What Dave Ramsey Gets Right (and Where Experts Disagree)

Dave Ramsey has been providing money tips for years, and most of it’s good. He created a system based on helping everyday people get out of being overwhelmed by their bills and finding a straightforward way to accomplish that. So there’s no complicated finance stuff or stock picking, it’s a series of steps you follow in order.

Here are the parts of his strategy that most financial professionals agree work best, broken down into simpler terms. At the end you’ll find an honest discussion about where some experts disagree with him, so you can determine how his strategies fit within your lifestyle.

Dave Ramsey’s 7 Baby Steps, in order

At its center is a list of 7 baby steps that you complete one step at a time. Once you’ve completed each step, you move onto the next. And completing these in order helps you avoid spreading yourself too thin.

Begin with $1,000 in the bank

As intended, Step 1 is modestly sized. As quickly as possible, you save enough to create a “starter” emergency fund of $1000. Only use this money for unexpected events such as needing to replace a tire on your car or having a leaky water heater.

While Ramsey emphasizes that $1000 will never cover all disasters, he points out that creating this “emergency fund” enables you to break free from the cycle of immediately reaching for a credit card whenever something goes wrong. For example, rather than facing a crisis if you blow out a tire, the loss of your tire now only represents an inconvenience.

If you have very limited income, beginning with even a few hundred dollars is a viable starting point.

Pay off debt with the snowball method

In Step 2, Ramsey employs what he refers to as the “debt snowball.” Create a list of all your debt (excluding your mortgage), ordered from smallest to largest. Ignore the interest rates associated with each piece of debt. Then, make the minimum payment due on all debt. Apply every available dollar toward the smallest piece of debt until it’s fully satisfied.

When you have eliminated the smallest piece of debt, increase your total monthly payments by applying the amount you had previously allocated toward the smallest piece of debt. Continue increasing your total monthly payments as each subsequent piece of debt is eliminated. Your payments continue to rise as more money becomes available, similar to a snowball rolling downhill. Why does it seem to work for so many? Paying off an entire piece of debt provides a tremendous feeling of accomplishment, and those feelings provide momentum to help you continue making progress on eliminating additional pieces of debt.

Give every dollar a job

Ramsey believes strongly in what he calls “zero-based budgeting,” and many financial professionals concur. Before the calendar turns over to the next month, assign every dollar of your income into categories (e.g. Rent, groceries, charitable giving, savings). Once you have assigned every dollar into its respective category, your total income less your planned expenditures should equate to zero. This doesn’t imply your checking account should reach zero; it implies no unassigned dollars remain with no intended use.

Many people combine this practice with the “envelope method” where they place cash for items such as groceries and dining out into labeled envelopes. When the designated envelope reaches capacity, they cease spending in that category. While this method may appear old-fashioned, it serves a useful function by causing spending to become more tangible.

Sinking funds for big expenses

A sinking fund is merely money that you allocate regularly for large future expenditures that you know will occur (i.e. Christmas gifts, a year-end insurance premium, etc.).

Assume you wish to save $600 for holiday purchases in December. Beginning in January, allocate $50 per month into a labeled savings account dedicated specifically for this cause. By December, the funds will be in place so you won’t need to borrow or scramble for money. Sinking funds prevent large future expenditures from negatively affecting your current budget.

Build a real emergency fund and start investing

Following completion of your debt elimination process (Step 3), establish your starter emergency fund into a reserve fund sufficient to support three to six months of your living expenses. A reserve fund is designed to protect you during times of unemployment or extended illness. If your income remains consistent throughout the year, prioritize building reserves that will last three months. Conversely, if your income varies or you’re approaching retirement age, strive to build reserves that will support six months or longer.

Step 4 is putting 15 percent of your household income toward retirement, usually through a 401(k) and a Roth IRA. To find your monthly target, Ramsey suggests taking your gross annual pay, multiplying by 15 percent, and dividing by 12.

Avoid taking on new debt

One underlying premise that permeates the entire strategy is avoiding new debt. Ramsey is quite adamant about avoiding credit cards, car financing and virtually any type of lending; he advocates for paying cash for everything so that you experience the money leaving your pocket.

Although you may not agree with all facets of this approach, it’s difficult to argue against not accumulating new debt while attempting to dig out of previous obligations.

Where other experts disagree with Ramsey

There are certainly areas where financial professionals critique Ramsey’s methods, and it would be wise to understand where the disagreement lies. Some experts suggest that utilizing the debt snowball can ultimately result in higher interest payments than an alternative referred to as the debt avalanche, wherein you repay your debts in order of highest interest rate first. Although the snowball creates motivation due to the satisfaction resulting from completely eliminating individual debts, the mathematical advantages favor the avalanche approach in most cases.

Also, Ramsey frequently references a 12% annual return on investment when discussing investing; however most financial professionals view that figure as overly optimistic when creating long-term plans. More conservative estimates usually fall within a range of 6% to 8% after adjusting for inflation are generally recommended.

Finally, many financial professionals would caution against banning ALL credit cards regardless of their usage patterns and reward structures since responsible credit card users can use cards responsibly for both earning rewards and improving their personal credit scores.

This doesn’t indicate that the overall framework presented by Ramsey is incorrect. Most households benefit from budgets, emergency funds and knowing exactly what needs to happen to succeed financially. However, please validate any numbers specific to your personal situation and consult with a certified financial advisor before implementing any major decisions.

Sources

• Dave Ramsey’s 7 Baby Steps – Ramsey Solutions
• How the Debt Snowball Method Works – Ramsey Solutions
• The Truth About Budgeting – Ramsey Solutions
• The Behavioral Ingenuity of Dave Ramsey’s Advice – Kitces

Photo by Katie Harp on Unsplash