Mutual Fund Investing: Dave Ramsey's Guide For Beginners

Investing in mutual funds is a proven way to build wealth and retire a millionaire. Mutual funds are actively managed by a team of investment professionals who select a mix of investments to include in the fund based on its objective. Dave Ramsey recommends investing 15% of your gross income every month for retirement. Before investing, it is important to pay off all debt (except for your house) and build a solid emergency fund. When investing in mutual funds, Ramsey suggests dividing your investments equally across four types of funds: growth and income, growth, aggressive growth, and international. It is also important to work with a financial advisor to help manage your investments and stay engaged with your investment strategy.

Calculate your investing budget

Before you start investing, it's important to calculate your investing budget. This means figuring out how much money you can and want to invest.

First, make sure you've paid off all your consumer debt and saved an emergency fund of 3–6 months' worth of expenses. This will give you a solid financial foundation to build wealth from.

Then, when you're ready to start saving for retirement, invest 15% of your gross income every month. This is a general rule that has been shown to help people become millionaires by saving consistently over time while still having money for other financial goals, like saving for children's education or paying off a mortgage.

For example, if you make $50,000 per year, your goal should be to invest $625 per month for retirement. If you invest that amount every month from age 35 to 65, you could end up with over $1.7 million for retirement, even if you don't get a single raise.

Of course, it's important to remember that everyone's situation is unique, and you may want to consult a financial advisor to discuss a plan that's tailored to your specific circumstances.

Open tax-advantaged retirement accounts

Once you've paid off all your debts and built a solid emergency fund, you can start investing 15% of your gross income every month for retirement. This 15% figure is based on the millions of Americans who have become millionaires by saving this amount consistently over time while still having enough money for other financial goals.

If you make $50,000 per year, your goal should be to invest $625 for retirement each month. If you invest that amount in good growth stock mutual funds every month from age 35 to 65, you could end up with more than $1.7 million for retirement.

The best place to start investing in mutual funds is in tax-advantaged retirement savings accounts such as a workplace 401(k) plan or a Roth IRA. If your employer offers a company match on your 401(k) contributions, that's free money and an instant 100% return on your investment. However, don't count the match as part of your 15% goal.

If you have a traditional 401(k) at work with a match, invest up to the match, then you can open a Roth IRA. With a Roth IRA, the money you invest in mutual funds goes further because you use after-tax dollars, which means you won't have to pay taxes on that money when you withdraw it in retirement. The only downside to a Roth IRA is that it has lower contribution limits than a 401(k). If you max out your Roth IRA without reaching your 15% goal, you can simply go back to your 401(k) and invest the rest there.

If you're self-employed or a small business owner and don't have access to a 401(k), you can save for retirement with a SIMPLE IRA or SEP IRA. A SIMPLE IRA plan allows you to save for your retirement while also contributing to your employees' retirement savings. A SEP IRA is another retirement plan option for small business owners or the self-employed, but only employers are allowed to contribute to SEP IRAs on behalf of their employees.

Pick the right mix of mutual funds

Picking the right mix of mutual funds is crucial to building a robust investment portfolio. Here are some tips to help you choose the right mix:

• Growth and Income Funds: These funds create a stable foundation for your portfolio by investing in large, well-known American companies, often referred to as "big and boring," that have been around for a long time. Examples include big-name companies like Toyota, Samsung, and Nestlé. These companies offer goods and services that people use regardless of the state of the economy. Look for funds with a history of consistent growth and dividend payments.
• Growth Funds: Growth funds focus on medium to large American companies experiencing growth. These companies are more sensitive to economic shifts and tend to ebb and flow with the market. They often produce the latest trendy products or luxury items.
• Aggressive Growth Funds: Think of these funds as the high-risk, high-reward portion of your portfolio. They invest in smaller companies with high growth potential. When these funds are up, they are really up, but when they're down, they can be way down.
• International Funds: International funds diversify your portfolio by investing in large non-US companies. This helps spread your risk beyond the US market. Be careful not to confuse international funds with world or global funds, which combine US and foreign stocks.

A well-diversified portfolio should have a mix of these four types of funds. Aim for a balance by investing an equal proportion of your money in each category. This strategy ensures that your investments are spread across different types of companies and sectors, reducing the overall risk of your portfolio.

When choosing specific mutual funds to invest in, look for funds with a strong track record of performance. Opt for funds that have consistently outperformed their peers over the long term (at least 10 years). Additionally, consider the fund's expense ratio, turnover ratio, and the experience of the fund manager. A good mutual fund should have a low expense ratio (below 1%), a low turnover ratio (indicating confidence in their investments), and a manager with at least 5-10 years of experience.

Remember, investing in mutual funds is a long-term strategy. Don't panic if the market experiences temporary downturns. Stay focused on your investment goals, and if needed, consult a financial advisor to guide you through the process.

Understand mutual fund lingo

Mutual funds are a great way to invest for your retirement, but it's important to understand the jargon before you get started. Here's a breakdown of some key terms to help you get started:

• Asset allocation: This refers to spreading your investments across different types of assets to minimise risk and maximise growth. It's a way to diversify your portfolio and reduce the overall risk.
• Cost: Understand the fee structure of your financial advisor and the fund's expense ratio. A ratio higher than 1% is considered expensive.
• Large-, medium- and small-cap: 'Cap' stands for 'capitalisation', which means money. However, in investing terms, it usually refers to the size and value of a company. Large-cap companies are larger and more established, with lower risk but lower returns. Medium-cap companies are moderately risky, while small-cap companies are the riskiest but offer the potential for bigger payoffs.
• Performance (rate of return): Look for funds with a strong and consistent history of returns over the long term (10 years or more). You want a fund that consistently outperforms others in its category.
• Portfolio: This simply refers to the collection of all your investments.
• Sectors: Sectors refer to the types of businesses or industries the fund invests in, such as financial services, healthcare, or technology. A diverse range of sectors means the fund is well-diversified.
• Turnover ratio: This refers to how often investments are bought and sold within the fund. A low turnover ratio (10% or less) indicates that the management team is confident in its investments, while a high ratio may suggest they are trying to time the market for bigger returns.

Understanding these terms will help you make more informed decisions about your mutual fund investments and work effectively with your financial advisor.

Manage your investment portfolio

Managing your investment portfolio is an important part of investing in mutual funds. Here are some tips to help you manage your portfolio effectively:

• Work with a financial advisor: Consider working with a financial advisor or investment professional who can provide guidance and expertise. They can help you choose the right mutual funds, stay on track with your investment strategy, and make informed decisions.
• Regular check-ins: Schedule regular check-ins with your financial advisor, whether it's once a year or once a quarter, to review the performance of your mutual funds and make any necessary adjustments to your portfolio.
• Long-term perspective: Maintain a long-term perspective when investing in mutual funds. The stock market will have its ups and downs, but historically, it has always recovered. Focus on long-term growth rather than short-term gains.
• Diversification: Diversify your portfolio by investing in different types of mutual funds, such as growth and income, growth, aggressive growth, and international funds. This helps to minimize risk and maximize returns.
• Performance and fees: Pay attention to the performance of your mutual funds over the long term (at least 10 years). Choose funds with a strong track record of consistent returns. Also, consider the expense ratios and fees associated with the funds to ensure they are not too high.
• Turnover ratio: Look at the turnover ratio, which indicates how often investments are bought and sold within the fund. A low turnover ratio (10% or less) shows that the management team has confidence in its investment choices.

Frequently asked questions