A 2019 Analysis Of The Dave Ramsey Baby Steps

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Choose FI has partnered with CardRatings for our coverage of credit card products. Choose FI and CardRatings may receive a commission from card issuers. Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities. Disclosures.

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, and Dave Ramsey's name stands out above most others.

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 nationwide and he turned it into a multimillion-dollar dynasty.

He based everything around seven baby steps and built a tribe of debt-free warriors. His product went viral in an era that predated social media and blogging.

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!

So now, more than 15 years later, 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.

At ChooseFI we subscribe to the “FI” (Financial Independence) way of thinking. Which broken down to it's simplest explanation is to keep your expenses as low as possible, invest as much as you can in low cost, broad-based index funds, and when you have saved 25 times your annual expenses you are considered financially independent.

What you do at this point is up to you. Many people quit their day jobs to start businesses or reduce their hours to part-time. Others stop working entirely and travel, pursue hobbies, or just spend more time with their families. The point is, when you can live off your investments, your time is your own.

Summary Of Dave Ramsey's Baby Steps

Baby Step 1: Get An Emergency Fund Of $1,000

Dave says that this is to prevent Murphy from knocking on your door. You know the saying:

What can go wrong will go wrong.
-Murphy's Law

I think this is a Universal Truth. Accidents tend to happen when you can least afford it. I don't take the small stuff for granted. 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 payday loan will typically be a short-term loan for $600-$1,200 dollars. And the interest usually runs $200-400 per month

$1,000 can be enough to stave off financial disaster. So, as Dave says:

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.

We totally agree with the concept of an emergency fund. You won't get anywhere if you're scrambling every time your car breaks down or your child needs to go to the doctor. However, in our minds, how much you choose to save is up to you. Do you feel comfortable with $1,000? If so, great. If you want more or less, that's ok too. The point is to spend time thinking about it and make a plan. Know ahead of time what you are going to do when an emergency strikes will reduce the stress.

Baby Step 2: Pay Off All Debt Except Your Mortgage

In this step, Dave recommends using a debt snowball, which involves paying the smallest debt down first. Here are his steps:

  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.

But, Mathematicians often favor the debt avalanche

This goes as such:

  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 $1,000 together. As long as the interest rates are similar then use the debt snowball and pay off the smallest debt first.

Exception: If you have any payday loans with 200% interest rates pay those off first.

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!

My Two Cents For Step 2

I have noticed that Dave really doesn't try to give you a whole lot of actionable tips to help to decrease the cost of your life–which can help you reduce debt.

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 ’90s but I think it's a shame that he doesn’t go any deeper on how to actually decrease expenses. I think we can do better.

The members of our Facebook group have endless ways to save money. Everything from cutting your own hair to finding low-cost entertainment in your city. If you want ideas to lower your expenses head over and see what others are doing.

Related: Quirky Frugal Habits: Level Up Your Frugality

Other Points Of Contention In Step 2

Dave Ramsey tells you to hold off on the match with your 401K while you're 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're being chased by the cheetah and it's short-term, usually less than two 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.

Baby Step 3: Get 3 To 6 Months Of Expenses In Savings

I agree with the importance of an emergency fund and savings but I have started to question the best place to keep the emergency fund. Especially for someone who is saving 20-60% of their income. Does this need to be in a basic savings account earning zero interest? I think it's so important to get your money working for you. We explored this in an episode with Big ERN. Don't misunderstand, I think it's incredibly important to be able to weather a financial storm and have a clear plan in place, but to be honest I skipped this step and went right to investing.

I Have Insurance

Insurance is a backstop; if I have a death in the family, or my house burns down, or the car is totaled. I have enough to cover the max out of pocket but after that, I am in the clear.

What If I Lose My Job?

This is where the personal factors come in and you have to weigh in how secure is your job? What would you do if you lost your job?

But it's important to play this out

Can you get another job?

Note that since this is an emergency you don't need to replace your income just cover your expenses, the lower your expenses are the smaller your cash emergency fund needs to be.

Do you have another source of income?

Side hustles are great for many reasons, one of which it can serve to cover some expenses if you lose your main source of income. Depending on the side hustle you may even be able to ratchet up the income and cover most if not all of your basic living expenses while you look for a new job.

Related: Why A Side Hustle Is FI's Secret Weapon

What If I Have An expensive emergency?

If I had an unexpected $10,000 emergency:

  1. I have a decent amount of money in my taxable accounts (for me it's Vanguard VTSAX) I could access within a week.
  2. I have a credit limit on multiple cards approaching $30,000 with a 30-day interest-free float.
  3. I could set up a HELOC ( Home Equity Line of Credit).
  4. I can access Roth contributions (contributions can be accessed tax and penalty free).
  5. I could sell something.
  6. I could cash flow it because my savings rate is so high. I can cut back on my savings and focus on paying for the expense.

Obviously, this is incredibly situational, and I don't think the emergency fund is a one size fits all answer. But too often it is taken as dogma. I guess more accurately I think everyone should have savings and the ability to financially survive emergencies I just question whether that massive emergency fund in a low paying savings account is necessary for everyone.

You should probably have some cash on hand, even if it isn't the full 3-6 months of expenses. If you do, you'll want to be earning as much interest as possible on this money. We recommend the CIT Saving's Builder account. Check out our full review here.

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 any time. So, between those categories, you should be able to access 3 to 6 months of expenses. Keep in mind that withdrawing from your Roth will mean you can't max out your contributions for that year. The money you withdraw doesn't subtract from the money you contributed.

For example, if you contribute the max of $6,000 and then in November you withdraw $1,000, you can't just put that $1,000 back in December. You've already contributed the full $6,000.

Baby Step 4: Invest 15% Of Household Income Into Roth IRAs And Pre-tax Retirement

For most Americans, saving 15% sounds extreme. However, in the FIRE community, 30%, 40%, and even 70% savings rates are not uncommon because 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.

Saving 15% will give you a 40-year career and a comfortable retirement. But here at ChooseFI, 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.

This is the crux of the Financial Independence community, and the biggest difference between us and Dave Ramsey. If you want an average life and retirement, then, by all means, save 15% of your income. But if you truly want to “live like no one else so you can live like no one else” then we suggest taking it the next level.

Let's look at the reality of Dave's plan by using two case studies. Let's say that our individual invests 15% of their household income into a Roth IRA and pre-tax retirement, earning an average of 8%:

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 about 1.6 million dollars.

Case 2

Amy decides to go to grad school. This is a 12-year path including four years of undergrad (age 18 to 22), four years grad school (age 22 to 26), and finally, four or five years pay down her loans (age 26 to 30). Amy earns a higher salary of $100,000 per year. But, because of school and student loans, Amy was not able to start investing until she was 30. Amy only plans on working/investing for 30 years till the age of  60. She invests 15% or $1,250 a month. At the end of 30 years, Amy would have about $1.8 million dollars.

Tom and Amy both retire at age 60 with roughly the same amount of income in retirement.

ChooseFI example

Paul decides not to go to college and at age 20 has a blue-collar career earning $60,000. He keeps his expenses low by house hacking, driving old cars, and packing his lunch to work every day. He also picks up a side hustle that earns him an extra $1,000 a month. He is able to save 50% of his income, or $36,000 per year. And he lives on the other $3,000 a month.

With his expenses being $36,000 per year, he would need to save $900,000 to be FI (36,000×25=900,000). Once he reaches this point, he could withdraw 4% of his nest egg and that would provide him with the $36,000 per year he needs to cover his expenses, and never touch the principal.

If he decides to keep his side hustle with it's $1,000 a month of income, then he only needs $600,000 in savings to be FI.

Investing his $36,000 per year, he would have $900,000 in 14 years–and $600,000 in just 11 years. 

Tom and Amy don't retire until they are 60. Paul retires at age 34! Big difference! He now has the freedom to do whatever he wants.

Baby Step 5: College Funding For Children

We all know that student loan debt is astronomical. The only answer to that is: teach your children about saving for college. This step no one disagrees with. But college has changed a lot in the 15 years since Dave Ramsey came out with his baby steps.

Also, college hacking can make a huge difference in the cost of paying for school. We can all do things such as:

  • Look into dual enrollment so your child can graduate from high school with an Associates Degree
  • Start looking into scholarships early
  • Work with your child so they do well on the SAT and ACT tests
  • Stay in-state, if possible
  • Set expectations that your child will work during college

Reducing the cost of college will go a long way to making it more affordable. Pair that with saving for college and you've gone a long way to reducing the burden of student loans. The goal is to graduate with zero debt–or at least as little as possible.

Related: Demystify College Scholarships With Brian Eufinger

Baby Step 6: Pay Off Your Home Early

This one we agree with–maybe.

What’s your interest rate and what’s the alternative?

Opportunity Cost

If we rely strictly on the math, it will make more sense to invest, rather than pay extra to your mortgage. $500 a month extra on your mortgage may save you

Assuming a mortgage balance of $200,000 at 4%, with 20 years left on the term. Paying the minimum payment will mean you'll pay $90,870.56 in interest. Adding $500 a month to the payment will save you $37,100.79 and will shave off about seven years.

The alternative is to invest that $500 a month. If we invest $500 a month into a low-cost broad-based index fund that averages 8% for the next 13 years (the time it would take us to pay off the mortgage with this extra money) will leave us with $134,994.85. A more conservative return of 6% would leave us with $117,442.07.

 You Can't Downplay Flexibility & Freedom

As you can see, the math leans heavily on investing over paying off your mortgage. However, there are other factors at play. Risk is one. There is zero investment risk when paying off the mortgage. You are guaranteed a 4% return, in this example. You are not guaranteed anything when investing in the stock market, no matter how well diversified.

Peace of mind is another factor. The security of having a paid-off home is something that allows for great peace. As Dave says, 100% of foreclosed homes had a mortgage.

Reducing your structural expenses is another reason people decide to pay off their home early. The FI community is huge on getting expenses as low as possible. You simply need less in savings if you have fewer expenses.

I go back and forth and clearly don't have the perfect answer. Mathematically it's probably suboptimal but the freedom and flexibility that not having a mortgage proves should not be discounted. I would never tell someone that they made a mistake by paying it off. It “may” be a mathematical mistake but that doesn't mean it's a life mistake.

The beauty of the FI journey is that you get to make you own choices. If you want to pay it, or if you want to invest that extra money–the choice is yours.

Related: Should I Pay Off My Mortgage Or Invest?

Baby Step 7: Build Wealth And Give!

This is literally the conclusion of Dave Ramsey's book. This sounds so boring. Why go through all these financial hoops if you are just going to sit back and count your money. Dream bigger! How would you spend your time if money were not a factor? Would you volunteer at charities close your heart? Would you travel? Would you move to another country? Do you want to start your own business?

What do you want to do with your life?

I think the reward of all this 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 for extreme flexibility.

Explore Travel Rewards, which involves taking advantage of credit card sign up bonuses to earn 5-10K in free travel each year. Become an expert at putting these travel hacks together. Then use the flexibility of FI to have the time to take advantage of four-week vacations anywhere in the world with my family.

If you want to listen to the podcast episode that inspired this article, click the link below:

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

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Choose FI has partnered with CardRatings for our coverage of credit card products. Choose FI and CardRatings may receive a commission from card issuers. Opinions, reviews, analyses & recommendations are the author’s alone, and have not been reviewed, endorsed or approved by any of these entities. Disclosures.

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