Revising Dave Ramsey’s Baby Steps

These revised baby steps will stand the test of time

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 But it’s also, unfortunately, out of date and sometimes not applicable.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While they aren’t bad, they’re a bit out of date and generalize too much.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The $1000 Dave Ramsey recommends is horribly out of date.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.

Once you’ve got your basic or hybrid emergency fund done, it’s time to crank up the saving for retirement. Ramsey recommends 15%, but that’s too low if you hope to retire at a reasonable age.

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.

Employ some tips and tricks to work your way up. This baby step doesn’t need to happen all at once (though it can) – just bank raises, bonuses, and promotions as best you can.

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!

Conclusion

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.

Question:

So, what do you think of the new revised baby steps?

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18 Comments

  1. Good points, Dave. I like changing out $1,000 for one month’s expenses and upping the savings rate.

    I think your method is “Dave Ramsey for FIRE Enthusiasts”while Dave’s figured out the general psychological triggers affecting the masses, and devised his steps accordingly. I.E. saving $1,000 makes you feel good and propels you to the next step. The snowball method works because it gives you a fast win, and so on.

    But all of his steps lead to wealth or comfort at a traditional retirement age which is out of step with those of us who want options earlier.

    1. I still think that even if you want to retire at a typical age, 15% is scary low. I suppose if you rely on social security then it’ll probably work out fine, but I always liked to consider that icing on the cake and not rely on it.

      I hadn’t really thought of these revised steps as baby steps for FIRE Enthusiasts but I like it! I might have to steal that wording when I promote this in the future hahaha.

  2. My parents didn’t pay for my college education because they weren’t able to. Although I am contributing to a 529 plan, I do expect my kids to pay for some of it on their own too through scholarships, grants, and loans like I did.

    1. I think that’s a perfect plan. Nothing wrong with not paying for your kids to go to school! πŸ™‚ They’ll be grown ups and can figure out what they want to do, with your help.

  3. I find a lot of Dave Ramsey’s advice to be outdated. He still suggests keeping your emergency fund in a money market account versus a high-interest savings account, and he is in favor of high-expense ratio mutual funds over low-cost index funds. He absolutely refuses to update his information. I guess it’s part of his stubborn and arrogant public image.

    I do like having baby step 1 to have an arbitrary amount as an emergency fund rather than a set amount of month expenses. This is mostly because most people don’t know how much their expenses are and need someone to just give them a number. Perhaps a compromise is to have baby step 1 be $1,000 emergency fund, then baby step 2 be 3 months. Of course, the amount of $ or months might change.

    1. Yeah I definitely don’t agree with his investment advice! That’s where I drew the line, for sure.

      I think having an arbitrary number could be helpful for people who don’t know what their expenses are, like you suggest. I’d argue that Baby Step 0 is doing your budget and all that, so you SHOULD know that going into it. If it’s going to be an arbitrary number, though, I think $1000 is still too low.

      Thanks for your feedback!

  4. Ayuuup. I know Dave Ramsey helps a lot of people, but his advice doesn’t ring true for everyone. It’s nice to have a plan laid out for you if you don’t feel like you know what you’re doing, so I understand how it’s become so popular.

    We did the Debt Snowball, but it’s important to look at interest rates before doing it. I think this process also depends on where you are in life; we’ll soon be in the position to pay off our house early, and do that before funding kids’ educations. It just depends on where you are and your goals.

    1. Yeah, the debt snowball ignoring interest rates isn’t ideal for sure, but those psychological wins I think give people a little bit of a high when they see the number of debts going down. I get that.

      And for sure your life stage needs to be considered. his typical advice is ‘skip saving for kids if it’s not applicable’ but I think that still leaves a gap. There’s other things that could be addressed also!

  5. As much as I’d like to say that personal finance is simple, it’s not. I have a version of my own “baby steps” in a draft and have decided not to publish for now because I kept arguing with myself.

    I hate DR’s baby steps because they are often sub-optimal. Yours are much better.

    Still, they are not perfect. For example, the method used to pay off debt should probably default to avalanche except when cash flow is tight and would be improved by paying off a lower amount first.

    To get a chart really correct it would look like a fairly lengthy decision tree. Variables would include your current and expected future tax brackets, interest rates on all debt, risk tolerance and numerous other factors. The problem with that is that you would lose the simplicity which is the beauty of DR’s steps in the first place.

    Anyway – I enjoyed reading your perspective.

    1. Thanks for the feedback Jason, I really appreciate it. I totally agree that Avalanche SHOULD be the default unless you’re super worried about cash flow, but I also didn’t want to ignore personal preference and the psychological wins. Honestly the difference is probably somewhat negligible in the grand scheme of things. I haven’t run the numbers to compare and a lot of it obviously depends on the interest rates and balances at those rates, but I’d rather see people do something versus nothing. For that reason, I figured letting them choose is good enough.

  6. Very nice, Dave. Count me in. This takes Dave’s 7 Baby Steps to 11. I especially like revised step 2. In a low-interest rate environment, it isn’t critical to fret over some debt. A cutoff line of 4-5% is an excellent guideline. Cheers.

  7. I have been considering writing a post similar to this myself. The baby steps are okay, but NOT for a person who knows the real basics of finance.

    You do a good job of updating them, and making more realistic recommendations.

    I may still need to write my own version of the plan since I have some ideas of my own πŸ™‚

    1. For sure, even a bit of research and you can start to easily poke holes in the Baby Steps! It’s pretty hard to make steps that can broadly apply to everyone, though

  8. I really like this post! You should call the show and tell Dave that you have improved on his Baby Steps. We all know how much he likes for people to question his advice. haha

    1. Haha, thanks! I feel like calling up DR would not be received well. I’d LOVE to have a great discussion on all of this with him though, I think it’d be super interesting…

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