Ramit Sethi outlines a simple, ordered "hierarchy of investing": (1) contribute enough to your 401(k) to get the full employer match (described as "free money"), (2) pay off personal debt, (3) max out a Roth IRA (preferred for wider investment choices), (4) return to the 401(k) to increase contributions up toward the annual limit (speaker cites roughly a little over $15,000/year), and (5) if funds remain, invest in a regular taxable account. The hierarchy is justified primarily by tax benefits (tax-deferred growth in 401(k), tax-free growth in Roth) and simplicity; speaker favors life-cycle/index funds for actual investment selection.
Questions this video answers
February 17, 2009.
"Roughly a little over $15,000 a year."
"Maybe up to 5% of your income, 1 to 1."
Chapters
Your hierarchy of investing starts at your 401k match. If your company, your employer, gives you a 401k match, you want to put as much money as you can to get that 401k match. That's free money. You've got to do it. Even if you have debt, you want to do that 401k match, okay? After you get that match, maybe up to 5% of your income, 1 to 1, then you want to take your money and pay off your debt. Now, this is debatable. A lot of people will say, well, my interest rate on my debt is low. For those people you can certainly debate, maybe you decide you want to keep your debt going at a minimum interest rate, fine. But for the vast majority of people, after you do step one, which is your 401 match, then you want to pay off your debt. Once you pay off your debt, then you want to go into investing and maxing out your Roth IRA. Your Roth IRA is a little different than your 401k, but you can pick. You have a much wider choice and variety of investment choices. So you want to do your Roth ira. After you max out your Roth ira, if you still have money, you want to go back to your 401. Remember the 401, you can invest roughly a little over $15,000 a year. You only did the match. So then you did your debt, then you did your Roth, Harry. Now, if you have money, you're going back to your 401k and you're going to invest as much as possible to max that out. Okay? By now, if you've invested all this stuff, you've invested over $20,000 a year, which is quite a bit. If you still have money left over, then you can go back and create what's called a regular taxable investment account. This is very simple. You just basically open up an account, it's not shielded by any tax benefits like a 401k or Roth IRA and you can invest there. So all that sounded a little confusing and I want to bring it back to what matters, which is why do you Invest in a 401k? Why do you then do your debt, why do you then do your Roth, etc. And the reason really is for tax benefits. And it's not just taxes for the sake of taxes. The fact is that you can save 20 or 30% by investing in something that is tax deferred. So when you do something like a 401k, normally you would get $100 and you would give away 20 or $30 to the tax man, and you'd be left with about 70 bucks to go invest. With a 401k, you can actually have $100 working for you, compounding until you take that money out. A Roth is just the opposite. You pay your taxes like normal, and then any money you earn, you don't have to pay taxes on in the future. So the main point is, with a hierarchy of investing, you stop worrying about, should I do this in my 401k? Should I just do 20% here and there? You have very clear steps as to what to do. And once you put your money in those accounts, then where to invest is a whole other story. As you know, I prefer life cycle funds. They're very simple. They're basically automatic index funds. But there are many other choices. Those are the investments I like.
