So basic right? What personal finance blogger hasn’t written a post about their opinion of Dave Ramsey’s Baby Steps? I can almost hear Dave sarcastically mocking the bloggers who debate his baby steps. But honestly, I gotta give it to the man, he’s done well. Personally, I think he’s created a fairly fool proof (say that 3 times as fast as possible) system for fixing the country’s finances. And it all seems to center around his attitude towards debt – Also a hotly debated topic in our country. Anyway, since I have you on the edge of your seat now, allow me to share my opinion of Dave Ramsey’s famous Baby Steps.
Not to be confused with Famous Dave’s Barbecue. They sound similar, but are very different… At least I think.
What Are the Baby Steps?
No, get real. Surely everyone knows these right? Maybe you heard them in church? The radio? Or if you’re like me, you heard them in your high school Bible class!
The Baby Steps are 7 steps that help virtually anyone get out of a bad personal financial situation. Personally, I like the baby steps! I respect that Dave has put together a repeatable plan that works for people. These steps work! Trust me, as someone who listens to a ton of his podcasts and hears all the debt free screams, these things work!
Alright, enough pleasantries. Let’s dive into these Baby Steps and see where the rubber meets the road.
Baby Step 1
Save $1,000 for your starter emergency fund.
Alright so most people that get started on the Baby Steps probably have some form of debt. Could be student loans, credit cards, car loans, or a mortgage. Now, notice that the No-Debt-King here himself doesn’t recommend eliminating debt at all costs on Step 1. Nope, he makes a solid recommendation to get a $1,000 cash cushion to prevent going into further debt during your debt elimination steps.
I like this step. I think it makes sense. If you spend every dime paying off debt and your car breaks down or you have a healthcare emergency, how will you pay for it? Well, probably debt.
Baby Step 1 also employs Dave’s psychological spin on personal finance. What I mean is, Baby Step 1 is pretty easy. It’s achievable. It’s the 1 mile walk as your first Couch-To-5K training day. It’s a momentum step. It’s not going to make you a millionaire. But it’s a very achievable step in that direction.
It’s the gateway drug. Now, are you ready for the heavy stuff? 😳
Baby Step 2
Pay off all debt (except the house) using the debt snowball.
At this point, you have a thousand dollars cash sitting under your mattress or in a checking account like a normal person. But if there’s a bank run, I guess you mattress people will be the ones laughing!
Baby Step 2 is when you roll up your sleeves and hang on tight. If Baby Step 2 were Baby Step 1, then this plan would be a lot less successful. Baby Step 2 is definitely the most difficult step in my opinion. This step instructs us to pay down all our debt, smallest balance to largest balance. If Dave Ramsey were famous for his Baby Steps, he might be even more famous for his popularization of the Debt Snowball.
The Debt Snowball
The debt snowball is a debt reduction strategy where you take all your monthly free cash flow and pay down your consumer debt smallest balance to largest.
This is not to be confused with the debt avalanche. The debt avalanche tells us to pay down all our debt, highest interest to lowest interest. Important difference worth noting there.
If you haven’t caught it yet, there’s a theme throughout the Baby Steps. A theme that plenty of “smart” people have beef with. And that is, the baby steps are not mathematically optimal. If you do the math, you will pay more money via the debt snowball versus the debt avalanche.
So why does Dave recommend the snowball and not the avalanche?
Psychology. Human behavior. We humans are not so different than the rats who slam the lever down wondering what will fall from the affixed hatch. Food? Water? Drugs? We have a finite amount of willpower to change our habits.
Dave wants us to get the reward as soon as possible when we hit the lever. He doesn’t expect, nor would it be reasonable to, us to hit the lever day after day, week after week, potentially for years without anything ever falling down from the hatch. That’s why Baby Step 1 is so easy. That’s why the fastest win of Baby Step 2 will come from the Debt Snowball, not the Debt Avalanche.
Personal Finance is 80% Behavior, 20% knowledge.
If you read my blog often (I’m talking to you, mom!), you know I’m full of golden examples like this. They are literature worthy examples. I know, my wife praises my examples all the time. But what I’m trying to explain here is that, in my opinion, Dave Ramsey’s Baby Steps are successful because they’re based on human psychology, not solely math. The math of taking a mortgage out on your house at 3% and investing in the stock market at 12% is what gets people in trouble. Dave knows and bases his steps off the Personal Finance 80/20. Personal finance is 80% behavior, 20% knowledge.
That’s how you explain the debt snowball. It’s about behavior. It’s about the lever rewarding us as fast as possible. It’s about getting little wins during the daunting Baby Step 2. Dave knows if he can get us through Baby Step 2, it wont matter that we spent a little extra paying down debt. Especially if the success rate using the Debt Snowball is drastically higher than the success rate of using the Debt Avalanche.
Baby Step 3
Save 3-6 months of expenses in a fully funded emergency fund.
Hang on, we STILL aren’t investing in the stock market? I don’t know how much longer I can listen to Uncle Bob tell me that I’m missing the biggest bull run of the century!Someone with a lot of S&P 500 FOMO
I will start by saying that I don’t know why it was important to include “fully funded” in the step here. It must mean that during Baby Step 1, the emergency fund is a “starter” because it’s not yet a “fully funded” 3-6 months. It’s just the way that adjective is used makes it sound like a type of emergency fund. Not a status of emergency fund.
At this step, we are probably sleeping better at night, but feeling like we are still at the starting gate. We are completely out of debt – no student loans, boat loans, car loans, credit card debt. Nothing except the house. We are out of debt! But we only have $1,000 cash to our name. That’s a scary place to be. Our net worth is probably positive now! But we might not feel rich when we look at our bank and investment accounts.
Our Cash Flow Is Like a Hose
During Baby Step 2, we turned the cash flow hose on and sprayed down the dumpster fire that was our consumer debt. Now that the fire is out, Dave recommends we take that hose over to our front garden and water the seeds in the ground – our starter emergency fund.
Yes, I know. Another absolute fire example.
No, literally, a fire example…
I know, I told you. It’s out of control! I can’t even stop it!
So, now we are told to use the cash flow we created to eliminate our debt and build up our emergency fund to it’s recommended 3-6 months of expenses. Easy enough! Honestly, whoever gets through Baby Step 3 I can only imagine has a 90% chance of getting through all the Baby Steps.
Insert Stock Market FOMO Here
Notice that this whole time, we are “missing out on the market” and acting sub optimally with our finances. But like I mentioned earlier, a persistent theme of the Baby Steps are a prioritization of psychology and behavior over math. Which sounds stupid. That’s until you start to believe that personal finance is not only not 100% knowledge (or math), but as little as 20%. Personal finance is behavior. Not knowledge. This is according to Uncle Dave at least – a man who’s helped more people get out of debt than anyone alive today.
Baby Step 4
Invest 15% of your household income in retirement.
Wow, finally we are told to do something smart with our money! This whole time I thought that Dave had his head up his… Well, I just thought he didn’t believe in the stock market! He doesn’t believe in math!– Someone in a lot of debt
This is the step where we start to see that 20% knowledge come into play. In this step, we take our free cash flow generated during the earlier steps and throw it into retirement. This could be your company retirement plan (get that match at least!), an IRA, or a pension (is that still a thing?). You get the point.
This step begs the question – what do we invest in? Putting money in a retirement account is good, but does he mean literally to hold cash in that retirement account?
No, he recommends spreading your money across 4 types of index funds. I do think I would take his advice here. I don’t think S&P 500 index alone is enough diversification because that fund is quite lopsided towards the largest 10 holdings. That’s probably a discussion for another post though.
Also, worth noting that Baby Steps 4, 5, and 6 are to be done simultaneously. I don’t know about you, but I only have 2 feet so it’s going to be hard to be on 3 steps simultaneously.
That’s right, I got jokes too.
Baby Step 5
Save for your children’s college fund.
This step is only recommended if you have children now. It’s not recommended if you plan to have children in the future. It’s also recommended that you create separate 529’s for each of your children – not one big one. These are flexible funds that have a broad use qualification.
I won’t go into detail on this one. Not a whole lot to see here. Make sure you open up 529’s for each of your children and fund them with something. A little bit goes a long way. Well, maybe not with today’s tuition prices…
Baby Step 6
Pay off your home early.
If you didn’t think ole Uncle Dave was an idiot before, you sure will now. In this step, Dave does not recommend throwing an extra 5-10% of your income into retirement. This step tells us to take all additional free cash flow after Baby Step 4 and Baby Step 5 and put it on the house. Yep, put that free cash flow onto your 3% mortgage.
I will admit this is the most fascinating step for me. This is the step that my wife and I are on and we waver between doubling down on retirement/investments versus throwing it at the house.
That’s right, I might appear to be a Dave Ramsey fan boy according to my Spotify listening history, but you’d be surprised at how often I sneak out of the house at night to go hang with friends.
More Psychology, Less Math
Now, we must come back to the common theme of the Baby Steps. These are not about math! The Baby Steps are about psychology! Dave knows that once you have experienced life without debt, you’re a lot less likely to ever go back. That’s why he makes the (debatably) mathematically incorrect recommendation to lock in a 3% return on your money when you could take the chance of making 12% in the market.
We could debate this forever – and it probably will be debated forever. I have a post on this if you want to go deeper – Interest Rate Arbitrage – pay down the house or invest.
Baby Step 7
Build wealth and give.
This is the step we’ve all been waiting for! This is the last day of high school before college where we get to leave the nest and go make our own decisions!
But seriously, now that we are completely debt free. We probably feel like a million bucks. At the very least, we probably have a positive net worth!
This step is an exciting one. It’s exciting because we’ve worked so hard to increase the water pressure in our hose that first put out the dumpster fire that was our consumer debt, then watered our garden that was our emergency fund and investments, and now spring is here and our seeds are sprouting!
Now we are in the difficult position of figuring out what to do with the cash flow generated by eliminating all payments – credit card, student loan, mortgage. We created extra cash flow to get us out of debt and start investing for retirement, now we have no more payments and probably feel incredibly rich.
Is cash really king? Is debt really dumb?
I can’t imagine anyone at this step is kicking themselves for any “mathematically sub-optimal” decisions made during the Baby Steps. They have no payments, tons of free cash flow, and no stress from “what-if’s”.
- What if I lose my job.
- What if the market tanks?
- What if I need to buy a new car?
- Pay my mortgage, float my income until my next job.
At this point, we are payment free. We have a solid emergency fund. We have little to no financial stress. Now the only headache is deciding how to allocate this fat stack of free cash flow each month.
Dave is clear here – build wealth and give. This is the step where we max out all retirement accounts well past the 15% recommended in Baby Step 4. This is also the step where we might go well above and beyond any kind of giving we do whether it’s the 10% tithe to your Church or any kind of charity you might be involved in.
My Opinion of Dave Ramsey’s Baby Steps
You know, the older I get, the more I start to think that these baby steps are a bit more valuable than meets the eye. They aren’t sexy. They aren’t clever. They aren’t mathematically optimal.
In fact, they’re simple. They’re straightforward. They work.
For whatever reason, the vast majority of us are born stupid with our money. Sure, we can blame the hundreds of millions spent on debt advertising. We can blame credit cards showing up in our mailbox. We can blame predatory lending.
But at the end of the day, blaming other people never solves our problem. It just gives us an “out” and we sit still in our bad situation.
If you’re still not convinced, why not listen to a few of the episodes of The Ramsey Show. Listen to a few debt free screams.
Most peoples beef with Dave is his attitude towards debt. But I can’t help but think how nice it might feel to have no payments and a fat stack of cash left over at the end of every month. No car payment, no student loans, no house payment.
To land the plane here, in my opinion, I really like Dave Ramsey’s Baby Steps. And I think anyone who wants to change their personal financial situation would benefit from following this method. You can read more about his Baby Steps here on his website.
Call To Comment
What’s your opinion of Dave Ramsey’s Baby Steps? Have you followed them? What about debt? How do you feel about carrying consumer debt?