The last week, I wrote an overview of Dave Ramsey’s baby steps system from his book, The Total Money Makeover, and I have been dissecting each of his individual baby steps as well. The Total Money Makeover is a personal finance book that I highly recommend ad one of the greatest personal finance books to read. Today, we will look at baby step four in more detail which is to invest 15% of your income for retirement. There are seven baby steps that you should follow in order that will lead you to financial peace. Dave Ramsey’s baby steps are…
Baby Step One – $1,000 Emergency Fund
Baby Step Two – Pay Off All Of Your Debt With A Debt Snowball
Baby Step Three – Fully Fund Your Emergency Fund
Baby Step Four – Invest 15% Of Your Income For Retirement
Baby Step Five – Save For Your Children’s College Education
Baby Step Six – Pay Off Your Mortgage Early
Baby Step Seven – Build Wealth And Give
Baby Step Four Is To Save 15% Of Your Income For Retirement
The fourth baby step in Dave Ramsey’s bestselling book and system, The Total Money Makeover, is to invest 15% of your gross pay in good growth stock mutual funds. While it is just a rule of thumb, he recommends 15% of your gross pay and not your net pay which means that you calculate the investment before taxes. So, for example, if you earn $60,000 per year, you should be setting $9,000 aside in either a Roth IRA if you qualify for one, your employer’s 401k especially if they have a matching contribution program, and then in taxable accounts through stock mutual funds. Dave Ramsey is especially fond of growth stocks thanks to their historic rate of return. The stock market has been struggling lately, but over the long term of almost one hundred years, the stock market has provided an excellent investment.
What Should You Invest Your Money In?
So, now that you know how much money you should be saving every month from your paycheck, then the ultimate question becomes where to put it? This is a problem that many people dwell on. Should you invest in individual stocks, bonds, mutual funds, or your company’s 401k? What about Roth IRAs? If you stick strictly to the Dave Ramsey method that he outlines in The Total Money Makeover, he recommends buying good growth stock mutual funds to help you build your nest egg for retirement. You should have a well diversified portfolio of stock mutual funds that include international stocks, mid-cap, small-cap, and large cap or capitalization companies. For most people, using a Roth IRA is one of the best tax advantages that you can find. By using after-tax dollars in a Roth IRA, you can withdraw your investment and its earnings tax free in retirement. Another investment that you should use first is a 401k if your company matches your contributions. Many employers match the first 3% of the investment that you make in a 401k. Not taking them up on that offer is essentially throwing away a 100% rate of return.
There is actually a rhyme to the reasoning as to where the 15% comes in. Dave Ramsey recommends 15% no more and no less. Investing more could hinder you from completing the next baby steps of funding your children’s college education and paying off your home mortgage early. Other things that are taken into consideration are the average rate of return for the stock market, inflation, how large a nest egg you will need to have in retirement, how many years you will invest before retirement, and how much of your nest egg you will withdraw. There are several great blogs such as Bible Money Matters and DoughRoller that have shown the detailed calcuations using Dave Ramsey’s financial calculators from his website to give you examples of how investing 15% works.