If you’re the average Total Money Makeover participant, by the time you get to Baby Step 4, you’re two or more years into this journey. Well done! You’ve destroyed your debt, built a solid emergency fund, and are now ready to invest in retirement! Bravo! There are many considerations you should take when getting into investments, so let’s tread carefully here. Again, here are the 7 Baby Steps:
Dave Ramsey’s 7 Baby Steps
- Step 1: Save up $1,000 to start your emergency fund.
- Step 2: Pay off all non-mortgage debt using the debt snowball.
- Step 3: Save up 3 to 6 months of expenses to complete your emergency fund.
- Step 4: Invest 15% of household income into Roth IRAs and pre-tax retirement accounts.
- Step 5: Work on college funding for children.
- Step 6: Pay off your mortgage early.
- Step 7: Build wealth and give!
Aren’t investments risky? Shouldn’t I just save my money?
Some people might be questioning why they should invest in mutual funds. From The Total Money Makeover:
Ibbotson Research says that 97 percent of the five-year periods and 100 percent of the ten-year periods in the stock market’s history have made money.
This is nearly a surefire way to make a return on your money. You can make serious progress in investments. Don’t let the current financial climate get in your way. If times are rough, it is especially opportune to invest!
What’s so magic about 15%?
Dave recommends investing 15% of your household income into good, growth-stock mutual funds that have a 5 to 10 year track record making 12% ROI annually or more. You’ll read in Dave’s book The Total Money Makeover that this percentage is based on many years of working with people on their retirement. 15% of your household income into retirement produces great returns while allowing you to save additional income for the next baby steps (paying off your mortgage and building wealth).
Let’s take a look at the typical scenario:
- Bob invests from age 30 to age 60.
- Bob contributes 15% of his household income into retirement.
- Bob’s annual income is $50,000.
- Bob makes an average annual return of 12% on his money.
Given these factors, Bob would have a little over $2,200,000 upon his retirement at age 60. Not bad! I’m convinced that Bob can do even better if he chooses winning mutual funds, which can be done if he takes the time to research his investments well.
How to diversify amongst mutual funds, that is the question!
Dave breaks up investing your 15% into four major categories of mutual funds amongst which you should contribute equally. They are as follows:
- 25% to Growth and Income (Large Cap or Blue Chip funds)
- 25% to Growth (Mid Cap or Equity funds; an S&P Index fund would also qualify)
- 25% to International (Foreign or Overseas funds)
- 25% to Aggressive Growth (Small Cap or Emerging Market funds)
What are some retirement account options?
You’ve probably heard of Roth IRAs and 401(k)s. But how much of your of your 15% contribution should you put into each? Is one type of retirement account better than another?
Dave recommends a prioritized investment approach – investing your 15% until it runs out down the following accounts:
- 401(k): If your company has a 401(k) and will match up to a certain percentage, take the match! You can’t beat free money! Let’s say your company matches 3%. Invest 3 percentages of your 15% and move on to the next prioritized account below.
- Roth IRA: The Roth IRA will allow you to grow your money tax-free since you will have already paid taxes up front. This is a huge advantage. Invest the remainder of your money into Roth IRA’s up to the maximum contribution limit (for example: $5,000 per year). If you still haven’t reached your 15% contribution amount, proceed to the next prioritized account below.
- 401(k)s, 403(b)s, 457s, or SEPPs (for the self-employed): Take the remaining amount you have and invest back into these types of accounts.
True Retirement: Financial Security
Dave usually makes the point that if you’re looking forward to retirement so you can quit work, you need to find another job! Work should be a life-long endeavor. You can always work and find enjoyment in what you do! Instead of seeking relief from work, seek financial security!
Now that you’re investing 15% of your household income into retirement accounts, it’s time to continue to do so and start thinking about the kids and their college! Join us next time for how you can put your kids through college if you start saving now!
Next In Series: Dave Ramsey’s 7 Baby Steps: Step 5 – Work on College Funding for Children
Previous In Series: Dave Ramsey’s 7 Baby Steps: Step 3 – Save Up 3 to 6 Months of Expenses to Complete Your Emergency Fund
Hey John,
My wife and I are HUGE Dave Ramsey fans. We are currently on Step 2 (paying off debt). We have about a year until we are done with our Student Loans. It has been a big push.
Question:
I recently got a new job in local government. I have a 457(b) deffered comp option to invest in. What are your toughts about someone in my position who still has some debt to pay off, but may want to consider contributing if there is a match or incentive? Should I only consider a Roth IRA when it is time to invest 15%? What options are out there that you reccoment?
We are 25 and 27. My wife has a 401 (k) from a previous employer and I have not done any reitrement investing yet as we have been paying off debt with gazelle Intensity and my employment was less than regular up until now.
What are your thoughts? Would love to chat. Thanks!
Hey Colin! Thanks for writing!
I’d follow Dave’s baby steps and avoid the temptation to invest in retirement until you have paid off all your non-mortgage debt and built a 3-6 month’s worth of expenses emergency fund. Your gazelle intensity will get you investing sooner than you think, because you’ll plow through your debt so quick you’ll wonder how you did it!
My day job also offers a match on a retirement account, but Courtney and I are waiting until we get to Baby Step 4. It doesn’t make the most mathematical sense, but let me tell you, when you have thousands of dollars waiting to defend your family against an emergency and no debt to get in your way, you’ll understand why it makes sense! You’ll experience a greater level of financial peace if you follow the baby steps in order.
In fact, we’re kind of on “Baby Step 3b” right now, saving for our college education (not to be confused with Baby Step 5) before we invest.
I hope that helps you Colin! Let me know if you have any other questions, and thanks for being a reader of The Christian Dollar!