Dave Ramsey's Baby Steps Can Wreck Your Retirement.
In this episode, we're looking at Dave Ramsey and his Baby Steps.
He touts them as a way to create wealth but as we see, they can really slow down your wealth-building.
- A deep dive into Dave Ramsey's 7 Baby Steps system to eliminate debt and create wealth
- The difference between good debt and bad debt
- How Warren Buffett used good debt - a mortgage on his 2nd home - to make $750 million
- Why I have no plans to pull money out of my investments making 104% (!) to pay off my 3.5% mortgage
- How to double your retirement portfolio by ignoring Dave's advice
This is the My Money My Freedom podcast, where we unpack and simplify all things money so that you'll always have more than enough to live your best life for life. Now here's your host. Financial coach Susan Lassiter-Lyons.
If there’s one thing I can’t stand, it’s shaming.
Making people feel bad about something with zero knowledge about that person’s specific situation.
Like a body shamer who makes people feel bad about their weight.
In the financial world, this is rampant because there’s already so much shame around money.
Whether it’s lack of it, too much of it, wasting it, not donating enough of it, not sharing it with your half-sister even though you already gave her a car and spent thousands on her son and she’s 47 years old and how much more are you expected to do for her….?
And when I look out over the sea of financial ‘gurus’ there are plenty of people to make you feel bad on a regular basis about where you are in life financially.
Especially if you have debt.
And today we’re talking about the shamiest of the debt shamers - Dave Ramsey.
I’ve been aware of Dave for years now but I’ve never really paid much attention.
Mainly because I think it’s shady when people tout biblically based financial advice.
When people try to tell me that God wants me to do something, I’m always a little suspicious.
Because I have a great relationship with God and if he wanted me to do something he could just tell me himself.
But my distaste for in your face evangelicals is a topic for another day.
Today I’ll focus on Dave’s biggest claim to fame: the Dave Ramsey Baby Steps.
The 7 Baby Steps are supposed to help people eliminate debt and create wealth.
But to me, the Dave Ramsey Baby Steps aren’t that useful.
Mainly because he focuses on saving vs investing and it’s impossible to save your way to wealth.
Now, I’m a financial coach who helps women invest to create retirement income and that’s the lens that I look at Dave through.
And in my opinion, if he is trying to prepare you for retirement, he's doing a lousy job.
Seriously, in his list of 7 Baby Steps, you don't start thinking about retirement until Step 4.
So, in this show, I’m going to breakdown each of the 7 baby steps.
Baby Step 1 is to Save $1,000 for your starter emergency fund.
Yes, you need an emergency fund, no doubt about it.
But that is a pretty broad brush Dave is painting, saying EVERY American household has the same financial needs.
$1,000 may be the perfect emergency fund for a young woman in her 20’s but is it really appropriate for a family with four kids? Probably not.
Every family needs an appropriate emergency fund, but don't depend on Dave to tell you what's appropriate. You need to make that determination.
Baby step 2 is Pay off all debt (except your home mortgage).
This is the one that really steams me.
Of course, you don't want to be neck-deep in debt.
And if your debt got out of control, make a plan to wipe it out.
But I work with women all the time who are confused about debt.
And the questions I get are always “Should I pull money out of my 401k or IRA to pay off… whatever?”
Here’s the deal.
There’s good debt and there’s bad debt.
Bad debt is credit card debt. The interest rates are sky high and you should definitely have a plan to pay off your credit card debt.
The simplest and most effective way to do that is by sorting your cards by interest rate - highest to lowest - and paying off the high interest rate ones first while making minimum payments on the lower interest rate ones.
mint.com is a great free tool to use for this. You just link your credit card accounts and it will create a monthly credit card debt payoff plan for you to follow.
Installment debt isn’t all bad. These are student loans and car loans. Anything with a set monthly payment instead of a variable one.
Tell me this… if you have a car loan at 4% but you’re earning 12% on your investments, should you take money earning 12% to pay off money costing you 4%?
No. It doesn’t make any sense at all.
Put your money where it can perform the best for you.
Baby step number 3 is Another emergency fund, called the fully-funded emergency fund, requiring 3 to 6 months of living expenses.
Here we go again with Dave and his obsession with emergency funds!
This one he calls “fully funded” and wants you to wait on all investments until you've socked away 3 to 6 months living expenses.
Let's do some quick math to figure out long Dave wants you to wait until he lets you start investing for retirement.
Let's say Amy, a 35 year old single woman, earns $5,000 a month after taxes.
But after the mortgage payment, car payment, car insurance, utilities, food, clothing, and miscellaneous, she has $1,000 left.
So that means her living expenses run $4,000 a month.
Multiply that by 6 months and it’ll take Amy two years to put aside another $24,000 before she gets to step 4.
Don’t forget she also had to pay off all her debt, too.
So, if Amy had say $30,000 in credit card debt, a $20,000 car loan, and $50,000 in student loans she’s already been at this for more than 8 years.
And now we’re tacking on another two years.
So, if she started when she was 35, now she’s 45 and finally allowed to start investing for retirement.
Baby step number 4 is to invest 15% of your household income into index funds.
So after 10 long years of saving, Amy finally gets to put her money to work investing for the future.
15% of her $5,000 a month income is $750 a month so that’s what she starts investing.
After 20 years, assuming an average 9% return, she’ll have $464,644 saved for retirement.
But guess what?
She would actually have almost double that amount if she started investing and paying off debt at the same time.
Of that $1,000 she has every month she could use half to pay down debt and half to invest.
And instead of having $464,000 when she’s 65 she’d have $824,000 instead.
Dave may be a good writer (I don't know, I haven't wasted my money on his books) and a popular radio show host.
And who knows, maybe he's great with babies, but his advice stinks!
I say enough of Dave Ramsey Baby Steps and outdated advice!
But more importantly, let's dispense with the nonsense and start with common sense.
First, if you have debt and want to invest, do both!
There is no law making you pay off debt first (except for Dave's law, but I think that has now been properly shredded).
Second, use debt to your advantage.
Even Warren Buffet knows to take out a mortgage on his home if the rates are right and the investment opportunity is ripe.
Back in 1971 he took out a mortgage to buy a second home even when he could have paid cash for it.
He used the cash to buy more Berkshire Hathaway stock and in an interview in 2020 he said the stock is now valued at $750 million dollars.
I guarantee you the house definitely did not appreciate that much.
Baby step number 5 is to save for your child’s college fund, which is easy enough but should also involve your kid. Make sure they’re also contributing to their college fund with extra money they earn and get as gifts over the years.
This teaches them financial literacy and involving them in the process all ensure they have realistic expectations when it’s time to check out schools.
Baby step number 6 is to pay off your mortgage early.
I’m a financial coach and I have a mortgage. I have no interest in paying it off early.
My mortgage rate is 3.5%. I have no children and I’m a high earner.
My mortgage interest deduction is one of the only tax write offs I have. And I’m never going to take money making 104.96% - yes, that’s my most recent 1-year retirement portfolio return - to pay off money costing me 3.5%.
That would be insane.
The final baby step - number 7 - is to build wealth and give.
On that, Dave and I agree.
The bottom line here is keep your bad debt low and invest early and regularly.
And we can accomplish that faster without Dave and his baby steps.
My money’s on you.
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