For many people out there, just uttering his name is enough to bring emotions of rage or praise to the surface.
For those of you who are not familiar, Dave Ramsey (he who must not be named in some circles) is the author of several very popular personal finance books, such as The Total Money Makeover, as well as the host of “The Dave Ramsey Show.”
Ramsey is famous for his aggressive stance on never using debt to purchase anything—including your house or real estate investments.
Being a part of the real estate investing community, I, of course, consider debt on cash flowing investment properties “leverage” rather than “debt.” Ramsey does not share this point of view (to say the least).
He also hates consumer debt, like credit cards and car loans, and believes they are crippling to a person’s financial position and future. This is the only place I agree with him.
Ramsey has come up with a method designed to get people out of debt and on a path toward building wealth. He’s dubbed this method the “7 Baby Steps.”
Dave Ramsey’s 7 Baby Steps
These are the steps:
- Step 1 – Save $1,000 for your starter emergency fund.
- Step 2 – Pay off all debt (except the house) using the debt snowball.
- Step 3 – Save three to six months of expenses in a fully funded emergency fund.
- Step 4 – Invest 15% of household income in retirement.
- Step 5 – Save for your children’s college fund.
- Step 6 – Pay off your home early.
- Step 7 – Build wealth and give.
Now, these steps have helped thousands and thousands of people get out of debt and reach a sound financial position.
If you are someone with little or no knowledge of personal finance—someone who is only interested in getting out of debt and retiring in your 60s—go ahead and follow Dave Ramsey’s “Baby Steps.” It will get you there.
However, if you are interested in getting out of debt and then building a sizable net worth through real estate, index funds, stocks, bonds, Smoothie King franchises, or a combination of all these things—and someone interested in reaching financial freedom at an early age—I would suggest you follow a more optimized path.
So what is the biggest flaw in Dave Ramsey’s “Baby Steps”?
Here it comes: not investing your money and making it work for you as soon as you possibly can is a huge mistake!
With Dave Ramsey’s approach, once you finish the second step—paying off all consumer debt (credit cards, car, student loans, personal loans, etc.)—you will have a $1,000 net worth.
But guess what? That $1,000 is likely earning you 0.01 percent interest in a savings account. That $1,000 is not working for you. It’s not making you rich.
In actuality, that $1,000 has lost you money over the multiple years you just spent paying off your credit cards, car, student loans, RV, and whatever else you financed. That $1,000 you put in a savings account in 2015 is now worth significantly less than $1,000 in 2019 (inflation, people!).
Plain and simple, Ramsey’s method of reaching a financially sound place in life is extremely flawed.
But is there a better way? Of course!
Here’s what I’m calling my “7 Financially Savvy Adult Steps” to get out of debt and reach a financially sound position in life. This method is both faster and more efficient than those little “Baby Steps” will ever be.
7 Financially Savvy Adult Steps to Rid Yourself of Debt and Achieve Financial Independence
- Step 1 – Save $1,000 for an emergency fund.
- Step 2 – Pay off high-interest debt only (8% or higher).
- Step 3 – Save 25%+ of your income to invest until you have $10,000 to $25,000 in assets working for you.
- Step 4 – Save three to six months of expenses in a fully-funded emergency fund, while still saving 25%+ of your income to invest.
- Step 5 – Pay off low-interest debt (8% or lower), while still saving 25%+ of your income to invest.
- Step 6 – Save for your children’s college fund, while still saving 25%+ of your income to invest.
- Step 7 – Give, while still saving 25%+ of your income to invest.
No need to build wealth here like in the “Baby Steps.” If you execute this strategy, you will already be wealthy at this point.
The reason that these “7 Financially Savvy Adult Steps” are more effective than Ramsey’s is that they focus on investing as soon as possible and continually investing 25 percent of your income rather than only 15 percent.
Why pay off 5 percent student loans or car loans when you can make an average of 8 percent a year in an index fund? Is paying off your 4.2 percent mortgage optimal when you could use that money to invest in rental properties that have a cash on cash return of 10 percent a year and appreciate at 8 percent a year?
The answer to both of those questions should be obvious.
Real-Life Example of 7 Financially Savvy Adult Steps in Action
How about we use me as a real-life example to see these more optimized steps in action?
About 6 months after I graduated college, I had just financed a car for $20,000, had about $4,000 in credit card debt, $60,000 in student loans, and earned a $50,000 salary per year plus bonuses. This is a pretty normal situation for people in their mid 20s to early 30s.
That adds up to -$84,000 in debt. But 18 months later I now have a net worth of $0. How is that possible?
Did I follow Dave Ramsey’s “7 Baby Steps”? Not a chance! I would still be in the negative 1,000s of dollars if I had done that!
Here is what I did instead.
Step 1: Save $1,000 for an emergency fund.
Easy enough. I made 90 percent of my meals and said no to going out to the bars more than I said yes.
At this point, if my car’s brakes go out, I wouldn’t have to turn to credit cards. This took about two months.
Step 2: Pay off high-interest debt only (8% or higher).
Luckily the $4,000 in credit card debt was at a 0 percent introductory rate for 18 months. I still treated this like high-interest debt though and paid it off ASAP. I did this because as soon as the 18-month period ended, it would carry a 20 percent or higher interest rate.
My next quarterly bonus was used to pay off all my credit card debt rather than buy some shiny new object like the rest of my co-workers.
Step 3: Save at least 25% of your income to invest until you have $10,000 to $25,000 in assets working for you.
My advice is to first identify what asset or assets you want to invest in. There are a number of options and different tax strategies, including but not limited to Roth IRA, 401(k), index funds, stocks, bonds, and real estate. Decide what is best for you and attack it.
For me, I decided investing my savings in real estate was my best course of action. For roughly eight months, I saved as much as I possibly could (50 percent or more of my income) to put 3.5 percent down on a house hack. This meant renting out my car, biking to work, and almost never going out to eat or drink.
After eight months of determination, I bought a 2-bed/2.5-bath townhouse in Denver for $260,000, which was $10,000 under asking. After an additional $4,000 in materials and labor, I added a third bedroom in the basement.
Next, I placed two roommates in the upstairs room. They cover my mortgage, taxes, and insurance.
I now have a house that is worth about $285,000, and I get to live there for free. There is my $25,000-plus in assets working for me!
Hey, Dave, which “Baby Step” is that?
Step 4: Save three to six months of expenses in a fully funded emergency fund, while still saving 25%+ of your income to invest.
Now that I get to live for free in a townhouse in a decent suburb of Denver, saving three to six months of living expenses took no time at all.
The reason? Since I don’t have to pay anything for a roof over my head, my monthly expenses are pretty low and I can save a large portion of my income. I checked off this step in about three months’ time.
Step 5: Pay off low-interest debt (8% or lower), while still saving 25%+ of your income to invest.
Here’s where I am currently. Right now, since I live for free, I save well above half of my income and live very comfortably. (Yes, I did add in eating and drinks out on occasion.)
Those savings are currently being invested in a Roth IRA, a savings account designated for buying my second house hack in 12 months, and paying down my student loans using the “Debt Avalanche” method, rather than the “Debt Snowball” method.
At this moment, my net worth is roughly $0. But guess what? I have $25,000-plus in assets that are working hard earning me money while I sleep—and they’ll continue to do so for years and years to come.
If I had followed Dave Ramey’s “Baby Steps,” not only would I still have a net worth of negative 1,000s of dollars, but when I finally dug myself out of that hole, I would have zero assets to speak of.
There are a number of ways to go about getting out of debt outside of Dave Ramsey’s method and Connor Anderson’s “7 Financially Savvy Adult Steps.” But the key is to start investing in assets as soon as possible and continue to do so forever.
My journey has involved a lot of hard work and sacrifice, but I promise you it is repeatable and a significantly more optimized path out of debt and into a financially sound position in life.
Are you a Dave Ramsey fan? Why or why not? How do you think my method stacks up against his?
Let me know in a comment below!