Ramit Sethi is the host of the Netflix show “How To Get Rich,” as well as a New York Times bestselling author and the host of the “I Will Teach You To Be Rich” podcast. In an Oct. 24 newsletter post, Sethi addressed the concerns of a reader whose friend made an incredible investing blunder that is unfortunately all too common.
To help readers avoid what Sethi called a “$9,000 mistake,” he outlined the steps that all investors should remember when it comes to depositing money into an investment account. Here’s a look at Sethi’s comments, along with a deeper dig into tips you can use to avoid falling into the same trap.
Depositing Without Investing
To understand the “$9,000 mistake” Reithi referred to in his newsletter, it’s important to highlight the all-too-common investor mistake of depositing money into an account without investing it.
When you deposit money into an IRA, for example, that money essentially just sits there unless you actively invest it. In some cases, it will automatically sweep into a savings account of some kind, but at many firms, it will literally just sit there and remain completely uninvested. Neither scenario will help you very much in terms of building your retirement nest egg.
The confusion lies in the fact that some investors think that a retirement account like an IRA is an actual investment in and of itself. Retirement accounts — or any investment accounts, for that matter — are simply places to hold money. To actually get a return on your money, you’ll have to pick and choose your own investments, be they stocks, bonds, mutual funds, ETFs or other options. If you don’t actually select an investment and enter a buy order, your money will just sit in the account, earning little to no return.
The mistake is understandable for those with little investment experience or those whose only source of savings is through a workplace 401(k) plan. If you have a 401(k), money comes out of your paycheck every month and is automatically invested into the portfolio you have chosen, so it may seem as if putting money into an account is sufficient to get it invested. But you’ll have to remember that when you first gained access to your 401(k), you likely had to set up your own portfolio of investments where your money would be allocated monthly.
Why Is That a ‘$9,000 Mistake’?
The “$9,000 mistake” Sethi describes in his newsletter refers to a woman who diligently contributed to her Roth IRA for 10 years but whose account value barely budged. It turns out that while the woman had been saving regularly, she neglected to actually invest the funds in her Roth IRA. By Sethi’s calculations, the $3,000 the woman invested should have grown to over $12,000 over that time period, accounting for the “$9,000 mistake.”
How To Avoid This Type of Mistake
Sethi highlights that the woman took two important steps that should have put her on the path toward retirement success: opening a Roth IRA and funding it. However, perhaps the most essential step was overlooked, which is actually investing the money in the account.
As Sethi describes it, “A Roth IRA is just an account. Once your money is in there, you have to start investing in different funds to see your money grow.”
One of the best ways to ensure that you get funds in your account to begin with is to automate your contributions. Nearly any bank or financial institution makes it easy to automatically transfer money from your regular account to your retirement or investment account. This removes emotion from the process and also prevents you from forgetting to save.
The most important step is to understand that you need to get your savings invested if you are to reach your retirement goals. Here are three scenarios showing in black and white the huge differences between investing your savings and simply making the deposits.
Under the optimal scenario, if you were to sock away $400 per month and earn 10% annually on your contributions for 30 years, you’d end up with over $900,000 as a nest egg.
However, if you didn’t actively invest that money, one of two other — and very different — scenarios would unfold. If your account automatically swept your contributions into a high-yield savings account — which is unlikely but possible — even with interest rates at the highest levels they’ve been in 40 years, you’d still earn only about 5% on your money. After investing $400 per month for 30 years, your account would grow to only about $333,000.
But, in the most likely scenario, if you simply deposited money but didn’t actively invest it, it would just sit in your account. After 30 years of contributing $400 per month, you would have a balance of just $144,000. That would amount to a $756,000 mistake, which would obviously have life-changing ramifications.
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