Financial Peace Lesson 7: Planning for retirement
(This post is part of my Finance Peace University Review series from 2019, and updated in 2020 with additional content!)
This review covers the 7th lesson in Dave Ramsey’s Financial Peace University Flex online course.
The previous lessons are covered in these posts:
- Week 1: Starting an Emergency Fund & Budgeting (Baby Step 1)
- Week 2: How to pay off debt using the Debt Snowball method (Baby Step 2)
- Week 3: How to build up a fully-funded 3 to 6-month emergency fund (Baby Step 3)
- Week 4: Retirement, homeownership, college, and building wealth (Baby Steps 4-7)
- Week 5: How to spend wisely and protect your wealth
- Week 6: The role of insurance in your defensive strategy
In this review of the Financial Peace week 7 lesson, Dave takes a deep dive into Baby Step 4 – saving for your retirement. He talks about how to invest, what to invest in, and how much to invest.
Financial Peace University “Flex” is the online version of this very popular personal finance course.
Rather than meeting in person like the signature small group format, FPU Flex is a self-study, web-based curriculum with access to an online community.
Over the course of 9 weeks, you’re taught smart money management strategies like budgeting, debt payoff, and financial planning through Financial Peace videos and downloadable worksheets.
Let’s get started!
Dave says invest 15% of your income
As mentioned above, saving for your retirement comes in Baby Step 4. That means by the time you get to this point, you have a hefty emergency fund in the bank and all of your debt (except the mortgage) is paid off.
If you’re on Baby Step 4, congratulations!!! You have already accomplished what most working Americans have only dreamed about.
However, there’s still work to do before you get to Financial Freedomville.
Getting out of debt and having a nice cushion is fantastic, but there’s still paying off your mortgage, funding a college account, and growing your retirement fund.
In order to do the first two effectively, Dave recommends investing 15% of your income for retirement.
No more, no less.
This percentage has proven to get you where you want to be by the time you retire, but also leave enough to pay off your house and save up for your kids’ college tuition (remember from week 4, these three are meant to be done simultaneously).
The total of this 15% should be invested in pre-tax retirement plans (like a 401(k)) and Roth IRAs (which is not pre-tax).
Dave uses a farmer as a metaphor for being a good financial manager – you need to know what to grow, how much to plant, and when to harvest.
That’s why it is *crucial* to educate yourself on how to be a wise and responsible investor. This means reading books and blogs, taking a class, finding helpful YouTube videos, and talking to people who know more than you do.
A good piece of advice that I’ve received from multiple self-help books is to find someone who’s already accomplished what you want to do, and then do what they do.
Success isn’t a secret nor is it complicated. Millions have people have done it before. You just need to find one or two that are willing to share with you how they got there.
Treat your money like manure
In other words, spread it around, so it can grow your money in different areas.
You don’t want to put all your money into a single investment. This increases your risk and makes you vulnerable to the highs and lows of that one individual holding.
With insurance, you’re transferring risk to someone else. With investing, you’re taking on risk in order to experience a profitable return on your money.
However, you want to minimize that risk so you don’t lose all your money due to one company’s decrease in value. This is called diversification.
Diversification is a risk management strategy that includes a wide range of investments in one portfolio.
The purpose of diversification is to average all the highs and lows within the portfolio, so your returns even out even though individual stocks might be soaring or tanking.
This is why Dave does not recommend investing in your company’s stock. Because if your company goes under, so does your job, your income, and your retirement fund.
So, yeah. Don’t do that.
A great way to diversify is by investing in a mutual fund. “Mutual” meaning two or more people mutually put their money into an investment, and “fund” meaning a sum of money.
So, in other words, a mutual fund is just a large sum of money used for investing, created by contributions from many different investors.
Now, the key is knowing how this large sum of money is handled. That’s the portfolio manager’s responsibility, and your job is to find out how responsible (and successful) this person has been in the past with other investment funds.
(*Dave tip: Never put your money into a fund that you don’t understand.)
Because a mutual fund is a diversified investment, your returns aren’t based on one stock’s performance or a single, fixed rate of return. The returns you realize are the result of the fund’s value as a whole.
So, if the majority of the stocks in the mutual fund increase in value, then you will realize a positive return – even if there were a few that took a nosedive. And, of course, vice versa.
There are different types of mutual funds, and their labels are self-explanatory:
- a bond fund is a mutual fund that invests in bonds
- an international stock fund is a mutual fund that invests in the stock of international companies
- a growth stock fund is a mutual fund that invests in companies that are growing (think Microsoft, Amazon, Starbucks)
It doesn’t matter which one you choose, all mutual funds are considered long-term investments (5 years or longer). If you put your money in them for the short-term, you will likely not optimize your investment.
Use the KISS method for investing
Yep, it is that acronym.
Keep It Simple Stupid.
Dave doesn’t teach or recommend complicated investment strategies.
In this course, he suggests the following investment mix for retirement planning, college funds, or just investing in general:
- 25% in Growth & Income Funds (consistent and predictable)
- 25% in Growth Funds
- 25% in International Funds
- 25% in Aggressive Growth Stock Mutual Funds (inconsistent and unpredictable)
In all of these mutual funds, there should be 90-200 stocks within each fund.
Having a mix of mutual funds in your portfolio (such as what’s listed above) is like diversifying your diversification.
Essentially, you would be spreading your money far and wide, giving you numerous opportunities to grow your wealth and decrease the risk.
Use the government’s money to get wealthy
Whenever you make any money, the government wants their share.
Typically, it’s a substantial amount – like, around 30%. That means if you grossed $70,000 last year, the government took about $21k of it.
So, when you have the opportunity to invest pre-taxed income, you get to keep the government’s share of your income and use it to increase your wealth!
This is really a no-brainer.
If your employer offers a retirement plan that you can contribute pre-tax income to, make sure you’re signed up. This would include:
- a 401(k)
- a 403(b) (for educators and non-profits)
- a 457(b) (for government employees)
- a SEP (for small business owners)
If your employer offers a matching contribution, make sure you are putting enough in to get the full match.
For example, my husband’s employer will match our contributions up to 3%. So, we make sure we are always putting in at least 3% so we get the full match. Get as much free money as you can!
However, if your employer doesn’t match, contribute anyway. It’s one of the best vehicles to grow wealth for retirement.
Dave also talks about the IRA – an Individual Retirement Agreement (or, as is more commonly known, “Account”). There are 3 main types:
- Traditional IRA: funded with tax-deductible income and income tax is deferred until you start withdrawing funds.
- Roth IRA: funded with after-tax income, but money is withdrawn tax-free.
- Rollover IRA: funded by “rollover” funds from an employer-sponsored retirement plan such as a 401(k).
As you can see, you can either contribute pre-tax income that grows tax-free but is taxed upon withdrawal. Or, you can fund your account with after-tax income that grows tax-free and is not taxed when withdrawn.
These are both considered tax-favored, which just means your money is in a qualified plan or has a special tax treatment.
According to Dave, you should always save long-term with tax-favored dollars whenever possible.
Some companies are now offering the Roth 401(k), which grows tax-free after you put in your after-tax portion. However, the match cannot be in Roth form. Instead, it will be traditional, meaning contributed pre-tax and then taxable on the matched portion for withdrawals.
Video: Dave Ramsey talks about investing for retirement
Dave’s list of things to NEVER do
If you change companies, never keep your retirement account with your old employer. Communication will be lacking and your investment choices will be limited. Instead, transfer the balance to a Rollover IRA and spread it across the investment types mentioned in the mix above.
Never bring the money home – ALWAYS do a direct transfer. Otherwise, you’ll get taxed on it – so always transfer your old 401(k) directly to an IRA. There is no cost and it will eliminate major potential problems.
NEVER borrow on your retirement plan. Dave says to never, ever, under any circumstances borrow from your 401(k).
You may get a lower rate on a 401(k) loan to pay a higher rate credit card, but you also “unplugged” a mutual fund that may have been paying you 12% or 15%.
Also, if you leave your company before you’ve paid off the loan, you’ll get hit with penalties and fees if you don’t pay it back within 60 days. Not worth it.
However, if you have taken out a loan on your 401(k) that you’re currently paying back, just add it to your debt snowball and get it paid off ASAP.
Then NEVER do that again.
(This course was created before COVID turned the world upside down, so if you had to take out a loan from your retirement fund just to stay afloat, those were dire circumstances. If you can, pay it back into your account instead of taking it out as a distribution.)
Related Post: 7 Steps To Catch Up On Retirement Planning
Dave’s order for retirement investing
We know the magic number is 15 – save 15% of your income for retirement.
We know the “mix” we’re looking for in our investments, and we know the types of investments that are out there.
But, how do we distribute that 15%? And what takes priority?
This is Dave’s recommendation for your retirement investment strategy, in order of priority:
- First, fund the percentage that equal’s your employer’s highest match in your employer-sponsored plan. So, if your company offers a contribution match of 3%, then put in 3%. Then you’ll already be 6% closer to your goal.
- Next, fund a Roth IRA (if you qualify). This is after-tax income, growing tax-free, and not taxed upon withdrawal. Put in the max you’re allowed.
- Finally, if you haven’t reached 15% of your income between the first two funds, then add more to your company’s retirement plan to round it up to the full 15%.
That’s it! K.I.S.S.!
And just remember – slow and steady wins the race. Put your blinders on, keep your head down, and continue pressing forward.
Tune out the fluctuations in the stock market, turn off the news and social media, and take your eyes off all the distractions around you.
This is a marathon, not a sprint. This isn’t getting rich quickly, it’s building wealth steadily.
If you commit to planting and growing the right seeds, eventually you will harvest a plentiful crop.