When I first started getting into personal finance, like many people, I found Dave Ramsey. My dad had some of his books, and so naturally I ended up reading them. His work really clicked with me.
He provided straight-forward concepts that were super easy to follow. It was a small start to get my finances under control.
Many people find success following Dave Ramsey because it’s easy. But it’s also, unfortunately, out of date and sometimes not applicable.
Dave Ramsey’s Baby Steps
Dave lays out seven primary baby steps, and I think all of them need some revision.
- Baby Step 1: Save $1,000 cash in a beginner emergency fund.
- Baby Step 2: Use the debt snowball to pay off all your debt except for the house.
- Baby Step 3: Save a fully-funded emergency fund of 3 to 6 months of expenses.
- Baby Step 4: Invest 15% of your household income into retirement.
- Baby Step 5: Start saving for kids’ college.
- Baby Step 6: Pay off your home early.
- Baby Step 7: Build wealth and give generously!
While they aren’t bad, they’re a bit out of date and generalize too much. They’re also a bit risky if you ask me. Let’s take a look.
Revised Baby Step 1: The Light Emergency Fund
The $1000 Dave Ramsey recommends is horribly out of date. In addition to being about a third higher due to inflation since the time he initially published the baby steps, the fact is that $1000 will barely cover most emergencies. I also dislike the fact that it’s an arbitrary amount.
For a lot of people, saving $1000 can be tough. It’s even more difficult when you’re paying money to credit card companies. But this is the most critical step – any mistakes or set-backs along the journey will completely undo progress unless this is in place.
So if $1000 isn’t adequate, what is?
Revised Baby Step 1 establishes an emergency fund worth one month of regular expenses. This is a relatively light emergency fund, but it’s better than $1000. For starters, it’s probably a bit larger.
It’s also relative to your expenses, which is largely overlooked by the initial baby steps. If you wind up jobless, it can sometimes take 4-6 weeks to find a new job and get paid, if not more.
While this is still pushing it, a one month emergency fund should get you by for most emergencies during this phase of your journey.
Revised Baby Step 2: Use a debt knockout method of your choice to pay off high interest debt.
Dave Ramsey abhors debt. A lot.
And that’s fine – debt can feel crippling.
But some debt can be worth the interest you pay on it, provided that rate is low enough. In this step, Ramsey recommends that you knock out ALL debt except for your mortgage.
I prefer to take a different approach. On average the stock market will return about 7% or so over time. (On shorter time periods, of course, volatility can eat into those returns.)
If you’ve got a car loan at 1.99%, it doesn’t make a lot of sense to prioritize paying it off in this stage. It particularly doesn’t make sense to pay it off before a high-interest credit card with a larger balance.
If you follow Ramsey’s baby steps, however, that’s precisely what you’ll do. The debt snowball is mathematically inferior to the debt avalanche. In the debt avalanche, instead of ordering your debts by size, you order your debts by interest rate.
The highest rate gets paid off first.
Honestly both strategies are sound, so long as you pick one and follow it. Don’t get stuck in analysis paralysis mode, and do whichever one will help you stick with the plan the longest (until it’s done!)
I also prefer to have a cutoff interest rate. That 1.99% car loan doesn’t make sense to be paid off before you’ve got a larger emergency fund built up. The line for ‘too low of a rate’ to bother is probably around the 4-5% mark.
Anything above that gets the avalanche or snowball treatment. Everything below waits.
Revised Baby Step 3: Save a fully-funded emergency fund to align with your risk profile.
Once your high interest rate debts are paid down, you should have some breathing room to start saving more money.
Three to six months is a great start for an emergency fund. It’s enough to cover you in the event of a job loss for most cases.
However, the three to six month advice doesn’t take your personal circumstances into account. If you’ve got some major medical issues that will mean you’re blowing through it more frequently, or if you have wildly unpredictable income, you may prefer to bulk this up more.
Likewise if you have multiple sources of income coming in that aren’t related, it’s likely that you don’t need the full six months. Something like 2-3 could probably let you sleep good at night.
Ultimately you need to establish an emergency fund that is adequate for your risk profile.
Revised Baby Step 4: Invest 25% of your household income into retirement.
For most people, saving 15% can feel like a stretch. Saving 25% seems downright daunting.
However, at a 25% savings rate you’re still probably going to be working for 25-30 years. By the time most people tackle these revised baby steps, their time horizon is probably shorter. The shorter the time horizon, the more you need to bump up your savings.
Revised Baby Step 5: Start saving for secondary goals or paying down low-interest, non-mortgage debt.
As DINKs, we can skip Ramsey’s Baby Step 5 – which is saving for your kid’s college. I don’t like skipping stuff like this, because I’m a money nerd, damnit.
And honestly it’s BS that parents are expected to pay for college for their kids anyway.
A quick revision to this baby step generalizes it to apply to everyone.
Start saving for secondary goals, whatever those may be. Maybe it’s another car, a vacation, or a rental property. Perhaps you aren’t entirely sure what it is you’re saving for, but you know you should save for something.
No matter what the circumstances, saving money can open up opportunities down the line. It may enable you to quit your job and start a consulting company you’ve wanted to, or live that digital nomad life.
Now would also be a good time to tackle that debt that didn’t make the first cut. Low interest debt can be annoying, and freeing up mental bandwidth has its benefits. If it bugs you, tackle it. If not, just save instead.
Just a quick note – obviously we don’t have kids, but if I were a parent, I’d pay for 4 years of in-state public university for my kid. If they wanted anything above that, there are scholarships, jobs, and student loans.
I’d encourage all parents to take a somewhat similar approach. You can’t take out a retirement loan, so make sure you’ve got your own finances in order first. Besides, if you’re inadequately prepared for retirement it’ll be your kids who have to take care of you anyway. They’ve got time on their side. You don’t.
Baby Step 6: Invest in a taxable account to optionally pay off your home early.
Paying off your home early isn’t necessarily mathematically prudent. Especially with interest rates still low (but on the rise), mortgage debt is pretty cheap.
If you want to maximize your returns, it’s likely that the best approach is to not pay off your home early.
However, that ignores huge psychological wins, cash flow advantages, and a ‘guaranteed’ return.
One way you can take advantage of the low cost of debt while also keeping early mortgage payoff as an option is to use a taxable account. Instead of paying extra mortgage principal, you’d invest that money each month into something like a total stock market index fund, or some combination of funds.
As the taxable account grows, it’ll give you a ton of options. One of those options may be to pay off your home early, once the balance exceeds your mortgage balance.
But…it might not be what you decide once you have that money. The nice thing about investing in a taxable account – aside from potentially out-earning your mortgage rate – is that you’ve got the flexibility to do whatever you want.
Revised Baby Step 7: Enjoy FI and give generously!
Once you’ve got the other six baby steps in process or completed, it’s simply a matter of time before you’re financially independent. Keep socking money away, investing in things that align with your goals and risk profile. Give what you can, both in money and in time.
If you retire early, it can be the perfect opportunity to volunteer more of your time and help others. This stage hopefully lasts pretty much forever, so enjoy it!
A big missing part for me with Ramsey’s steps was that it’s mathematically inferior, and inadequate. Motivational, sure. And there’s no denying that if you follow it, you’ll get out of debt eventually.
But there are ways to speed it up, be a bit more conservative in some ways and more aggressive in others.
Ultimately your financial journey shouldn’t be dictated solely by a series of seven steps by some dude on the internet. Take what you like, leave the rest, and keep on improving and enjoying your life. That’s what it’s all about.
So, what do you think of the new revised baby steps?