Money Management

Dave Ramsey Baby Step Review: A CFP®’s, Pros, Cons and Verdict

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When it comes to financial planning, one of the most well-known frameworks is Dave Ramsey’s Baby Steps. 

What makes the Baby Steps framework so popular is its simplicity. You simply work through the steps in order, making sure to check off one step before continuing on to the next. 

But the big question is this: are they right for you, or is there a better path to pursue?

This article will:

  • Review each of the seven Baby Steps.
  • Offer my own take on each, as well as other factors to consider.
  • Provide smart tips to get through the Baby Steps faster.

Overview: The 7 Baby Steps

Dave Ramsey’s seven Baby Steps are:

  • Baby Step 1: Save $1,000 for your starter emergency fund.
  • Baby Step 2: Pay off all debt (except your mortgage, if you have one) using the debt snowball method.
  • Baby Step 3: Save three to six months of expenses in a fully-funded emergency fund.
  • Baby Step 4: Invest 15% of your household income for retirement.
  • Baby Step 5: Save for your children’s college fund.
  • Baby Step 6: Pay off your mortgage early.
  • Baby Step 7: Build wealth and give.

Baby Step #1: Save $1,000 To Start An Emergency Fund

Summary: Ramsey suggests building a $1,000 emergency fund before investing or starting to pay off high-interest debt. 

Does it make sense? Yes and yes! Having a small amount of cash savings is vital. In fact, the Federal Reserve did some research on families with low incomes who had a $500 emergency fund in place. What they found was that when a financial hardship occurred, these lower-income families fared better than middle-income families who did not have $500 set aside.

In other words, when it comes to preventing financial catastrophes, how much you save matters more than how much you make.

Tips For Success:

  • The goal is to accomplish this step as quickly as possible
  • The best way to do so is to focus on saving more first.
  • Give yourself a deadline. Design a plan that can help you build $1,000 as fast as possible — ideally, in 30 days or less. This may involve some creative strategies, and you may miss the mark. That’s OK, as you’ll at least be better off than you were a month ago.

Baby Step #2: Pay Off All Debt (Except Your Mortgage) Using The Debt Snowball Method

Summary: When paying off debt using the debt snowball method, you start with the lowest balance first. For example, if you have two credit cards, you focus on paying off the one you owe less on first —even if the interest rate on that card is the lowest of the two.

The idea behind this strategy is that paying off the lowest balance first is a more achievable goal, and that doing so will help you build momentum.  

Does it make sense? As a CFP® with a love of numbers, it may surprise you to learn that I’m a big fan of the debt snowball strategy. In fact, studies have proven that more people succeed in paying off their debt with the debt snowball

Editor’s Note: The alternative to a debt snowball is a debt avalanche, where you pay off your debts in order from highest interest rate to lowest.

While I love the debt snowball method as a strategy for paying off debt, where I disagree with Ramsey is that he recommends using it to pay off all debts beside your house.

First things first: if you have high-interest credit card debt — which we’ll define as being around 18% APR — you want to focus on getting rid of that debt ASAP. You can’t get ahead when you’re paying that much interest.

But what about things like student loan debt, which often has an annual rate of around 6%?

For lower-interest personal debts like those, a good number to keep in mind is 7%. That’s the average percentage that the stock market returns (after inflation) each year. So, if you want to go by the numbers, it makes sense to pay off any debts above 7%, while prioritizing investing over paying down those with rates of less than 7%.

Think about it like this: if you can make 7% by investing, you’re losing money by paying off debt that costs less than 7%.

Important notes: The exact equation is more complicated than this. For example, you may lose a deduction for paying off your student loans early, or get a deduction for starting to invest. 

Plus, it’s worth mentioning that paying off debt is a guaranteed rate of return, while investing does not offer such guarantee. So look at 7% as a rough guideline, not an absolute law. Often, it comes down to what you’re more motivated to do.

Another situation worth mentioning here is when your employer matches your 401(K) contributions. In that case, you’re getting as high as a 50% return on your money. And I would absolutely invest up to the maximum at that rate of return prior to paying off my lower-interest debts. Choosing not to is the same as walking away from free money.

Tips For Success:

  • Behavior can trump math. A study published in the Journal of Consumer Research — which is summarized in plain language in this Harvard Business Review article — found that it’s best to pay off the smallest debt firsts, even though this doesn’t save the most money in the long run.
  • Sell your way to success. When you’re in high-interest debt, consider anything you own that has value as also accumulating debt. For example, that old cell phone that can go for $100 in your desk drawer? You’re paying interest for not selling that item.
  • Don’t let bad decisions in the past continue to set you back. If you’ve overspent on a car or purchased whole life insurance, undo that damage. Sell the car and cancel that policy. If you made a mistake, get yourself out of it without beating yourself up.

Baby Step #3: Save Three To Six Months Of Expenses

Summary: In Baby Step #1, you built a basic emergency fund, setting aside enough money to prevent a sudden economic setback — like an unexpected car repair — from spiraling out of control. But you also need to think about whether your finances can withstand a more prolonged setback, such as losing your job because of a global pandemic. 

Does it make sense? I have a couple of thoughts about this particular Baby Step.

  • Six months is a lot of money for beginners to set aside, and it may be more than you actually need. Analyze your situation and your risk, and make sure you’re taking everything into consideration.
  • For most people, the biggest risk is losing a job. So it’s important to analyze just how big a risk that represents in your particular situation. Are you in a field where you can easily replace your job if your company announces layoffs, or would you have trouble replacing your current level of income? If you have low risk, you may be able to get by with just three months of expenses tucked away. 
  • Building an emergency fund and investing don’t have to be exclusive to one another. It’s possible to do both. So, again — if you have a 401(K) match, I would contribute up to that match and build your emergency fund at the same time. 

Editor’s Note: It’s best to put your emergency fund in a high-interest savings account. That way, it’s earning interest but is still easily accessible. My favorite high-interest account provider is CIT Bank, which consistently offers some of the best rates you can find.

Tips For Success:

  • Make it a challenge. Try to do it fast, because that speed will help you avoid you giving up. Set a goal and make it aggressive.
  • Take up a side hustle that has big potential. You can make a lot of progress in a few months with these side hustles. This is one of the single best ways to make headway on this baby step.
  • Look for a higher paying job. If a side hustle won’t work, don’t be hesitant to switch companies. You can often command 10- 20% more in salary just by changing employers, and that will mean a lot more money going towards your financial goals.

Baby Step #4: Invest 15% Of Your Household Income Into Roth IRAs And Pre-Tax Retirement Funds

Summary: With this Baby Step, you start saving 15% of your income for the specific purpose of retirement.

Does it make sense? I think 15% is a good target to reach. If you invest 15% for 30 or more years and keep your living expenses manageable, you’ll have enough to retire.

But if you want to retire early, or if you’re starting later in life, you’ll need to invest more than that.

In that case, what’s more important is to work backwards by first figuring out how much money you’ll need to retire and then identifying how much you need to invest/save to hit that mark 

Tips For Success:

  • Start with your 401(K) employer match. That’s free money, and you should always take any free money that’s available to you.
  • Keep an eye on fees. Not all retirement accounts have equal fees, and high fees can cut into your long-term returns.
  • Know the alternative options. If your employer doesn’t offer a match and has high fees, consider a traditional or Roth IRA.
  • Start where you are. If you can only save a few percent each month, do it. Strive to start with at least enough to get your full company match, so that you aren’t leaving money on the table. Then reevaluate your savings percentage every three months and challenge yourself to add another percent each period. It might take you two, three or even four years to build your way up to 15%, and that’s ok.

Baby Step #5: Save For Your Children’s College Fund

Summary: Having enough money for their kid’s college weighs heavily on most parents’ minds. With three kids of my own, it’s something I think about often. 

Does it make sense? A common mistake here is skipping over Baby Step #4 to start saving for college funding. That’s a mistake you do not want to make.

You must remember to put yourself first. That may seem like the opposite of what a good parent is supposed to do, but it isn’t. A cash-strapped elderly parent can be a huge burden for an adult child to bear.

Keep that in mind when figuring out how much to save for college; you can borrow money for college education at relatively low interest rates, but not for retirement.

Tip For Success:

Check in with your state’s 529 college savings plan. These plans offer a tax advantage when saving for your child’s education.

Baby Step #6: Pay Off Your Mortgage Early

Summary: For most people, their house payment is their biggest financial commitment. It can be incredibly freeing to pay that off.

Does it make sense? There’s nothing wrong with paying your mortgage off early. It’s certainly the right move for many people. But you have to keep in mind the opportunity cost; you might be losing money over long-term by paying your mortgage instead of investing more.

One other thing to keep in mind is that these two actions aren’t mutually exclusive. You don’t have to choose between paying off your mortgage early and investing more. Say you have $500 left over at the end of the month; consider investing $250 of it and putting $250 toward paying off your home debt.

Tips For Success:

  • Increase your paydown little by little. Challenge yourself each month to see how many months in a row you can increase your payment, even if it’s only $25 more a month.
  • Take advantage of bonuses. When you come across a large sum of money, like a tax refund or bonus at work, put it toward your mortgage.

One strategy that some people use to pay off their mortgage ahead of schedule is velocity banking, in which you take out a home equity line of credit and use those funds to pay down your mortgage in big chunks. You can learn more in this velocity banking guide, which goes into the pros and cons of the approach.

Baby Step #7: Build Wealth And Give

Summary: This isn’t as much a practical step as an acknowledgement that, at this stage, you’ve checked off the big financial goals — which opens up the possibility to do anything you want with your money.

Here, Ramsey uses phrases like, “you can live and give like no one else” and “keep building wealth and become insanely generous.” It’s here too that Ramsey advises to start thinking about leaving an inheritance. 

Does it make sense? This is the point we all want to get to. After years of prioritizing more foundational financial goals, the idea is that once you’re at this stage there’s a world of possibilities.

But is it really that simple?

I’d prefer more guidance on how much one should be saving. Many individuals don’t start their debt-free journey — and more importantly, get through it — until their 30s or 40s. In Baby Step #4, Ramsey suggests saving and investing 15% of your income. Is that enough? I’d certainly run the numbers myself to make sure. 

Overall, however, the idea here is solid. This is definitely the point you want to reach — the stage where possibilities open up, and where leaving a larger inheritance or giving very generously can be on your radar.

Final Thoughts On Dave Ramsey’s Baby Steps

The big value of the Baby Steps framework is the structure it provides. You can work your way through each of the Steps one by one, always knowing what to focus on. At the end of the day, if you follow the plan, you’ll be in a good place in the years ahead. 

But this fixed structure can also present problems. Every decision you make has an opportunity cost. Focusing on becoming absolutely debt free means allocating extra money to your debt paydown efforts, and that may not be the most efficient allocation of those funds. It’s important to remember that Ramsey is anti-debt as a general rule, and these recommendations reflect that perspective. 

Plus, personal finance isn’t always so black and white. Life changes fast. So, from time to time, it’s important to take a step back and analyze your situation to make sure you’re on the right path.

Often, there’s a better path for getting to your goals. 

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R.J. Weiss
R.J. Weiss is the founder and editor of The Ways To Wealth, a Certified Financial Planner™, husband and father of three. He's spent the last 10+ years writing about personal finance and has been featured in Forbes, Bloomberg, MSN Money, and other publications.

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