Dave Ramsey’s Baby Steps: Pros, Cons and Alternatives
If dave ramsey baby steps is on your radar, this short guide cuts through the noise. Here is what is worth knowing, and how to put it to work today.
Key Takeaways
- Share This content is for educational purposes only and does not constitute financial advice, advisory, or brokerage services.
- We may earn compensation from some links on this page.
- When it comes to financial planning, one of the most well-known frameworks is Dave Ramsey’s Baby Steps. What makes the framework so po...
When it comes to financial planning, one of the most well-known frameworks is Dave Ramsey’s Baby Steps.
What makes the framework so popular is its simplicity. You just work through the steps in order, making sure to check off each of the seven before moving on to the next one.
But the big question is this: should you follow the Baby Steps formula or is there a better path to pursue?
This article will:
- Review each of Ramsey’s seven Baby Steps.
- Look at the pros and cons of each Step.
- Outline the plan I would follow instead of Ramsey’s.
Table of Contents
ToggleOverview: The 7 Baby Steps
Dave Ramsey’s seven Baby Steps are:
- Baby Step #1: Save $1,000 for your starter emergency fund.
- Baby Step #2: Pay off all debt (except your mortgage, if you have one) using the debt snowball method.
- Baby Step #3: Save three to six months of living expenses in a fully funded emergency fund.
- Baby Step #4: Invest 15% of your household income in a retirement account.
- Baby Step #5: Save for your children’s college fund.
- Baby Step #6: Pay off your mortgage early.
- Baby Step #7: Build wealth and give.
Baby Step #1: Save $1,000 to Start an Emergency Fund
Summary: Ramsey suggests building a $1,000 starter emergency fund before investing or starting to pay off high-interest debt.
Does it make sense? Yes and yes! Having a small amount of cash savings is vital.
In fact, the Federal Reserve did some research on families with low incomes who had a $500 emergency fund in place. What they found was that when a financial hardship occurred, these lower-income families fared better than middle-income families who did not have $500 set aside.
Tips for success:
- The goal is to accomplish this step as quickly as possible.
- Give yourself a deadline. Design a plan that can help you save $1,000 as fast as possible , ideally, in 30 days or less. This may involve some creative strategies, and you may miss the mark. That’s OK, as you’ll at least be better off than you were a month ago.
Baby Step #2: Pay Off All Debt (Except Your Mortgage) Using the Debt Snowball Method
Summary: When paying off debt using the debt snowball method, you start with the lowest balance first. For example, if you have two credit cards, you focus on paying off the one you owe less on first, even if the interest rate on that card is the lower of the two.
The idea behind this strategy is that paying off the lowest balance first is a more achievable goal, and that doing so will help you build momentum.
Does it make sense? As a CFP® with a love of numbers, it may surprise you to learn that I’m a big fan of the debt snowball strategy. In fact, studies have proven that more people succeed in paying off their debt with the debt snowball.
Editor’s note: The alternative to a debt snowball is a debt avalanche, where you pay off your debts in order from highest interest rate to lowest.
While I love the debt snowball method as a strategy for paying off debt, where I disagree with Ramsey is that he recommends using it to pay off all debts beside your house.
First things first: if you have high-interest credit card debt , which we’ll define as being around 18% APR , you want to focus on getting rid of that debt ASAP. You can’t get ahead when you’re paying that much interest.
But what about things like student loan debt, which frequently has an annual rate of around 6%?
For lower-interest personal debts like those, a good number to keep in mind is 7%. That’s the average percentage that the stock market returns (after inflation) each year.
So, if you want to go by the numbers, it makes sense to pay off any debts above 7%, while prioritizing investing over paying down those with rates of less than 7%.
Think about it like this: if you can make 7% by investing, you’re losing money by paying off debt that costs less than 7%.
Key notes: The exact equation is more complicated than this. For example, you may lose a deduction for paying off your student loan debt early, or get a deduction for starting to invest.
Plus, it’s worth mentioning that paying off debt is a guaranteed rate of return, while investing does not offer such guarantee. So look at 7% as a rough guideline, not an absolute law. Frequently, it comes down to what you’re more motivated to do.
Another situation worth mentioning here is when your employer matches your 401(k) contributions. In that case, you’re getting as high as a 50% return on your money. I would absolutely invest up to the maximum at that rate of return prior to paying off my lower-interest debts, because choosing not to is the same as walking away from free money.
Tips for success:
- Behavior can trump math. A study published in the Journal of Consumer Research , which is summarized in plain language in this Harvard Business Review article , found that it’s best to pay off your smallest debt first, even though this doesn’t save the most money in the long run.
- Know your debt payoff date. Use The Ways To Wealth’s Final Thoughts
The bottom line: a little research on dave ramsey baby steps goes a long way. Compare your options, watch for seasonal offers, and never pay full price when a better deal is one click away.
Originally published at thewaystowealth.com.
R.J. Weiss
Our editorial team researches and verifies every money-saving guide before publishing. Editorial policy · About us
