Ramit’s investing approach: Follow the Ladder of Personal Finance
There are six steps you should take to invest.
Each rung of the ladder builds on the previous one, so when you finish the first, go on to the second. If you can’t get to the sixth step, don’t worry—do your best for now.Â
Here’s how it works:
Rung #1: Contribute to your 401k
Each month you should be contributing as much as you need to in order to get the most out of your company’s 401k match. That means if your company offers a 5% match, you should be contributing AT LEAST 5% of your monthly income to your 401k each month.
A 401k is one of the most powerful investment vehicles at your disposal.
Here’s how it works: Each time you get your paycheck, a percentage of your pay is taken out and put into your 401k pre-tax.
This means you’ll only pay taxes on it after you withdraw your contributions when you retire.
Often, your employer will match your contributions up to a certain percentage.
For example, imagine you make $150,000 per year and your company offers 3% matching with their 401k plan. If you invested 3% of your salary (around $5,000) into your 401k, your company would match your amount, effectively doubling your investment.
Here’s a graph showcasing this:
This, my friends, is free money (aka the best kind of money).
Not all companies offer a matching plan — but it’s rare to find one that doesn’t. If your company offers a match, you should at least invest enough to take full advantage of it.
Where’s my 401k money going?
You have the option to choose your investments when you put money into a 401k. However, most companies also give you the option to entrust your money with a professional investing company. They’ll give you a variety of investment options to choose from and can help answer any questions you have about your 401k.
The other great thing about a 401k is how easy it is to set up. You just have to opt in when your company’s HR department offers it. They’ll withdraw only as much as you want them to invest from your paycheck.
When can I withdraw money from my 401k?
You can take money out of your 401k when you turn 59 ½ years old. This is the beginning of the federally recognized retirement age.
Of course you CAN take money out earlier — but Uncle Sam is going to hit you with a 10% federal penalty on your funds along with the taxes you have to pay on the amount you withdraw.
That’s why it’s so important to keep your money in your 401k until you retire.
If you should ever decide to leave your company, your money goes with you! You just need to remember to roll it over into your new company’s plan.
Rung #2: Pay off high-interest debt
Once you’ve committed yourself to contributing at least the employer match for your 401k, you need to make sure you don’t have any debt. If you don’t, great! If you do, that’s okay. I have 4 ways to help you get out of debt quickly.
Rung #3: Open a Roth IRA
Once you’ve started contributing to your 401k and eliminated your debt, you can start investing into a Roth IRA. Unlike your 401k, this investment account allows you to invest after-tax money and you collect no taxes on the earnings. There’s a maximum for how much you can contribute to your Roth IRA, so stay up to date on the yearly maximum.
Unlike a 401k, a Roth IRA leverages after-tax money to give you an even better deal. This means you put already-taxed income into investments such as stocks or bonds and pay no money when you withdraw it.
When saving for retirement, your greatest advantage is time. You have time to weather the bumps in the market. And over the years, those tax-free gains will prove an amazing deal.
Your employer won’t offer you a Roth IRA. To get one, you’ll have to go through a broker.
There are a lot of elements that can determine your decision, including minimum investment fees and stock options.
A few brokers we suggest are Charles Schwab, Vanguard (this is the one I use), and E*TRADE.
NOTE: Most brokers require a minimum amount for opening a Roth IRA. However, they might waive the minimum if you set up a regular automatic investment plan.
Where does the money in my Roth IRA get invested?
Once your account is set up, you’ll have to actually invest the money.
Let me say that again, once you set up the account and put money into it, you still need to invest your money.Â
If you don’t purchase stocks, bonds, ETFs, or whatever else, your money will just be sitting in a glorified savings account not accruing substantial interest.
My suggestion for what you should invest in? An index fund that tracks the S&P 500 and is managed with barely any fees.
For more, read my introductory articles on stocks and bonds to gain a better understanding of your options. Or, you can watch my deep dive into how you can choose a Roth IRA:
