I will have my loans paid off within the next 3 months.

Baby Step 3: Get 3 to 6 months is of expenses in savings

I agree with this. I'm getting very close to being in this step and plan on having 3-6 months set aside. Brad is even more extreme. He has upwards of a year of expenses saved for an emergency.

My plan (3-6 months of expenses):

  1. 3,000 bank account
  2. 3,000 money market  (something I can easily access)
  3. Everything else in VTSAX -or some other index fund but a taxable account that I can access

Investment Life Hack

  • I also like the idea of using a Roth IRA for an emergency fund because you can park it in VTSAX and you can withdraw contributions without penalty at anytime. So, between those categories, you should be able to access 3 to 6 months of expenses.

Baby step 4: Invest 15% of Household Income Into Roth IRAs and Pre-tax Retirement

Dave Ramsey commonly assumes a 12 to 18% rate of return. To justify that, he recommends that you use his endorsed local providers who are active fund managers. They will put you in specific mutual funds which will give you this high rate of return. In most of the math equations that he uses, he assumes a 12 to 18% rate of return. He has been criticized by most fact checkers for continuing to use these numbers to make projections. But we do not have the time or inclination to dive into whether or not this is still possible. We try to use more realistic numbers like an 8% average rate of return which should provide more realistic results.

Three Case Studies

Okay so let's look at the reality of Dave's plan. Let's say that our individual invests 15% of their household income into a Roth IRA and pre-tax retirement:

Case 1:

Tom makes $40,000 a year and invest 15% or $6,000 annually and does a combination of pre-tax and post-tax investment accounts. He does this every year for his working career, which is 40 years so from the age of 20 to 60.  He never gets a raise, which is unlikely, and he never fails to contribute. He’s  going to have a 1.6 million dollars.

Case 2:

Dick decides to go to med school or grad school. This is a 12-year path including 4 years of under grad (age 18 to 22), 4 years of med school or grad school (Age 22 to 26), and finally,  4-5 years of residency or to pay down his loans(Age 26 to 30). Dick earns a higher salary of $100,000 per year. Because of the student loans, Dick was not able to start investing until he was 30. Dick only plans on working/investing for 30 years till the age of  60. He invest 15% or $1,250 a month.  At the end of 30 years, Dick would have $1.8 million dollars.

Opportunity Cost

It's important to realize the opportunity cost here. In Case 1 Tom was able to invest a mere, $500 a month. If you give up 10 years of your life, so you start 10 years later, you're going to have to pay more than twice as much as $1,250 vs $500 if you want to retire at the same time as them. That's opportunity cost!

So If You Follow Dave's Plan You Will Be a Millionaire

But this is not the 40-year career podcast.This is the ChooseFI podcast. We are not interested in a 40-year career. We plan on putting a lot of work in now so it becomes optional in the future. Saving 15% sounds extreme to most of America who is being begged by their financial advisors to tuck away anything (2%-4%). However, in the FIRE community, 30%, 40%, and even 70% savings rates are not uncommon because we understand the simple math of early retirement. More specifically, we understand the importance of your savings rate. We live far beneath our means, focusing on building passive income streams through investments, real estate, and business ventures.

Joshua Sheets from Radical Personal Finance had a podcast episode where he aptly pointed out if you want to experience Dave’s level of success… Don’t do what he says… Do what he did:

What did Dave do?

  1. He Slashed his cost of living creating space between is cost of living and income
  2. He built a business from the ground up
  3. He scaled it to reach millions

That's what we are doing here now and you can be apart of that.

Baby Step 5 – College funding for children

Yes – but be smarter about it- things are changing. Don't be the person with 300 CDs and no way of listening to them. College is changing. The world is changing. We have several podcasts and articles planned which will go into further details.

Baby Step 6 – Pay off home early

Yes/Maybe. What’s your interest rate and what’s the alternative? Do you have a 3% interest rate? Yes? That is free tax payer subsidized money! In addition, it's enabling you to itemize other deductions. 

What's the opportunity cost of doing that? If you have $200K in the bank and you decide to use it to pay off your loan, which has a 3% interest rate, which is subsidized by the government, you are essentially giving up the additional 5% income per year. You could have made this money by investing that in the stock market.

Or do you have a 6% interest rate? Maybe the case is more compelling. Maybe you should pay it off? I don't think there is a single answer, although there is a specific answer for everybody.

Baby Step 7 – Build wealth and give!

This is literally the conclusion of Dave Ramsey's book. This sounds so boring. I would like some sizzle. I don't mean the pyramid scheme sizzle, which dazzles with free cars and a personal island in the Bahamas, but why go through the fire if not for some reward? I think the reward is freedom and flexibility. You get to design your best life now and maybe that's not opulence, but service and family time. Or maybe it's traveling the world and consulting on ideas that you love to think about. Maybe it's writing a book as you geo-arbitrage around the world. So many options and the only thing you are running out of is time! 

This allows extreme flexibility.

This year I am exploring Travel Rewards, which involves taking advantage of credit card sign up bonuses to earn 5-10K in free travel each year. I want to become an expert at putting these travel hacks together. Then use the flexibility of my FI to have the time to take advantage of r4-weekvacations anywhere in the world with my family.

I also want to start several businesses. In 2016 I started 2 businesses and in 2017 I plan on starting 2 more in a different niche. I want to dabble in everything, I view www.ChooseFI.com as a platform to access that information faster. My plan as I navigate steps 3 through 7 is to build 5 passive income streams. I also have a serious interest in real estate. So I am going to find the experts and bring them on the show to teach Brad and I what they know and hopefully you will learn along with us.

I have never had analysis paralysis and you will benefit because you will get a ground floor look at how to build your FI life from the ground up.

If you want to listen to the podcast that went along with this episode, click the link below:

Dave Ramsey, Why Everyone Needs Him and Why You Should Ignore Him

Leave a comment if you have feedback!





15 thoughts on “A 2017 Analysis of the Dave Ramsey Baby Steps

  1. Hey! Just found you guys from RPF. Great stuff.

    Quick correction on the Roth Emergency Fund – you can withdrawal contributions at any time, no need to wait 5 years.

    Looking forward to more!

  2. I can see where some of his plan is a bit of a stretch but I think it all ties together to make the steps following possible. Like getting rid of a credit card and score all together. If you have the money saved up and are secure enough to ditch it then why need it?

  3. Great site guys; thanks for making it available to the rest of us! My wife and I are taking Financial Peace University through our church and enjoying it immensely. To your point, there are some (many?) areas that aren’t black/white in finances, but some of us need to make them black and white until we fix our basic habits and ways of looking at money. Then (so my plan goes at least) we can make course corrections with our new FI navigation skills and explore new worlds…

    • Hey Travis, as you will hear when you listen to episode 5. We are not Dave Ramsey haters. In fact I am a huge fan, I think he helps way more people than we ever will *people that are at the financial cliff* I took the Financial Peace university. I’m a graduate 🙂 but he gives up after getting to debt free and there is so much more 🙂 Enter ChooseFI : because debt free is just the start and Build Wealth and Give is too vague 🙂

  4. Really like your podcast. It fills a definite need in the community.

    Your Dave Ramsey critique podcast/this article was interesting to read. I don’t agree with some of the logic conclusions.

    Main points –

    Step 4 – 12% and 18% returns. Dave mentions 18% returns for paid off rental real estate. Which is achievable. As for 12% returns, what is your time horizon? SGENX has returned 13.32% average since inception. Granted it’s 10 year is currently lower but it is one example that makes Daves position based on facts.

    Step 7 – you mention in the podcast Dave didn’t put much into this step. I would point to the Legacy Journey. The follow up book and class that comes after Financial Peace.

    You say that FI and Dave diverge widely at this point but I would say that they are not that divergent. Dave says keep working even if your considered FI because your work should be something you enjoy and brings value to your life. FIREs believe the same thing after they get tired of not working. Just look at MMM with his successful blog and now his new physical location. MrFreeat33 with his blog and now personal training.(just 2 examples among many)

    Keep up the good work!

  5. Y’alls plan to invest the step 3 emergency fund in a mutual fund is a high risk strategy. In most situations, you won’t need to touch that money. You should be able to cash flow a lot of things that are ’emergencies’ for the average person after you are out of debt and have your spending under control. If you are in this step, or beyond, you are most likely to need that money during a period of economic turmoil resulting in job loss. If you have your emergency fund invested, you may be forced to sell shares while they are worth less than you had expected. Also, you should be looking to put money into your Roth IRAs during this period of time, not pulling money out because you didn’t keep enough cash on hand. Keeping (a reasonable amount of) cash on hand allows you to take advantage of opportunities when everyone else is forced out.

  6. Found your site while googling Dave Ramsey baby steps… great article! I’m just starting to follow his steps to get rid of some debt. Not sure we like the idea of passing up the 401k match either. Our household income is over 150K and our debt under 50K so passing up the match doesn’t make sense. Secondly, I like your passive income stream mantra. That’s what I do in my spare time. Make some websites to get affiliate commissions. It’s nice having an extra $500-700 per month dripping in.

  7. Recently found your podcast last week. I love it! Fairly new to FIRE community, but on my way! I really enjoy breaking down DR’s baby steps in this way. Keep up the great work guys!

  8. I had an ex who avoided credit cards at all costs… but thought it was okay to use pay day loans.

    I could never figure that one out.

    She was also always several payments behind on her car, which she bought brand-new without even checking if she could afford it.

    Come to think of it, she used the pay day loans a lot to catch up on her car loan.

  9. Great article – I love Dave! I don’t agree with him 100% (I use credit cards and take the cash back), but I don’t think I would be in bad shape if I did follow his advice 100%. One fine point of clarification – Dave does indeed advise his listeners that it is ok to take on debt in the case that it is for a home mortgage that is 15 year, fixed rate, with a payment of less than 25% of their income.

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