Dave Ramsey is a well-known financial guru, radio show host, and best selling author. His advice on debt management has helped many Americans recover from the Great Recession of 2008. But does his advice apply to all? Let’s take a look at some pros and cons of following Dave Ramsey’s Baby Steps.
The Pros of Dave Ramsey Baby Steps
Debt reduction will make you feel accomplished by taking control of your finances and improving your credit score while saving money on interest payments over time which can be invested elsewhere. With an improved financial situation, comes increased opportunities for career advancement or starting a business as well as more peace of mind in general.
Dave also advocates investing 10% of income into retirement accounts like 401ks or Roth IRAs. Many people do not pay themselves first, and when you are young, this is very important.
Dave suggests paying off your home mortgage early if possible since the interest can be tax deductible as well as lower property taxes (capped at 1% for most homeowners in their primary residence).
The idea of building equity so quickly while reducing debt is appealing as well because, unlike other investments like the stock market or real estate, you know exactly how much your home is worth at all times.
The Cons of Dave Ramsey The Baby Steps
Some people simply cannot afford the baby steps as given by Mr. Ramsey. He suggests paying off all debt (including mortgage) before funding any retirement accounts or even saving for emergencies. However, it is often beneficial to have some type of emergency savings fund so that if something should happen your savings are available and not tied up in a house you cannot sell easily.
Often, people who follow Dave Ramsey’s baby steps have no savings and too much debt. The baby steps assume that the reader has no debt, which is rarely the case.
Dave Ramsey advises against getting into further debt to pay for things you cannot afford such as a vacation or home remodel in principle. However, some people will benefit greatly from incurring new debt or even having additional credit cards.
For example, a person who would benefit from opening their first credit card to build or rebuild their credit as well as increase their available credit limits could benefit greatly by building a strong foundation before tackling further debt reduction strategies.
Some people recommend paying off your mortgage early only if you can earn more on that money in investments elsewhere and/or your home value will increase significantly.
In addition, some people point out that you never stop paying off your mortgage no matter how much you pay down since the interest on your house is tax deductible.
Similar to investing in real estate with a low debt-to-income ratio, for example less than 20% leverage (loan amount compared to the current value of your home), Dave Ramsey suggests investing in stocks and mutual funds with a low debt-to-income ratio.
However, actual research has shown that high-income, high net worth investors do not follow this rule of thumb since the risk is more than compensated for by larger investment returns over time. Although it would be ideal to have much higher income in retirement to be able to afford the mortgages and debt you may incur while investing, it is unlikely that your income will be high enough compared to your mortgage interest payments.
With Dave Ramsey Baby Steps, you pay off all debt before saving for a future house or college education for your children. However, many people would rather pay for college or their own retirement before helping their children pay for school.
Investing in stocks and mutual funds over the long-term is a great idea. However, many people who are new to investing would be better off with less risky investments such as bonds and CDs until they improve their investment savvy.
The biggest problem with Dave Ramsey Baby Steps is that many of his readers do not have the income to pay off ALL their debt and save for emergencies. Because they cannot afford to save, people who follow his baby steps end up with too much debt and no savings at all.
While it can be tempting to follow the baby steps, you should consider your current situation. If you are not earning enough income or do not have any savings, then following this plan might cause more problems than it solves.
The best thing for most people is to work on a debt repayment strategy that they can afford before worrying about saving money. You can watch some of Dave Ramsey’s videos on YouTube while you prepare to buy his Baby Steps Program in full.
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