While we respect the financial guidance that Dave Ramsey has provided to many people, we don’t think that there should be a one size fits all solution to personal finance. The foundation of Ramsey’s financial education geared to the masses are his 7 baby steps to financial freedom. He claims that they “work every time” and that nearly 6 million people have had success with his plan. Find out more about Ramsey’s baby steps and why this financial plan might not be the best fit for you.
What Are Dave Ramsey’s Baby Steps
According to daveramsey.com, below are his 7 baby steps to financial freedom:
- Save $1,000 for Your Starter Emergency Fund
- Pay Off All Debt (Except the House) Using the Debt Snowball
- Save 3–6 Months of Expenses in a Fully Funded Emergency Fund
- Invest 15% of Your Household Income in Retirement
- Save for Your Children’s College Fund
- Pay Off Your Home Early
- Build Wealth and Give
We recently read Ramsey’s book, The Total Money Makeover: A Proven Plan for Financial Fitness. While it provides some personal finance fundamentals, we don’t believe that his method is right for everyone – and it isn’t right for us.
Different Financial Goals
Despite Ramsey’s baby steps being a proven method to achieve financial freedom for many people, first think about what “financial freedom” means to you. It doesn’t mean the same thing to every person and that’s why we find this cookie cutter approach to personal finance outdated. For YOU to achieve financial freedom you need to evaluate your finances, consider what’s holding you back and decide on short and long-term financial goals.
Where do you want to be 5 years from now? 10 years from now?
When do you want to be able to retire?
What debt do you have?
If you don’t already, do you want to own a home?
A significant underlying issue with Ramsey’s baby steps method is that you can only work toward one financial goal at a time. This is an oversimplification and is clearly false. You can have a multi-focus financial plan if you put in the effort and commit to it.
Snowball vs Avalanche Debt Methods
Baby Step 2 says to pay off all debt, except the house, using the debt snowball. The snowball debt method is the process of paying off each debt from smallest to largest. This may work well for people who struggle to pay off debt and need to take small steps to build confidence to pay off larger balances. However, while you are using the snowball debt method you could be racking up significant amounts of interest because you aren’t paying off the debts with the highest interest rate first.
Instead, we recommend using the avalanche debt method. The goal of the avalanche debt method is to minimize the amount of interest you pay on your debt and accumulate while paying it off. The avalanche debt method works by paying off each debt from highest interest rate to lowest interest rate.
Why waste your hard-earned money on interest? To learn more, read Paying Off Debt: Snowball vs Avalanche Methods.
Not All Debt Is Bad
Another belief of Ramsey’s that is sewn throughout his baby steps and educational resources is that all debt is BAD. We do agree that you should be very cautious racking up debt, but there is such a thing as “good debt.” Good debt builds your net worth or helps you generate future value and generally includes mortgage loans and student loans. This still means that you should be smart with your money and shop around for the lowest interest rates to get a loan. Learn more about good debt in our article, How Debt Can Actually Make You Richer.
Buying A House
You’re not alone if you read through the 7 baby steps and thought, “when am I supposed to buy a house?” It seems very difficult to fit mortgage payments in with the rest of the requirements of these steps. Ramsey is adamant with his suggestion that people should only buy a house with cash or a 15-year mortgage with at least a 20% down payment. Unfortunately, that just isn’t realistic for many people. A 30-year fixed-rate mortgage makes buying a home more affordable, but at the expense of a significant amount of interest over the term of the loan as compared to a 15-year mortgage. We recommend a compromise of getting a 30-year mortgage with the options of paying it off faster. It’s the best of both worlds. To learn more, read 15-Year vs 30-Year Mortgage: Which Is Right For You?
Paying Off The Mortgage
Obviously if your goal is to be debt free, then paying off your mortgage is on your to-do list. There are many advantages to this route, but there are also several disadvantages. By allocating more of your money now to paying off your mortgage, you will have additional cash flow later on when you have less debt. Paying off the principal of your mortgage early will enable you to save on interest as compared to if you make the minimum payments for the entire term of the loan.
However, it seems like Ramsey hasn’t fully considered the disadvantages. Rather than paying off your mortgage early, you could use that extra cash to invest, which may provide a higher return than paying off your home. Moreover, if you have a long-term fixed-rate mortgage, then the lender assumes the risk of inflation and the risk of the value of your property declining. You also lose the mortgage interest deduction on your taxes once you have paid off your home.
The bottom line is that there is no clear cut answer as to whether you should pay off your mortgage early or not. You should learn about both sides in order to make an educated decision that fits in with the rest of your financial goals. Read our article, Should You Pay Off Your Mortgage Early?
We do recommend that you start saving for retirement as early as possible, however saving 15% of your income does seem out of reach for many people. If your employer has a 401K and offers an employer match, then you should be depositing the amount that gets you the maximum employer match. This is usually about 3-6% of your income and is a realistic amount to set aside as early in your career as possible without disrupting your finances. For those who don’t have the option to save for retirement in a 401K, you should research the options you do have available, such as traditional and Roth IRAs, and start saving a small amount each month now to take advantage of compound interest over time.
Ramsey’s baby steps have without a doubt helped many people to take control of their finances. But they may not be right for you. Don’t hesitate to create your own financial plan in order to achieve your goals.
Financial freedom begins with good habits.Rebecca & Tiago, theloadedpig.com