Steps” to financial freedom. His story is truly remarkable as he went from being bankrupt to building a successful empire. He and his team are all over the internet including having a very popular YouTube channel.
I’ve followed Dave Ramsey and his Baby Steps for awhile now, and while I don’t completely agree on all his views (Stay away from Credit Cards), I do think in general that most would find success in adopting his Baby Steps.
Let’s dive into these steps and I’ll point out what I agree and disagree with.
Step 1: Save $1000 for starter emergency fund
I strongly believe that building an emergency fund is crucial for everyone, as unexpected expenses can arise at any time. I understand the rationale behind setting the initial goal at $1000, targeting a specific dollar amount may not be universally suitable. The intended audience for this advice for Ramsey likely comprises individuals who are still early in their financial journey and may find the concept of an emergency fund challenging to grasp. By setting a relatively modest goal of $1000, it enables people to experience a sense of achievement when they reach this milestone.
I have a slightly different perspective on the recommended amount. Personally, I believe a starter emergency fund should ideally cover at least one to two months’ worth of expenses. Life often presents unexpected twists and turns, such as car problems, health issues, or appliance breakdowns, which tend to occur at the most inconvenient times. By having a reserve equivalent to 1-2 months of expenses, you provide yourself with a financial safety net to rely on during such challenging situations. That being said if coming up with one to two months’ worth of expenses is difficult, following Ramsey’s $1000 goal is totally acceptable.
Where should you put the money?
Once the importance of having a starter emergency fund is established, the next question is where to keep the money. I do not recommend storing it in your closet or under the mattress. In fact, I suggest opening a separate High Yield Savings Account with a reputable bank and depositing the funds there. This type of account offers higher interest rates, ensuring that your money grows over time. It’s important to maintain at least the established amount in the account at all times. If you need to utilize the funds for any reason, make it a priority to replenish the account as soon as possible.
Ideally, your emergency fund should be something you forget about and never have to use. However, knowing that it’s there provides peace of mind and a sense of financial security. In Step 3, we’ll talk about adding on to this emergency fund.
Step 2: Pay off all debt (except the house)
In my humble opinion, this step is the heart and soul of the Ramsey plan. Although not explicitly mentioned, the idea is to pay off all forms of debt, such as credit cards, car loans, student loans, and any other outstanding loans. Now, while I generally agree with this step, I do have a slightly different perspective, especially when it comes to credit cards. Dave Ramsey strongly advises against their use altogether, but I believe there’s a middle ground.
Let’s face it, the credit system in the US heavily relies on credit cards to build a respectable credit rating. Without a good credit score, it becomes challenging to secure loans for major purchases like a house or a car. So, I wouldn’t go as far as completely dismissing credit cards. However, the key is to use them responsibly and avoid carrying a balance from month to month. My recommendation is to set up automated payments that cover the entire balance each month, without you having to lift a finger. If you find yourself unable to pay off your credit card balance in full every month, it may be worth considering cutting up your cards to regain control.
Now, for those who can’t pay off their credit cards entirely each month, it’s essential to take a close look at your spending habits. Distinguish between necessary expenses and discretionary spending. One option to consider is reducing your credit card limit to a comfortable amount that aligns with your financial goals.
As for other forms of debt besides credit cards, it’s crucial to assess the interest rates involved. For instance, let’s say you have a student loan with an interest rate below 5%. In that case, it could be argued that you may be better off in the long run by investing the extra money in a low-cost index fund like Vanguard’s VOO ETF, which historically has averaged a 10% annual return. However, this approach requires a dedicated mindset and commitment to consistently allocate those extra funds toward investments instead of using them to pay off debt sooner. Ramsey refers to this as employing the “army of dollars” strategy and putting your money to work effectively. But if your focus is more on indulgent spending rather than investing, then I strongly recommend prioritizing debt repayment, regardless of the interest rates charged.
