Dave Ramsey’s Baby Steps is a financial plan designed to help you get your finances in order, get out of debt, and achieve financial freedom. Dave Ramsey has taught these Baby Steps to millions via radio, The Total Money Makeover, Financial Peace University, and on DaveRamsey.com. But how practical are these steps? I offer a review of each step in the process so that you can decide whether or not Baby Steps will work for you.
Dave Ramsey’s Baby Steps
Dave Ramsey’s financial plan includes 7 steps:
- $1,000 to start an Emergency Fund
- Pay off all debt using the Debt Snowball
- Three to six months of expenses in savings
- Invest 15 percent of household income into retirement savings
- College funding for children
- Pay off home early
- Build wealth and give!
The first thing I’d like you to note that Dave’s plan is NOT the only financial plan. However, it is an excellent plan, it works, and it has helped a lot of people. It’s a good place to start if you’re looking to get out of debt and get your finances in order. Realize that Dave’s plan focuses more on psychology than mathematics, and this is one reason why it works well for so many people.
Baby Step 1: $1,000 to start an Emergency Fund
The first step of Dave Ramsey’s Baby Steps is to start an emergency fund. This even takes precedence over paying down debt. The key reason to start an emergency fund is to prevent you from slipping back into the mindset of borrowing to deal with financial problems.
How to Build Your Emergency Fund
This is where making changes to your spending habits will come in handy. Review your expenses and find ways to save money. And if saving money alone is not good enough, you should figure out how to earn more money.
Where to Keep Your Emergency Fund
Despite the current low-rate environment, the best place to keep an emergency fund is in a good savings account — it is safe, accessible, and your money still earn some interest.
What I Would Do Differently
Although I believe having an emergency fund is important, I prefer paying down debt to starting an emergency fund. I am not alone on this; Suze Orman supports this method in her book: Suze Orman – For the Young, Fabulous & Broke. In any case, either method should work fine for you.
Articles about Baby Step 1
- Baby Step 1 at Dave Ramsey
- Dave Ramsey Baby Steps Step 1: $1000 Emergency Fund at Gather Little By Little
- Dissecting Dave Ramsey’s Baby Steps: Baby Step 1 at No Credit Needed
- Start an Emergency Fund or Pay Off Debt?
- How Big Should an Emergency Fund Be?
- Where Should You Keep Your Emergency Fund?
Baby Step 2: Pay Off All Debt Using the Debt Snowball
The second step is to pay off your debts using the Debt Snowball method. The only exception is mortgage debt, which shouldn’t be included in your Debt Snowball. The Debt Snowball method is a technique that helps you focus on paying off your smallest debt first, so that you have a greater ability to pay off the next smallest debt.
What I Would Do Differently
I acknowledge that Dave’s method is psychologically powerful, especially when you’re able to eliminate your first debt quickly. However, my preference is for the more mathematically efficient method of paying off your highest interest debt first. It uses the same framework, but you pay your highest interest debt first.
There is no “right” or “wrong” way to pay down your debt; do what works for you and is most likely to result in your success.
Articles about Baby Step 2
- Baby Step 2 at Dave Ramsey
- Dave Ramsey’s 7 Baby Steps: Step 2 – Pay Off All Debt Using The Debt Snowball at Smart On Money
- Dave Ramsey’s Debt Snowball Debt Payment Method
- How to Get Out of Debt Fast
- Reduce Your Debt: Debt Snowball vs. Highest Interest Method
Baby Step 3: Three to Six Months of Expenses in Savings
Now that your debts are paid off, Dave Ramsey puts you on the fast track to building your financial security. This is where you add everything you can to your emergency fund so that you’ll have a bigger cushion against emergencies.
I agree with Dave here — with two reservations.
- First, I think a bigger emergency fund is necessary because it could take a long time to find a new job.
- Second, my preference is to keep money in a high interest savings account as opposed to a money market account, since many money market accounts come with inconvenient minimum balance requirements that can result in fees if not met.
Articles about Baby Step 3
- Baby Step 3 at Dave Ramsey
- Step 3: Fully Funded Emergency Fund at Being Frugal
- How and Why to Start an Emergency Fund at Get Rich Slowly
- Emergency Fund: Your Safety Net Against Financial Emergencies
Baby Step 4: Invest 15% of Household Income into Retirement Savings
At this point in the Baby Steps financial plan, you have no debt except for the house (if you own one) and a large enough emergency fund to cover 3 to 6 months of your living expenses.
Step 4 is the first step in your journey toward active wealth building. As you read steps 5 and 6, you’ll notice that Dave Ramsey advocates a balanced approach to wealth building. He suggests that you divide your money among investing, paying off your home early, and saving for college.
What I Would Do Differently
I offer several key counterpoints for Baby Step 4:
- 15% Depends on Your Age — I think 15% is a good guideline. However, you’ll need to save considerably more if you have less than 35 years to invest for your retirement. Conversely, you need to invest less if you start young. Why does age matter? Because you need time for compound growth to work.
- Traditional 401(k) versus Roth IRA — If you don’t have the option of investing in a Roth IRA, don’t overlook the traditional 401(k). At minimum, invest enough in your 401(k) to fully capture your company’s matching contribution. Once you do this, the Roth IRA is the next best thing.
Articles about Baby Step 4
- Baby Step 4 at Dave Ramsey
- Dave Ramsey’s Step #4: A Visual Guide to Saving 15% for Retirement in a Roth 401(k) at The Dough Roller
- How to Start Investing in Stocks for Beginners
Baby Step 5: College Funding for Children
If you have children that will be going to college (or if you want to go back to college yourself), Dave’s plan encourages you to put some of your income toward college savings. Dave doesn’t want you to save for college using insurance, savings bonds, zero-coupon bonds, or pre-paid college tuition. Instead, he recommends Education Savings Account (ESAs) and 529 plans.
How Much to Save
As always, the answer to this personal finance question depends on many factors in your individual situation. Like Dave, I want to emphasize that saving for your retirement takes precedence over saving for your children’s college expenses. As a guideline, I think it’s
- fair if you can help your children fund 2 years of public college;
- good if you can fund 4 years at a public university, and
- 4 years of a private college education is more than necessary.
Here’s a good article that discusses whether or not you should pay for your children’s college education or make them work for it.
To figure out the right amount for your situation, you can start with this statistics from Value Penguin:
Average Total Cost of Public Colleges: $25,290 (in-state) $40,940 (out-of-state) Average Total Cost of Private Colleges: $50,900
Remember that college costs has risen about 3.64 times faster than inflation, or roughly 11% (source: Education Week)…so you have to calculate in the inflation to figure out the amount you’re aiming for.
For example, if you plan to pay for 2 years of in-state public college and your son will be in school in 10 years. Your goal is to save $25,290 x 2 and adjusted for 10 years of projected cost increase.
College Saving Goal = $50,580, or $115,224 (after 10 years increase at 11%)
That’s a lot of money…wow!
Articles about Baby Step 5
- Baby Step 5 at Dave Ramsey
- Dave Ramsey Baby Step 5 – College Funding For Children at My Two Dollars
- How much to save for a baby’s college education? at Sense to Save
Baby Step 6: Pay Off Home Early
If you are able to do everything described so far, Dave wants you to think about paying off your home mortgage sooner (as opposed to increasing your investment contribution or adding more to college savings for your children).
Key points that Dave makes regarding this step includes:
- When selling a home, think like a retailer.
- When buying a home, think like an investor.
- Never get more than a 15-year fixed mortgage.
- Don’t tie up more than 25% of your income in house payments.
What I Would Do Differently
I think this step works well for many people. It’s certainly a good and balanced approach if you’re also investing and saving for college at the same time. I would not advocate paying off your home early if you have to sacrifice the other two.
However, I want to encourage you to look at all the pluses and minuses of paying off your home early before you dive into this step — especially if you are an experienced investor. Also, I believe that prepaying your home mortgage is NOT the best option either.
Articles about Baby Step 6
- Baby Step 6 at Dave Ramsey
- You should NOT pay off your mortgage early at How to Make 7 Million in 7 Years™
- How to Pay Off Your Mortgage Early at The Greenest Dollar
- Should You Pay Off Your Mortgage Early or Invest?
Baby Step 7: Build Wealth and Give!
At this point, you’re in better financial shape than you’ve ever experienced before. And it’s up to you to continue to build on the momentum and grow your wealth. Also, you are now in a position to give — whether it’s your money or your knowledge. Giving is a good thing.
Articles about Baby Step 7
Additional Dave Ramsey’s Baby Steps Resources
- Dave Ramsey’s 7 Baby Steps – Financial Peace University Overview
- Evaluating Dave Ramsey’s Total Money Makeover — Which Baby Step is Right for You? at Mrs. Micah
- Dave Ramsey’s Baby Steps To Financial Success at The Digerati Life
- Dave Ramsey’s Baby Steps Review at The Happy Rock
- A Deeper Look At Dave Ramsey’s Seven Baby Steps To Financial Freedom – And How They Apply To Us at The Simple Dollar
So there you have it: Dave Ramsey’s Baby Steps in a nutshell. With this plan as a template, you’re ready to beat credit card debt, build your emergency fund, invest for your retirement, save for your children’s college education, and build wealth.
Pinyo is the owner of Moolanomy Personal Finance and a Realtor® licensed in Virginia and Maryland. Over the past 20 years, Pinyo has enjoyed a diverse career as an investor, entrepreneur, business executive, educator, financial literacy author, and Realtor®.