Ramit Sethi breaks down the order to prioritize retirement savings: grab your 401k match first, then pay off credit card debt, then max a Roth IRA, then go back to your 401k. Skip a 401k without a match and choose a Roth instead if you're young.
$5,000
about $16,000
up to 5%
Got this question from Pharrell in San Diego. He asks, if my employer doesn't match 401k contributions, should I still contribute to it? Is a Roth IRA a better option? That's a great question. The other day, I was reading this wonderful book by a young, charming young man, and I found just the perfect answer in it. And it's called the Ladder of Personal Finance. So here's how you want to think about it. Everyone wonders, I have this money sitting around. What should I be doing with it? So here's a little approach when it comes to investments. First of all, if you have a 401k match at your office, take it. Take it before anything else, because that's free money. It basically means for every dollar you put in, they'll contribute 50 cents, often $1, to whatever you put in. Free money. So take that up to the match. They'll say something like, you know, we limit it up to 5%. Do it. Just ask your HR person what that number is. Then pay off your credit card debt. Usually credit card debt is in a very high interest rate. So I like for you to do that with the rest of your money that you have now. You still have money. You should still have money left over. I would like you then to go to a Roth ira. Now, for young people, a Roth IRA is a terrific option because basically what you're doing is you're taking money after taxes. You're putting it here, and your money grows and grows and grows, and you pay no taxes on the earnings. So just to give you an example, if you'd invested in Southwest around 1970, when it pretty much open, you would have put $10,000 in there. By the time you took it out in 2000, it would have been worth $10 million. If they had Roth IRAs back then, you would have only paid taxes on the $10,000, not on the 9 million plus that you made in earnings. Now, you're not smart enough to get a Southwest type of stock. In fact, you shouldn't even be picking individual stocks. None of us should. But the point stands. You do not pay taxes on your earnings, which is a massive benefit. Now, if you still have money left over after contributing $5,000 to your Roth IRA in a year, and go back to your 401k and contribute beyond the match, you can usually contribute around $16,000 to your 401k. If you still have money left over, give me a call. Let's go out for drinks on you. But what else you can do with that is you can basically start putting it aside in a savings account. You can start investing even in taxable accounts. So that's how you think about your ladder of personal finance, in terms of what should you do with all the money that comes in. In answer to your specific question, Pharrell you based on the ladder of personal finance, what you'll discover is no, if it's not a 401k with a match, I would actually just skip that. I would go right to the Roth ira, because you're going to get far more benefits, particularly as a young person. That's my answer.
