Dave Ramsey is a radio personality turned author and public speaker who uses his story of financial turmoil followed by tremendous wealth as a way to teach others about personal finance.
Some of his antics and advice are polarizing – like when he recommends you NEVER use a credit card for any reason ever again – but he has a cult-like following.
If you enjoy reading and learning about money and personal finance, then you already know who Dave Ramsey is.
Whether you love him or hate him, there’s no doubt that Dave Ramsey has made a lasting difference for many people over the years. Since the 1990s, The Dave Ramsey Baby Steps have helped millions of people get out of debt and start them down the path to achieving financial freedom.
But that’s not to say all financial experts agree with everything he says. In fact, some of his advice is sub-optimal. But I’ll touch on that later.
For Many, Dave Ramsey’s Methods Are Pure Gold
No matter how many blogs I read or podcasts I listen to, his name stands out. He’s built a media empire with his faith-based teachings about money.
It’s because he understands the motivation people need to get out of debt and be better with their money. Regardless of whether you are a Dave Ramsey fan or not, it’s impossible to deny that he hasn’t been wildly successful.
Heck, he even inspired me to go through his Financial Peace Program and helped my husband and I pay off over $60,000 of debt in less than 18 months.
I think the world would be a better place if we take his example by sharing our failures with others to help them avoid the same mistakes that we make.
While in his early 20’s, Dave had owned over a million dollars worth of real estate, but lost it all and went bankrupt. He then turned his failure into a multi-million dollar company that started with a radio show.
He’s also a marketing wizard. Early in his career, he wrote the book Financial Peace and offered it for free to his church members.
When he later started his radio show, he was able to use it as a platform to both sell the book and the Dave Ramsey Baby Steps and the rest is history…
His entire focus then, and now, centers around his 7 Baby Steps and is known for encouraging people to become debt-free.
Whether you agree with him or not, I think most would at least benefit from listening to what he has to say.
Both my husband and I owe him a debt of gratitude. We now have financial peace and a big reason why is because of his baby steps.
So today I’d like to give an overview of his 7 Baby Steps. Each Dave Ramsey baby step is geared to help you pay off debt, save for retirement, and achieve financial freedom.
Dave Ramsey Baby Steps Introduction
The Dave Ramsey Baby Steps are straight forward. The seven baby steps are simple to understand, but for some, they’re difficult to accomplish. It takes discipline and hard work to turn your dreams of having financial security into a reality.
The Dave Ramsey Baby Steps:
- Step 1: $1,000 in an emergency fund.
- Step 2: Pay off all debt except the house utilizing the debt snowball.
- Step 3: Three to six months of savings in a fully-funded emergency fund.
- Step 4: Invest 15% of your household income into a Roth IRA and other pre-tax retirement plans.
- Step 5: College Funding (i.e. 529 plan).
- Step 6: Pay off your home early.
- Step 7: Build wealth and give.
Dave created a course to help people he calls Financial Peace University. You can either take it online or find a church near you that offers it. If you don’t have access to any of these resources, you can always just follow these steps or buy his book.
His 7 step system is the cornerstone of his course and provides a road map to help people get out of debt and move toward financial freedom.
Here’s a step by step breakdown of each from Dave.
Baby Step 1 – Save $1,000 in a Starter Emergency Fund
Have you ever had something bad happen when you could least afford to? Maybe your A/C unit went out in the heat of the summer or you totaled your car and didn’t have the money to cover it?
There’s a saying that can explain this phenomenon called Murphy’s Law.
“Anything that can go wrong will go wrong.“
It’s for this reason that Dave recommends starting off by focusing all your attention and energy on saving up $1,000 in an account and label it for emergencies only. This initial beginner emergency fund will be there for you when you experience an unforeseen emergency.
You can use a high-yield savings account or a no-penalty CD, but the most important thing is that you can quickly access the money without paying fees!
This has been the cause of many debates as Dave thinks $1,000 can be enough to ward off most financial disasters, where others don’t. In my opinion, I think doctors and other high-income professionals make enough to save more than this, somewhere in the $3,000 – $5,000 range.
But I get where he’s coming from. He wants to get people to have a “small” win first, to encourage them to continue to the next baby step.
As you will see throughout this baby steps, he believes that these small victories will help participants make through all of Dave Ramsey’s baby steps.
The Emergency Fund Is Rightfully Step 1
Some critics of Dave Ramsey believe that before saving up an emergency fund you should contribute to your 401k in order to get the employer match.
From a pure mathematical standpoint, that can make sense since the 401k match is essentially free money. The only problem is that the free money won’t be able to be used to repair your car if it breaks down (unless you pay a penalty for withdrawing early, which defeats the purpose).
The emergency fund serves as short-term insurance to help insulate you from unexpected events that could prevent you from continuing to work or have food and shelter. These are basic human needs that you are helping to protect. An emergency fund isn’t for living expenses like your cable bill or new iPad. We are talking necessities here.
Don’t try to skip this step and move on to Step 2 because you are impatient and want to start paying off your debt and start investing. It could end up setting you back even further.
Baby Step 2 – Pay Off All Debt Except Your Mortgage
Baby Step 2 is all about psychology. Remember when I mentioned earlier that Dave is a master of getting people motivated for debt payoff?
A lot of people think his lessons are all about money. But the behavioral aspect is just as important as the nuts and bolts of managing money.
This step is one of the most important ones that show his power of motivation by using something he calls, “The Debt Snowball.”
The Debt Snowball gives people quick wins from the start, just like in Baby Step #1. It keeps people motivated because the majority of people will stay in this step for several years before they get rid of their consumer debt altogether. The quick wins help to keep folks motivated so they can continue to stay the course.
Learn To Harness The Debt Snowball
The Debt Snowball Method is where you list all of your debts (except your house) from the smallest balance to largest.
Next, you make minimum payments on all of the debts and put every extra dollar you can spare towards the smallest balance until it’s gone.
After the smallest debt is paid off, you move on to the next smallest debt on your list. With that one, you simply add what you were paying on the debt before it + the minimum payment you were already paying until it’s paid off. Continue this process with all your debts on the list until you’re consumer debt-free.
We created our list on an excel sheet which helped keep us even more motivated through the process. Once we paid off a debt, we’d erase it then move on to the next one. We also listed the amount of money we were putting towards them each month which forced me to want to attempt to add more and more.
There are chemicals in the brain that actually enhance The Snowball. As you start paying off each loan one by one and the snowball starts growing, it causes the brain to release chemicals whenever you win something such as dopamine and serotonin. These feel good chemicals cause you to want to continue the process more and more.
This is why his first step is to save a $1,000 starter emergency fund. If it were set to $2,500 a lot of people would likely give up and never even make it to step 2.
The Debt Snowball Is Controversial
Many people swear by the debt snowball method for debt repayment because of the psychological and behavior boost that you can get from small wins. But from a financial perspective, it might not be optimal. The debt avalanche is the competing method.
Let’s think of an example where someone has $10,000 of credit card debt with a 21% interest rate and a $5,000 student loan with a 4% interest rate.
The snowball method would require you to repay the 4% student loan in full before starting to make more than the minimum monthly payment on the credit card debt. During that time, there’s a good chance your credit card debt would just continue to grow.
When it’s all said and done, you will end up paying a lot more money in interest by following his method and repaying your smallest debt instead of paying off your highest interest rate debt.
In the end, he’s betting that paying extra interest is worth the motivation you’ll get to actually stick with the plan and eventually become debt free.
Whether you use the debt snowball method or the debt avalanche, this step is the most important because it sets the tone for the rest of your financial journey.
Once you’ve completed this step, congratulations! You’re debt-free (besides the mortgage)!
It’s now time to move on to Baby Step #3… but first, pat yourself on the back for reaching debt freedom because this is an accomplishment that most people will never reach.
A lot of people say that step in Dave’s plan is when they realized they could actually do it and build a brighter future for their family.
Baby Step 3 – Finish The Emergency Fund With 3 To 6 Months Of Savings
At this point, you’ve gotten rid of your consumer debt and should have a good chunk of cash to start dispersing elsewhere. The temptation can be to jump the gun and start retirement investing, funding kid’s college accounts or paying off the house early.
Now there’s nothing wrong with doing any of those things. And Dave wants us to do them… but NOT until we finish building up our emergency fund with 3 to 6 months of monthly expenses.
He claims that by doing it this way, we’re reducing the risk of having to go back into debt if we experience an emergency. Remember, these emergency savings are for events that you can’t even imagine. Like being furloughed for a month because of a global pandemic.
If you don’t take his advice then how would you handle an emergency? Pull money from your retirement account? Tap into your kid’s college savings? Take out a personal loan or HELOC? Not good choices.
Dave also recommends putting your emergency fund in a money market that is liquid, meaning easy to access. Money markets have a higher interest rate than a typical savings account at your local bank. Dave says that your emergency is insurance, not an investment.
Once you’ve completed this step, you now have protected your family with a nice buffer against major financial emergencies.
How do you know if you should have 3 or 6 months saved?
Basically, the more unstable your income is, the more you should save. If you’ve been at your job for a decade, your income is predictable every month, and you do not see a lay-off in the future, then a 3 to 4 month emergency fund will do.
Here are some examples of when you should have at least a 6 month emergency fund:
- You work on commissions
- You have a single household income
- You are self-employed
- There is a chance you may be laid-off or furloughed
- You will be better to sleep at night
If you ever have to use your emergency fund, make sure to build it right back up.
Baby Step 4 – Invest 15% Of Your Gross Income Into Your Retirement Accounts
This is the step where you really start to build your retirement fund. If you like the sound of not having to work for money until the day you die, keep reading.
Step 4 is all about starting to invest your money. Most people avoid investing because they are afraid of losing money. But if you don’t invest your money won’t grow over time and set you up for financial freedom.
One question I often get asked is how to start investing. The truth is that you have a lot of options. Your jobs 401K is a good place to start.
Next, you’ll want an IRA. You can use investment apps like Webull or M1 Finance if you want to manage your own investments. An app like Acorns also allows you to open an IRA.
You can also use traditional brokerages like Fidelity and Vanguard if you prefer. Lastly, there are no-commission apps like Robinhood, but they don’t have IRAs so you’ll only want to use them if you are looking to open a taxable investing account.
Shouldn’t I Save For My Kid’s College First?
Another one of the frequently asked questions I get is, “Why is retirement ahead of college funding for our kids?”
Great question. Let’s briefly think through this. It’s natural to want to put our kids ahead of ourselves. The thought of them having your kids drown in student loan debt probably scares you.
But what if you end up without sufficient retirement savings because you made college funding a higher priority? You’d have to depend on your kids to take care of you.
So before you begin doing anything with the excess money left over from paying off the consumer debt, Dave suggests investing 15% in your retirement account such as a 401(k), Roth IRA, 403(b) or other.
I’ve said this before and I’ll say this again, high-income professionals should be able to invest at least 20% or more of their gross household income into retirement accounts. If you can’t reach a savings rate that high, that’s not a big deal.
But if you can, then that’s just less time it will take to reach financial freedom.
This step is different the the first 3 steps because it will likely last the majority of your working career. The finish line is when you finally save enough money for retirement.
Does that mean you can’t move on to step 5 until you have your retirement fund full? No, once you are consistently able to save and invest 15% of your income, you can move to the next step.
Baby Step 5 – College Funding For Kids
By the time you reach this Dave Ramsey step, you should:
- have a fully funded emergency fund with 3-6 months of expenses
- be debt-free (except a mortgage)
- be investing at least 15% or more of your gross income
Now that you have your finances and money in order, it’s time to put some money back for the kids’ college educations.
There are two ways Dave recommends saving for your kids college – An Educational Savings Account (ESA) and a 529 plan.
These are both tax-advantaged accounts specifically used for educational expenses.
Here are some tips for both an ESA and 529 plan:
- ESA – Educational Savings Account
- $2,000 maximum annual contribution limit per child as of 2020
- Account may be transferred to another member of the beneficiary’s family
- You can choose any investment
- 529 Plan
- No contribution limit, but to avoid Gift Tax, you cannot exceed $15,000 per contributor for 2020
- Account may be transferred to another member of the beneficiary’s family
- Have to pick within a preset list of investments
Saving a children’s college fund is a personal decision. The fact of the matter is that the cost of college is growing much faster than wages are. That means that future generations are going to struggle to pay off their degrees. A $40,000 student loan today might be $100,000 in the future.
We prioritize college saving because we don’t want it to be the reason that our kids aren’t able to buy a home or achieve retirement.
Deciding how much to save here will depend on how much income you have leftover each month. Remember that step 4 never ends. You should continue to save and invest until you reach your financial independence number. For most people that lasts until the day they retire.
Baby Step 6 – Pay Off Your Home Early
At this stage of the game, Ramsey’s Baby Steps say that you should take any extra money coming in after you’ve progressed through the other Baby Steps in order, and throw it towards the mortgage.
Whether you should actually pay off your house early is a question that’s been around as long as the concept of personal finance. You’ll hear arguments stating that you should pay off your house early and those that tell you investing that extra money is the way to go.
The “don’t pay off your mortgage folks” are looking at this strictly from a numbers standpoint.
Our personal goal is to pay off our mortgage from a psychological point of view. It will simply make us happy and put our mind at ease knowing that we will never have another mortgage payment.
I imagine that there will also be this gratifying feeling knowing that the house is now ours and not owned by the bank. What an exciting feeling that will be!
Baby Step 7 – Build Wealth And Give Generously
If you’ve made it to Baby Step #7, congratulations!
You don’t owe anybody anything and now it’s time to really build wealth and help others. For those of us that make it to this Step, this is what Dave calls your time to, “Live and give like no one else.”
It’s also the ending in his book, The Total Money Makeover.
It’s what he wants all of his readers to obtain, financial independence, to do whatever we want to do both for ourselves and others.
2 Corinthians 9:11 – “You will be enriched in every way so that you can be generous on every occasion, and through us your generosity will result in thanksgiving to God.”
With no consumer debt, 3-6 months of expenses saved, 15%+ of your income going into retirement accounts, college accounts being funded, and the mortgage paid off, you should have extra money to use to begin building massive amounts of wealth.
To be quite honest, I haven’t given the “building wealth” instruction he gives much thought. But the more I think about it, the more I realize that the sky’s the limit whenever you reach this point in your life.
He mentions investing in both mutual funds and real estate.
I am more of a fan of investing in Index Funds, particularly with Vanguard, but that is a personal choice.
Also, don’t forget about setting up and funding a Health Savings Account (HSA) and using it’s triple tax advantage.
I recommend that you pay your medical expenses out of pocket and let the HSA continue to grow to use it as another retirement account. Just save your medical receipts so you can prove you incurred medical expenses when you finally withdraw that money in retirement.
Real estate crowd funding is also another option. Something else to consider is creating multiple sources of passive income via side hustles.
The Goal Is To Have Enough To Help Others
When you’ve arrived at Baby Step #7, Dave suggests giving generously and we can do so by refreshing others.
Do you know someone that is always tired, living paycheck to paycheck? Know any single moms that could use some help? How about an elderly person that could use some help with yard work or groceries? Can you cook them a meal or mow their yard?
There are so many people that go around overwhelmed and need help daily, and we can be there to give a helping hand.
Many successful athletes tell stories about how others helped them along the way when they were down in life and then they go on to help undeserved youth to inspire them to win in life.
Once you complete the Baby Steps, consider living a life of generosity.
Generosity is one of the few things in life that no one regrets. After all, if you want money to bring you happiness, nothing beats helping others.
Other Things You Might Want To Know About Dave Ramsey
First, I think his steps are very effective if followed. I do think he’s too strict with his policy toward credit cards. At the end of the day, credit cards can provide protection from fraud and also can help you establish solid credit.
Having a strong credit score can allow you to save money on a mortgage, which can mean thousands of dollars on interest saved.
If used correctly, credit cards can also save you thousands of dollars on travel. My husband and I am just now starting to travel hack by strategically opening up certain credit cards, which will help us fly internally for free!
You will notice about the baby steps is that Dave doesn’t mention life insurance. If you have a family, there’s a good chance you’ll want to learn about life insurance and consider protecting your family in case something where to happen to you.
Make sure to avoid whole life and get term life insurance. My husband and I each have a $1,000,000 20 year term life insurance policy and it costs us $72 total per month. We got ours through Zander.
You Might Not Agree With The Way He Allegedly Runs His Company, Ramsey Solutions.
Dave is known for his brash personality and no-nonsense spirit on his show.
However, there are claims that his company has a few unspoken rules including that male and female colleagues can’t ride in cars or elevators alone together.
These claims aren’t verified, but they are definitely alarming.
Dave Ramsey FAQ’s
Who is Dave Ramsey?
Dave Ramsey is a radio personality turned author and public speaker who uses his story of financial turmoil followed by tremendous wealth as a way to teach others about personal finance. He is the creator of the Dave Ramsey Baby Steps, a financial system to help people get out of debt and live within their means.
What Are The 7 Dave Ramsey Baby Steps?
– Step 1: $1,000 in an emergency fund.
– Step 2: Pay off all debt except the house utilizing the debt snowball.
– Step 3: Three to six months of savings in a fully-funded emergency fund.
– Step 4: Invest 15% of your household income into Roth IRAs and pre-tax retirement plans.
– Step 5: College Funding (i.e. 529 plan).
– Step 6: Pay off your home early.
– Step 7: Build wealth and give.
Does the Dave Ramsey Plan Work?
It depends. Many people have found it extremely helpful. Like all self-help programs, the Baby Steps are only as effective as the amount of work that you put into them.
At its core, the program is all about debt reduction. His system is easy enough that you shouldn’t need to pay a penny in order to follow along. If you need the discipline that comes from doing it with a group, that’s fine, but you won’t get any information that you can’t get for free anywhere else.