This is part 2 of the money priorities where we analyze Dave Ramsey’s 7 Baby Steps.
For those who have not read the first part where we looked into Baby Steps 1-3 click here.
Step 3: Save 3-6 months of expenses
Congratulations! You’ve made it to Step 3, and that’s definitely something to celebrate 🎉
Why celebrate you might ask? Let’s talk about a staggering statistic. In 2023, Americans carried a whopping $986 billion in credit card debt, according to data from LendingTree. To put it into perspective, that’s even more than the combined value of companies like Tesla, NVIDIA, and Meta! It’s mind-boggling! So, if you’re not part of that $986 billion, I genuinely applaud your financial wisdom—kudos to you!
However, there’s more work to be done. Step 3 builds upon Step 1, and to be honest, it shouldn’t be as challenging as Step 2 for most people. If you recall, instead of the $1000 initial emergency fund that Ramsey suggested, I recommended saving 1-2 months of expenses. Now, for Step 3, I suggest taking it a step further and saving up to 6 months’ worth of expenses. If you’ve already set up a separate High Yield Savings account with a reputable bank for Step 1, you can combine your savings and gradually increase your reserves. Remember to maintain at least the established amount in your emergency fund at all times. If you ever need to dip into it for any reason, make it your top priority to replenish the fund as soon as possible.
By setting aside 6 months’ worth of expenses, you’ll likely be well-prepared to handle any unexpected events that life throws your way. More importantly, having this financial safety net will provide you with a priceless peace of mind. It’s like having insurance for your finances—a valuable asset indeed!
Step 4: Invest 15% of your household income in retirement
This step may pose challenges for some Asian Americans due to their upbringing and cultural beliefs. There is a prevailing notion that investments beyond real estate are considered risky. This belief may stem from experiences like witnessing their parents’ investments suffer significant losses during events like the “dot com” bubble in 2000, the financial crisis of 2008, or the recent market downturn caused by Covid.
However, if we observe the historical performance of the market, we can see that despite those drops, it eventually recovered and continued to reach new all-time highs. This highlights the importance of time as a valuable asset in investing. There’s a saying that “Time in the market beats timing the market.” While I could delve deeper into my investment philosophies, I’ll save that for future posts.
Moving on to Step 4 of Ramsey’s plan, it recommends contributing 15% of your pre-tax income to retirement accounts. The priority order for retirement account contributions is as follows:
- 401k up to the company match: This may vary depending on your company’s policy, but let’s say your employer matches your contributions dollar for dollar up to 5% of your salary. It’s highly recommended to take full advantage of this benefit because it’s essentially free money. You’re receiving a 100% return on your investment from day one, and you get to enjoy the growth it generates. It’s a no-brainer in my opinion. In fact, I wouldn’t argue if you told me you did this even before paying off your debt.
- Roth IRA: Roth IRAs work by investing money that has already been taxed (i.e., your take-home pay) into the IRA. The best part is that withdrawals after the age of 59.5 are tax-free. However, there are certain limits to consider. For example, there is an annual maximum contribution (in 2023, it’s $6,500 or $7,500 if you’re 50 or older) and an income requirement that must be met. In 2023, if you’re single and your income exceeds $153,000, or if you’re married filing jointly and your income exceeds $228,000, you are not eligible for a Roth IRA.
- Back to 401k: If you’ve taken advantage of the 401k match and contributed to a Roth IRA but still haven’t reached the 15% mark, it’s advisable to contribute more to your 401k, even without additional matching from your employer. Keep in mind that there are annual contribution limits for 401k accounts (in 2023, it’s $22,500).
- Brokerage account: If you’ve followed the previous steps and still haven’t reached the desired 15% contribution or wish to invest more, congratulations! You likely have a higher income that disqualifies you from a Roth IRA, and the $22k limit in your 401k falls short of the 15% target. In such scenarios, I recommend opening a brokerage account that allows fractional share purchases and facilitates automatic monthly investments. Choose low-cost index funds or target-date funds and set up automatic withdrawals from your bank account for monthly purchases. This account should be straightforward and low maintenance, much like your 401k. Keep in mind that this account is subject to taxes on sold profits. However, the intention is to hold these funds for many years to come.
