The Truth About Dave Ramsey’s 7 Baby Steps

0:01Brian Preston:This episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome? That's new. It can help you with practically anything on the web, like restoring a vintage motorcycle from a 50-page restoration block, or finally break down that long article you've had open for weeks. Gemini and Chrome is here for it. Ready to make anything online make sense? There's no place like Chrome. Check responses set up required, compatibility and availability varies 18+. This episode is brought to you by Facebook. So you were scrolling on Marketplace, and there it was, the bike you'd been searching for.

0:35You sent a message, and it turned out the seller was super chatty, kind of funny, and an avid cyclist. The next thing you know, you're in a cycling crew. Well, a community cycling group. The thing about Facebook, you might find more than what you're looking for. From a browse to a bike ride, this summer, find more on Facebook. No one can deny that Dave Ramsey has helped millions of people start taking their finances seriously and even get out of debt.

1:03Brian Preston:And Brian, I am so excited about this because if you know Dave, you know his seven baby steps. There is step-by-step money management plan. And while we respect that Dave has led a lot of people to financial success, we do feel like there's a better way to do money. We're going to compare and contrast the baby steps with our very own system to show what we agree, disagree, or just want to fight. Just kidding. We don't really want to fight, Dave. We're going to start out with what might be the most controversial baby step. Baby step number one.

1:41Brian Preston:Baby step number one, according to Dave Ramsey, seven baby steps to save$1 ,000 for your starter emergency fund. And look, Dave, when he wrote this, this is for people just starting to take their finances seriously and just starting out of the gates. But it's harder than probably most people even realize. Yeah, we know that 59 % of Americans, literally six out of 10 Americans, don't make it past this first baby step. But I do want to give Dave a little bit of grace because he has even said himself that they know$1 ,000 is not enough for an emergency fund. He goes, I think I've even heard Dave say this, it was never about the$1 ,000.

2:19I know. This is bothering me because they say it's all about mastering the behavior, building good saving habits, eliminating bad spending habits. But what's the purpose? Was it just arbitrarily$1 ,000? Now, look, in 1995, when this was written, maybe$1 ,000 was more than it was. But our take,$1 ,000 is just not enough.

2:39Brian Preston:Yeah, even for a starter emergency fund, it's not going to get the job done. Dave says it's about mastering behaviors, but in our world, we think it's more about not allowing your financial life to be taken off the rails. In the world in which we live today, there are a number of things that can take you off the rails. We gave examples. These are basic things that could happen to anybody. If you just have to go to an emergency room, look at that. It's going to cost around$2 ,500. If you had a major home repair, something you had to do that blew up in your house, a hot water heater or so forth,$2 ,000 to$4 ,000.

3:14By the way, I don't even cover my HVAC system. That's right. That's going to be even more. Car transmission,$2 ,300. If you had an emergency travel, meaning you had to go fly somewhere to go visit somebody in the hospital or even worse, go to a funeral, that's probably going to cost somewhere around$2 ,000. All those things would leave you making desperate decisions if you only had$1 ,000 to your name.

3:37Brian Preston:So if that's the case, this step has to be about more than just behavior. Your emergency fund is a crucial tool, like I said, to keep your life from going into the ditch. So while$1 ,000 is a way to think about it, a way to start, we think that it should be different. It shouldn't be this one-size-fits-all. When it comes to actually doing this well, we think that the solution should be unique to your unique circumstances and your unique risks. Yeah, and I've seen other systems where they changed$1 ,000 to$2 ,000. But once again, it's not unique. We think that this is why let's set up the compare and contrast to baby steps number one versus the financial order of operation step number one.

4:24We think it needs to be customized to you, and that's why our step number one is have your highest insurance deductible covered.

4:31Brian Preston:And so the very first question you might be asked is, okay, guys, well, what is an insurance deductible? As a reminder, this is the amount that you're going to pay out of pocket annually for qualified expenses before insurance kicks in. So for most of us with our health insurance, there might be a$1 ,000 deductible or a$500 deductible or a$2 ,500 deductible. It is very much dependent upon your unique health insurance plan. And you can walk this through all the different types of insurance you need. Again, it needs to be customized to your unique circumstances. This is the part where I know it seems more complicated.

5:05But if you think about the fact is, where do bankruptcies come from? People usually file bankruptcy because they're having to make desperate decisions when bad things have happened to them. This step, the way we've designed it is we've gone through all the catastrophic stuff, the car crashes, the home damage, the health emergencies, this stuff. Plus, it also is now going to force your behavior to where you actually go and account for and go see, do I know what my risks are? What is catastrophic in my life? I think that it's a twofer. Not only do you get to cover these risks, but you also are forced to go and do the exercise of figuring out what protections do I have or what do I need to seek to protect myself from.

5:49Brian Preston:And that's why we like it being your highest deductible. Because if you can cover your highest deductibles, that means you can also cover all of the other deductibles that are less than that. So it protects you from a wide range of emergencies. And we love that it is custom to you. While$1 ,000 may be enough for your neighbor, that's not to suggest it's enough for you. We want to make sure that personal finance is indeed personal for you. And while it is likely going to be more than$1 ,000, I do think this step is great because it's still small enough that most people can knock it out quickly.

6:26Brian Preston:In most circumstances, depending on what your highest deductible is, it's not going to take you 6, 8, 10, 12 months to be able to build up that amount of cash. No, just go write down all your insurance deductibles and choose the highest. It's not the sum of them. It's the highest. So you're going to be able to move out of that pretty quickly. And then that leads to step number two. So according to Dave Ramsey's baby steps, step number two would be pay off all debt using the debt snowball except for the house. And you may be wondering, okay, what's the debt snowball? It's this idea that I'm going to line up all my debts and whatever the smallest balance is, I'm going to pay that off and then I'm going to go off to the next smallest, next smallest, next smallest, next smallest, so that I can build momentum through the strategy.

7:09Now, this is where at a young age, remember, just 20-something-year-old Brian, I had a friend who was very successful starting out in their career, and they basically paused doing 401K. They paused just Roth, anything, because they were trying to knock out their low-interest student loan debt. Because realize, step number two is pay off all debt using debt snowball except for the house. And that's the part where I was just like, Like, oh, yeah, I get it. You're supposed to have intensity. But do you realize the opportunity cost of what that intensity is going to cost you in the long term? Because there's stats out there that show that it takes people two years to get to that point where you pay off all those debts.

7:52Well, I think about, I mean, you've seen our wealth multiplier, Bo. That, if you just took what the average person makes, we could be talking about something that is hundreds of thousands of dollars in the future. Plus, how many people get led down that primrose path of becoming debt crusaders and never get into building wealth through discipline and saving and investing through automatic saving strategy? This stuff scares me a little bit.

8:17Brian Preston:But again, I want to give Dave credit. One of the reasons why he says this is the debt snowball does help you stay motivated. So if it is something that is going to take two years, it is a mechanism to stay motivated. But again, we think that there is a better way to do money. And we think that rather than paying off debt in step two, we agree that it's dangerous. And we agree that it should be eliminated. And we agree that it should be a high priority. But we think that Dave is missing a step. We think while we can be on the same page with all of those, there is something so exciting that Dave is missing that is likely leading a lot of his followers down the wrong path.

8:59Well, I think this is where the optimizers, all of you guys who, you know, I think about my engineers out there, my attorneys, my pilots, people who just, you respect what Dave has created, but then you start going, wait a minute. My student loan debt is like at four and a half percent, four percent. I'm doing, I'm missing out on what? So here's where our take just completely takes you in a different place. We love get out there and get that free money. because goodness gracious, if your employer is offering you 50%, 100 % guaranteed rates of return, that blows that 20 % you might be paying on credit cards.

9:38Look, I hate it. I hate credit card debt with a passion. You know we have credit card use is okay. Credit card debt, no way. Because we don't allow any credit card debt whatsoever, even if it's 0 % interest. But if I can get you to get out there and get that 100 % dollar for dollar match for your employer, your future self is going to love you for making that decision.

10:02Brian Preston:So rather than passing on getting that, rather than going and prioritizing paying off all of your debts, we indeed want you to go get that free money. We want you to recognize that a 50 to 100 % rate of return is more powerful even than a 20 % cost on interest rates. and if you don't have a match maybe you're someone who says hey i don't have access to a 401k or a 403b or i do have access but there is no matching that's okay if you don't have that then great go on to step three but if you are someone who has the opportunity for free money where all you have to do is show up and your employer is going to put money in your account you cannot walk away from it even if you have high consumer loans standing out there well and that leads to because look, I want to make sure people don't mishear us.

10:53If you look and compare step two to FU, financial order of operations, steps two and three, we also hate debt. But we want you to understand and differentiate not all debts are created equally. We differentiate between high interest debt, not just all debt except mortgage. We say you need to know what's high interest debt versus what's low interest debt so you can prioritize and not work against your long-term wealth building and optimize the path.

11:20Brian Preston:Yeah, we know that our dollars can be powerful. We want every dollar to be used in the best way that it can be used. And so satisfying high interest debts might be a good way to use that, but satisfying low interest debts might not be. So that naturally begs the question, and a lot of people ask this, well, how do I know if something is high interest or if something is low interest? We have a few benchmarks that you can use. For example, student loans, which a lot of people now in this country are coming out of higher education to have student loans. Well, if you're someone in your 20s and your student loans are below 6%, it might not make sense to prioritize paying those off quickly.

11:59Brian Preston:By the time you get to your 30s, that number is 5%. And by the time you get to your 40s, that number is 4%. When it comes to auto loans, again, assuming that you're following 23, 8, meaning you put down 20%, you do not finance for any more than 36 or three months, and your total auto payments don't exceed 8 % of your gross income, if your car loan is below 10 % in your 20s and you're inside of 23.8, you might not want to accelerate that. In your 30s, it drops to 9%. In your 40s, it drops to 8%. And Brian, you already alluded to this. When it comes to credit cards, you got a pithy little saying you love to say.

12:34Yeah, I like to say credit card use is okay. We got to love the miles, love the rebates I get on that. But credit card debt, no way. So we'd also don't want you to have any credit card debt whatsoever, but it's just that we think that there's an optimization. Now, a lot of people are going to say, man, this seems like y 'all have added some layers of complexity. Yes, because money, if you're going to optimize to do this, that's why we try to teach you. This is not one of those things where we make it so simple that it's well-intentioned, but it doesn't actually give you the roadmap to actually how you create and build for the long term.

13:10That's why we've tried to go into the details. So the 22-year-old version of yourself actually feels like they know what to do with their next dollar.

13:19Brian Preston:And so one of the places or one of the ways that even we think that adding some sophistication on the thought process can improve the efficiency of the plan is even how you pay off your debt. We've already noted that Dave likes the debt snowball. I'm going to list all my balances. I'm going to attack the smallest balances first. And while that is behavioral and that will give you some motivation to stay motivated, we actually love the avalanche method. Rather, I'm going to list all of my debts from the highest interest rate to the lowest interest rate, and I'm going to start paying off the highest interest rate because that's going to have the biggest bang for my buck, the biggest ROI on my strategy.

13:56Brian Preston:Now, even though we love the avalanche, we think it is superior to the snowball, do you know what method we want you to pursue? whichever method you're going to stick to whichever method you will have the staying power to get out of step three to get out of that high interest debt so then you can move on to the further steps in the financial order of operations know thyself we don't if you maybe if you need to do the the snowball knock yourself out we just we're optimizers that's why we like avalanche but that does lead and look i'm feeling a little guilty because i mean if you watch this and seen my passion on this a lot of people but these guys must not like what ramsey and them do no we love how dave gets everybody out of debt and that's why i think it's good let's go let's start doing some consensus building back if you look at baby step number three save three to six months in a fully funded emergency fund i do want to give credit to the fact that both in baby steps and in the financial order of operations, we both have two steps devoted to a fully funded emergency fund.

15:00Brian Preston:Yeah, that's right. Dave says, you know, you need three months of an emergency fund if you have a stable income or no dependents, or you might need six months for more variable incomes, or if you're like a single income household, are there other potential risk factors that would cause you to need a bigger cash buffer? Well, that's not a whole lot different than what we say. When you look at baby step three, fully funded emergency fund, it's almost identical to The FOO, step number four, fully fund your emergency fund of three to six months of living expenses at your disposal. And by the way, this is real cash.

15:31This is like an emergency fund, high yield FDIC type accounts. I don't want you to fall into the access to cash trap. Both Dave's plan, our plan, we want you to actually have emergency reserves so you don't make those desperate decisions when life happens.

15:46Brian Preston:Now, okay, you said you want to come back to consensus building. You want us to be on the same page. And that was great. We were there for approximately one step. But now it changes a little bit because according to Dave Ramsey's Baby Steps, he wants you doing Baby Step 4, Baby Step 5, Baby Step 6 all at the same time. Now, they do recognize if there is scarcity, they want you to prioritize retirement saving. But we're going to talk in a moment about why we don't think that that's good enough. We think that you can improve upon that by focusing on how you order the steps that you pursue. But before we get into that, let's dive into baby step number four.

16:22Brian Preston:Dave says that in baby step number four, he wants you investing 15 % of your household income for retirement. That household income is gross household income. Yeah, it's 15%. And then you can do it in your 401k. You can do it in an IRA. And this is pretty straightforward. That's pretty standard. Now, this is where I've been around the block for a while. and i've told you guys this is right in line with you know you see industry advice in the 1990s in the previous century sure everybody was saying hey you need to save 10 to 15 percent i mean if you read the wealthy barber which influenced me back in the 90s it was 10 percent um dave is doing 15 and that makes a lot more sense when you understand the context that when these books were written, we had pension funds.

17:12We had, you know, social security and other things at the government safety nets. We were like, these things are going to be much more stable. Now we've kind of, the curtains have been opened and we realized those are a bunch of promises that maybe weren't fully funded. The world has changed from these. And I feel like there needed to be, just like we say, there's a better way to do money. Let's bring this into the modern century we're in now. How do we compare and contrast on this?

17:38Brian Preston:Yeah, so our take is that 15 % is a great start, but we'd argue that it's not quite enough. Rather than shooting for saving 15 % for retirement for future financial independence, we actually want you saving 25%. So it is a larger number than what Dave's Baby Steps would recommend. So the question was, okay, why? Why would we suggest that? Well, there are a few reasons. Number one, people are starting to save much later in life. I mean, yeah, maybe if you're someone who comes out at age 20, 21, 22, 15 % would likely be okay. But we know that right now most people don't actually start saving for retirement until they get into their early 30s or maybe even late 20s at the best.

18:22Brian Preston:So it's a little bit later than people have saved historically. Well, and even people want more flexibility. I mean, look, the traditional thing in the past was you go get a job in your early 20s and you retire at 65 and that's just normal. But now we have so many movements out there where people want to own their life that much sooner. Well, guess what? If you want to retire sooner than 65 to 70 years of age, you're going to have to take more accountability and put more pressure on your shoulders and save more than that 10 to 15 percent of the latter years of what people thought was the standard.

18:58Brian Preston:You said that. I love it. You said you have to take more of that responsibility on your shoulders because you don't want to have to rely on the social safety nets. It is less certain today than it might have been 20 or 30 years ago that those safety nets will even be there or be there in their current form. So while 15 percent is a great start, when we actually analyze and look at the numbers and think about savings rates. And we said, okay, well, let's play this through. What's it look like if someone saves 15 % versus someone who saves 25 %? And how do these numbers contrast? And when we looked at it, it seemed pretty clear to us that one of these strategies is more likely to get you to the outcome you want to have than the other.

19:40How dare you do some math on this? Because look at this. We love, by the way, go to moneyguy.com slash resources. This is one of our favorite deliverables for you to go out there and download for free. And look, we even say this, if somebody is starting to save and invest in your 20s, saving 25 % is very much aspirational. And the research shows this too. You can see both of our systems, 15 % in your 20s is going to yield a great retirement for you. But here's the problem. If you, just like we showed, the average investor starts saving and investing at age 33. They just realize this. They don't have the blessing of understanding this content sooner than that.

20:18And you quickly see 15 % is in the yellow danger zone where you're not getting a fully funded retirement. That's right.

20:25Brian Preston:It would suggest that you could replace about 71 % of your pre-retirement income. So you're not at the place where you're actually able to maintain the same lifestyle that you had pre-retirement. Whereas if you save 25%, now you can actually replace 119 % of your pre-retirement income at age, at full retirement at 65. So, I mean, the reality here is take control of your life. Let the numbers, we're not just giving you mantras. We're actually putting math to this thing so you can personalize your financial walk towards independence and know that you're going to be in a good place. And for many people, especially if you're discovering this 30 plus, you need to be saving and investing 25 % of your gross income.

21:08Brian Preston:So we differentiate on that. We think you should be doing 25 % as opposed to 15%. But we also think that where you put your dollars is important. And Dave's baby step number four, he just said, okay, well, you can save in a 401k or an IRA. But we believe that there's a better way to do money. And inside of that better way to do money, there's a better way that you can deploy your dollars to work just as hard as you do. Now, look, this is where the context matters, too. Dave specifically talks about retirement savings. And that makes sense. And back when the book was written and a lot of this plan was developed, that's what you had.

21:46That's what was available, yeah. But think about what has happened since all this content was written back in the 90s. We've got Roth IRAs. We've got Roth 401ks. We've got health savings accounts. And I think about my 22-year-old self that I came out of school, University of Georgia, with this accounting degree. But I didn't come from money. Nobody had ever told me how money works. and I had all this opportunity, but nobody was actually giving me the instruction manual for how do you make this happen? So I wanted to create a system that actually told you what to do with your next dollar and the different account structures actually come into play because you need to know the difference between Roth accounts, health savings accounts.

22:26It's not good enough. It's kind of like if somebody says, hey, if you come to me and say, I want to lose weight, is it better to just say, just go eat better? Or is it better for somebody to actually come up with a nutritious plan that actually takes into account the calories, takes into account the protein? And that's what we try to do. Yes, it adds complication to it, but it also adds the teeth of success that's going to make this stick and work for you in the long term.