Investing your money is crucial to building wealth. But where, exactly, should you be putting your funds?
There are lots of opinions on the best types of accounts to use, but here’s what financial expert Dave Ramsey thinks is the best approach to distributing your investment dollars.
Get an emergency fund
First and foremost, Ramsey stresses the importance of having an emergency fund before you invest. Your emergency fund is money that’s set aside to cover unexpected expenses, and it’s a good idea to have three to six months’ worth of bills in this account. It should be easily accessible, rather than invested. That means it should be in a high-yield savings account where you can withdraw cash when you need it without incurring penalties or having to sell investments at a loss because you need the money quickly.
Once you have an emergency fund, however, Ramsey has some other suggestions for which investment accounts you should use.
Find the right retirement account for you
Specifically, Ramsey advises that you should first put your money into a workplace 401(k) if your employer has one available to you. He recommends investing in your 401(k) up to the amount of your employer match. (An employer match is a contribution that your employer makes when you invest in your account.) Not all companies offer this type of retirement account, but if yours does, it’s free money for the future. And Ramsey believes you should claim as much of it as you can.
However, if your employer offers a Roth 401(k), Ramsey says that is preferable to a traditional one. You contribute to a Roth 401(k) with after-tax dollars. That means your contribution isn’t tax deductible when you make it. But your money grows tax free, and you can withdraw cash without paying taxes as a retiree. A smaller number of employers offer Roth 401(k) accounts compared with traditional accounts, though, so if you don’t have access to one, Ramsey recommends starting with the traditional account.
Once you’ve invested enough to earn your employer match, Ramsey suggests investing the rest of your money in a Roth IRA. This is a favored account among many experts, including Suze Orman. Like Roth 401(k)s, Roth IRAs allow tax-free growth and withdrawals (although, just like with Roth 401(k)s, you don’t save on taxes in the year of your contribution). Ramsey likes these tax-free features, and he recommends automating contributions to your Roth if your brokerage firm allows it (most do).
Finally, Roth IRAs have maximum contribution limits that are lower than those of a 401(k), so Ramsey suggests that if you have maxed out the amount you can contribute to a Roth IRA and still have money left over to invest, then you should go back to your 401(k) and put the remainder there.
The good news is, you don’t need an employer to open a Roth IRA for you, so this Ramsey-preferred account is widely available even to people whose companies don’t offer retirement plans. In fact, many online brokerage firms let you open and contribute to this type of account. So check out the best Roth IRA accounts and find one that works for you.
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Gallery: 11 Savvy Tax Decisions That Could Save You Thousands (The Motley Fool)
Lower those tax bills
1. Know whether to itemize versus claim the standard deduction
2. Bundle deductions for a greater tax write-off
3. Keep solid records of business expenses
4. Hold investments at least a year and a day
5. Load up on dividend stocks
6. Sell losing investments strategically
7. Buy municipal bonds
8. House your retirement savings in an IRA or 401(k)
9. Take advantage of an HSA
10. Sign up for an FSA
11. Hire a tax professional
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