Are you trying to get out of debt while saving money and building wealth? This is my review of Dave Ramsey’s Baby Steps. I will evaluate each step and explain what I agree and disagree with. This review is from the perspective of someone that is striving for financial freedom and not just debt freedom.
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Step 1 – Save $1,000 for your starter emergency fund – AGREE
While $1,000 is not sufficient for a 3 – 6 month emergency fund, it is a step in the right direction. Dave makes it clear that this is a starter emergency fund. This means there shouldn’t be any confusion that $1,000 is simply a starting point.
This is a great way for someone that is working to pay off debt to have something that they can fall back on during hard times.
While paying off debt should be a priority, not having money set aside may force you to take on more debt. Building an emergency fund is a huge foundational step while on the path for financial freedom.
Step 2 – Pay off all debt (except the house) – DISAGREE
While I agree that paying off debt is important, the opportunity cost of missing out on saving or investing to pay off all forms of debt outweighs the benefits.
When I first graduated college, I was on was on Step 2. I had over $1,000 in savings and all of my discretionary income went to paying off my car and my student loans. I was at the point where I paid off my car and half my student loans when I realized that the small amount of money that I had in savings was very dangerous.
It was clear that I did not have any wiggle room when it came to taking risks because I had such limited funds. I realized that while paying off debt is important, having cash and assets that can be drawn on in case of an emergency is much more important.
Oftentimes, our decision to pay off debt as fast as possible is driven my fear. Fear of the unknown, a job loss, or an unexpected expense. I realized that being debt free isn’t true freedom. Having enough money to choose is freedom. This is the case whether you have debt or not.
At this point I started to scale back my student debt payments to beef up my emergency fund. It was difficult at first to put less money towards my debt each month but it was worth it to become more financial secure.
I eventually saved up enough were I could pay off my debt in full at any time, but choose not to because that money is working harder for me than the low interest debt I pay every month.
The variables involved in this are based on how much you owe and the interest rate you are paying on the debt. If you have high interest debt, it makes sense to have paying off debt be a priority. However, if you have low interest debt evaluate what type of returns you could get from the stock market and determine what makes sense for you in relation to your goals.
Step 3 – Save 3-6 months of expenses in a fully funded emergency fund – DISAGREE
If anything I believe Step 2 & 3 should be done together. I chose disagree with this step since it is my opinion that a 3 – 6 month emergency fund is a priority that takes precedent over the debt snowball.
Depending on the size of your debt, you could be working on Step 2 for a long time and miss out on a huge opportunity to build wealth. While paying off debt does increase your net worth, it is not the same as owning assets. If you pay off all of your debt and own no assets, your net worth is ZERO.
Times have changed and you don’t needed a sizable amount of cash before investing your money. Since fees have been eliminated with most brokerages, the barrier to invest in the stock market is very low and should be taken advantage of if you are in a position to do so. Brokerages like Robinhood and M1 Finance make it very easy to invest in small amounts.
Step 4 – Invest 15% of your household income in retirement – AGREE
Investing for retirement is an extremely important task that shouldn’t be overlooked. I agree that allocating 15% of your income towards retirement is a solid amount. If your company matches your contributions that is another way to reach an allocation of 15% faster.
Do you have an Individual Retirement Account (IRA)? An IRA is a great way to invest and choose your own portfolio. If you are invested in a 401(k) through your employer, you are at their mercy when it comes to the investments that are available for you to select. The management fees on an employer retirement account are typically higher than simply investing in funds within an IRA.
While I do agree with the retirement contribution amount, I do not agree that you should wait until you have paid off all debt and have an emergency fund to start saving for retirement. It is important for your retirement account to have time to grow and the later you wait the more you will have to save later to catch up. If you can, it may be a better option to work on Step 3 and Step 4 concurrently. Even if it is a small amount, get into the habit of saving for the long term.
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Step 5 – Save for your Children’s College Fund – AGREE
While there are many other scenarios that can play out between Step 4 and Step 5, saving for your child’s education is never a bad thing. It is a wonderful gift to be able to be able to reduce the debt your child takes on to go to college. People straddled with student loan debt often delay many life decisions like buying a house or getting married because they are not in a financial position to do so.
Having a college fund for your child will allow your child to explore more college opportunities and take more risks in adulthood. It will also make the college selection process much less stressful for you since you have been preparing for so long. Having a college fund for your child is a great way to set your child up for a strong financial future.
Step 6 – Pay off Your House – DISAGREE
Unless you own your forever home, it makes absolutely no sense to pay off your mortgage early. On average, people stay in a home for seven years and then move on to something else. It is important to remember that in most cases, if you make extra payments to your mortgage, the amount goes towards the back of your loan.
A common argument is that you pay so much interest over the life of the loan that any extra payments will save you money. This will all depend on what is important to you. Would you rather have no debt or cash flow? The longer the term on the loan, the lower the payments. By having a mortgage over a 30 year period, you are essentially paying for the cash flow this provides you. Since mortgage debt is low interest debt, you may be better off using your excess cash to invest instead.
People often feel that they are putting themselves in a more secure position by paying of their mortgage when really you are just mitigating the risk for a bank. The less you owe on your mortgage, the more attractive it is for a bank to repossess because they have received more of their money back.
If you fall on hard times and have to forclose, you have just given the bank more of your hard earned money. Also, if you are ever in need of extra cash and want to do a HELOC, you are paying the bank to gain access to your own money!
Unless you owe a small amount that you can pay off in full, making extra payments to pay off the debt does not make financial sense. Make sure to account for your mortgage in your emergency fund budget. Your investments could also serve as a backstop if you fall on hard times.
Step 7 – Build Wealth & Give – DISAGREE
I choose to disagree with this step because it can and should be done in every step of the Baby Steps process. There are plenty of people that are on Step 1 that are giving to causes they care about and are focused on building wealth. Many people may not even reach this step. If you wait to do this step last you could be missing out on a huge opportunity.
Step 7 will be more difficult to achieve because building wealth requires cash flow. If you are throwing all of your cash flow at low interest debt like federal student loans and your mortgage, you are missing a valuable opportunity to build assets and have your money work for you at a higher rate of return. You don’t have to only invest for the long term using retirement accounts. You can invest now and reap the benefits now.
Key Takeaways
The Debt Snowball Method
Dave Ramsey has stated that the snowball effect is more about the psychological ROI than the math behind the numbers. Paying off smaller bills is a way to stay motivated and see real progress. However, there are other methods that can make you more money over time.
The Baby Steps are not practical for everyone. If you have ambitious financial goals, it will be very difficult to reach them using these methods. If you are extremely risk adverse and are reluctant to have debt, this may be a good roadmap for you. You may want to choose an alternative method if your goal is to reach financial freedom before retirement age while your money works for you more efficiently.
These steps can be done in stages depending on your situation. Consider a hybrid plan and do multiple steps at one time. For example, you could do Steps 3 and Step 4 at the same time to be better prepared for an emergency while also thinking long-term for retirement.
Debt Free vs. Financial Freedom
Dave teaches people how to become debt free and have peace of mind when it comes to your finances. Being debt free and having financial freedom are completely different goals and the paths to achieving them are different. Financial freedom often requires a different perspective when it comes to money. Instead of looking at debt as an enemy look at it as a tool for getting what you want.
Look at your personal circumstances, evaluate Dave Ramsey’s baby steps and think about how long it will take you to achieve all seven steps? For the average person, it will probably take a life time. This is what Dave says all the time. If you live by these principles you will probably be a millionaire by the time you are in your 60s. While there is nothing wrong with that, I don’t want to wait until I am in my 60s to be a millionaire.
The Power of Leverage
Using debt in moderation can be very powerful. Think of your personal finance journey as you running your own business. In 2020, there are only 15 debt free companies of the S&P 500. This is because most companies have to use leverage to reach their goals. Leverage is not required to be successful, but it can help you reach your goals much faster. If businesses only used cash, most would never reach their full potential. The same can be said for you. You can build wealth and have debt at the same time.
Know What Your Goals Are
Each person is on their own financial journey. Don’t let anyone tell you what is right or wrong for your life. Some people want to make a ton of money and live an extravagant life while others embrace minimalism and want to live a simple debt free life. If you know what your life goals are, you won’t others opinions regarding your goals get to you. Check out my FREE Life Goals Worksheet if you are on the fence about what you want out of life. This worksheet will help you create a roadmap for reaching your goals!
Disclaimer: The content in this post is my opinion and should not be considered financial advice. I am not a financial expert or advisor. This content is for informational and educational purposes. For more details please visit the Disclaimer Page.
