When Melissa and I graduated from hygiene and pharmacy school over a decade ago, we were staring down a massive amount of student loan debt. We were lucky enough to have high income professions but we lacked a game plan of how to tackle our problem. A couple years before that, my sister had read The Total Money Makeover by Dave Ramsey and passed it along to us. Dave Ramsey is probably one of the most popular financial self help voices out there. He has a national radio show, several best selling books and a real no-nonsense approach to finances. If you google how to pay off debt, his website will be one of the first that pops up. And almost as famous as name are his seven baby steps. A lot of people applaud his style and advice, however, we aren’t his biggest fans.
The Seven Baby Steps
Ramsey teaches seven baby steps to help you pay off debt and become financially free. Here are his steps:
- Create an emergency fund of $1000
2. Pay of all your debt except your mortgage using the debt snowball
3. Save 3-6 months of expenses in a fully funded emergency fund
4. Invest 15% of your household income in retirement
5. Save for your children’s college fund
6. Pay off your home early
7. Build wealth and give
As we unpack these steps we can see some really great advice. However, as with most advice you get in life, you have to adapt it to what works best for you and the stage of life you are in. Let’s go over each step and see if we can find some good things and see where we may have different opinions.
Baby Step 1: Create an emergency fund of $1000
Yes, yes, yes. This is a very important first step for everyone. Life comes at you fast and if you are living paycheck to paycheck any number of emergencies can knock you off of your course. Research shows that about 40% of Americans would not be able to pay for a $400 emergency. So this is a step we 100% agree with. Once you have your emergency fund in place, you can start putting all extra money towards your debts.
Baby Step 2: Pay off all your debt except your mortgage
When we graduated, we followed this advice and used Dave’s debt snowball and it was a huge help for us. There is something about being able to erase a line of debt on your list and then rolling that payment into your next debt. It’s very satisfying. Is it the only solution though? I don’t think so.
I think that with large debt repayments you kind of have to use a hybrid of the debt snowball (start with the smallest loan amount first) and the debt avalanche (pay off the highest interest first). If you have any loans that have massive interest rates like a payday loan you would want to focus on that first regardless of the amount on the loan. If you had $200 at 8% but $5000 at 15% interest it can be helpful to just get rid of the smaller one to keep yourself motivated and make it seem like you are accomplishing something. You have to find a balance between the absolute best process numbers wise and the one that will keep your mental health intact and keep you motivated until the task is complete. We talked more about that in our post about debt.
Unfortunately, I feel like most people get stuck on this step. Either their debts are too large and they lose motivation, or they don’t decrease their spending and can’t gain any traction. Or perhaps they are like us, and finish it, but feel like there isn’t much direction after that.
Anyway, the one main drawback to Dave Ramseys second baby step is that he doesn’t really give solid advice as to how to actually make or save money to pay these loans off faster. What if you are drowning in minimum payments and can’t make any headway? We’ve been trying to focus on some of the things we do to reduce our costs to free up money in our cutting costs posts (cars, gas, cellphones, insurance). Most people spend the majority of their money on housing, food, and transportation so finding ways to reduce costs on these and other things will drastically speed up your debt repayment. Otherwise you’ll never move past this step.
Dave Ramsey also says that while you are paying off debt you should not be investing anything even your 401k. This is something that I wholeheartedly disagree with. If your company offers a match of any kind on your 401k you need to be contributing up to the match but stopping there. Never pass up free money. Also, investments need TIME to grow, so if you have years ahead of you paying off debt, it would be a shame to not put at least a little bit into retirement accounts so it can start growing!
Baby Step 3: Get 3-6 months of expenses in savings
There is a lot to take into consideration with this step. While I agree on having some type of emergency fund set up, it will probably take the average person several years to get this much money saved up. This is why my recommendation is to work on both steps 3 and 4 simultaneously.
As often as possible we want our money to be working for us, not just sitting in a savings account collecting minimal interest. So here is what I would recommend you do in order to work on both steps 3 and 4 at the same time:
- Contribute to your 401k up to your employers match (hopefully you’ve already been doing this).
- Max out a Roth IRA ($6000/year) for each person (so $12K per couple)
- Contribute to a high yield savings account AND increase your 401k contributions in equal amounts.
While it’s important to fund a 401k and it provides significant tax benefits, it isn’t very liquid. We also need to keep some of our money more accessible in case of emergencies. That will provide flexibility while we get that emergency fund completely funded with 3 to 6 months of expenses.
The beautiful thing about a Roth IRA is that because you put money in AFTER taxes, you can withdraw your contributions penalty free at anytime. So your money is there if you need it. But if you can avoid using it, you can have it invested in a low cost index fund and be making money in your sleep. It’s a real win win.
Baby Step 4: Invest 15% of household income to Roth IRAs and Pre-tax Retirement Accounts
We’ve already partially covered this with the previous step, but once you have your 3 to 6 months of expenses saved up you can really start pouring in your extra money into investments.
This is where I think Ramsey really differs from the FIRE community. Up until this point, you could see that what he’s doing works, but 15% for retirement? That is fine if you plan on working well into your 60s. Often we see this where people will work long enough to get social security and medicare, but that doesn’t necessarily provide financial independence. And really doesn’t give you the option to retire early.
If you are serious about becoming financially independent 15% is not nearly enough. That may sound crazy at first but just this last year we were able to save/invest 46% of our income. I go over our order of operations in how to get started investing in this post.
This step will be an ongoing thing until your retirement so just enjoy the ride at this point.
Baby Step 5: College Funding for Children
It’s no secret that college tuition is out of control. But it’s hard to say where we will be with this issue in 5 or 15 years. Will there be a federal program making tuition more affordable? Will college degrees be less important like we are seeing with a lot of tech companies now?
Even if nothing changes there are a lot of way to reduce the cost of college tuition. Dual enrollment or AP classes, attending a community college, and getting scholarships are just a few.
If you decide to save for your child’s education you can put money in a 529 tax advantaged account. Do I think you need to have tens of thousands or hundreds of thousands of dollars in there? No. Do we have college funds set up for any of our kids? Nope. Do we want them to go to college? Maybe? We will give it another 5-10 years before we decide anything for sure on this.
Baby Step 6: Pay off your home early
If you only crunch the numbers on this proposition it will almost always tell you not to pay off your home early. If you were to invest the money you would’ve used to pay additional principle each month into an index fund at the end of your loan the amount of money you make will be significantly more than the interest you pay on the loan.
Even if the numbers say it’s not the most ideal plan there is something to be said about being completely debt free and the peace of mind and freedom that brings. We have talked about the mental game of it here.
Personal finance is always just that, personal. You have to make the decision what to do and mathematically paying off your home early is not always the wisest decision. We have decided that we think it would be great to pay ours off a little early, but it’s not for everyone.
Baby Step 7: Build wealth and give
The final step of Ramsey’s plan is to keep making more money and be generous with it. While I love the idea of giving back if you have excess, what else are you doing? Are you swimming in a Scrooge McDuck style swimming pool, or do you have specific dreams? Do you want to travel the world, pursue your hobbies, start a business? And again, are you still working during all of this or have you retired?
Do we agree with Ramsey?
Yes. And no. While Ramsey gives some good advice on certain subjects, it is very much a “money for the masses” or “finances for dummies” approach. I think he needs to give very straight forward and simple advice to try to appeal to everyone. But like we’ve said multiple times, personal finance is PERSONAL. Don’t do or not do something that is in your best interests because it doesn’t fit into his baby steps.
Being financially free gives you the time you’ve always wanted to do whatever you want. It might be wise to start thinking less about the baby steps and more about what you need to meet your longterm goals and what you will do when time and money are no longer factors.