When Dave Ramsey teaches about investing, he always bases his mutual fund returns on the average rate of return of the entire stock market since inception.  Over its entire history, the stock market as a whole has averaged an annual rate of return of around 11.9%.  Some years have done a lot better and others have done a lot worse, but on average the return has been 11.9%.  Dave rounds that to 12% for discussion purposes.

Many of Dave’s critics counter with the argument that you cannot get a 12% rate of return in mutual funds.  However, in my Roth IRA alone I have 4 mutual funds that have averaged over 12% since their inception.    If you visit Morningstar, you will see that there are plenty of mutual funds that have had a long-term rate of return greater than 12%. 

The key is to pick mutual funds that have a long-term track record.  The mutual fund should have been open for at least 10 years and averaged at least 12% over that time.  Also, as an investor, you must have a long-term mentality when investing in mutual funds.  If you cannot leave your money alone in the mutual fund for at least 5 years, then you should not invest.

Below are the four mutual funds in my Roth IRA that meet the criteria above.  They are all part of the American Funds family.  The Fund Lifetime Rates of Return are all as of March 31, 2010.

A disclaimer is in order here…  By no means am I advising you to invest in these funds.  If you are interested in them, then you should review their prospectus carefully and decide for yourself if they are right for you.  My point here is not to recommend a specific fund or fund family.  My point is to dispel the myth that a 12% rate of return is not possible, because that is simply not true.

Fundamental Investors (growth-and-income fund)
Class A shares
Fund Number       10
Ticker/Quotron Symbol     ANCFX
Newspaper Abbreviation     FdInvA
CUSIP Number     360802 10 2 
Fund Inception  August 1, 1978
Fund Lifetime Rate of Return:  12.52%

The Growth Fund of America® (growth fund)
Class A shares
Fund Number       05
Ticker/Quotron Symbol     AGTHX
Newspaper Abbreviation     GwthA
CUSIP Number     399874 10 6 
Fund Inception  December 1, 1973
Fund Lifetime Rate of Return:  13.79%

The Investment Company of America®  (growth-and-income fund)
Class A shares
Fund Number       04
Ticker/Quotron Symbol     AIVSX
Newspaper Abbreviation     ICAA
CUSIP Number     461308 10 8 
Fund Inception  January 1, 1934
Fund Lifetime Rate of Return:  12.18%

New Perspective Fund® (growth fund)
Class A shares
Fund Number       07
Ticker/Quotron Symbol     ANWPX
Newspaper Abbreviation     N PerA
CUSIP Number     648018 10 9 
Fund Inception  March 13, 1973
Fund Lifetime Rate of Return:  12.65%

Baby Step 4 of Dave Ramsey’s Plan is to invest 15% of your household income into Roth IRAs and pre-tax retirement plans.  At this point, because you have your Emergency Fund in place and are out of debt except for your home mortgage, you should easily be able to put away 15% for retirement.  Do not, however, put more than 15% into retirement at this Baby Step because there are still other Baby Steps to tackle first.

Dave recommends that you invest in 4 categories of mutual funds within your retirement plans:

Growth (Large Cap)
Growth and Income (Mid Cap)
Aggressive Growth (Small Cap)
International

Dave does not recommend that you ever invest in single stocks, bonds, commodities, CDs, or permanent life insurance, either inside of or outside of your retirement plans.

Because of different income levels or job benefits, not everyone has available all of the different types of retirement plans.  For example, if your income is too high, then you do not qualify to invest in a Roth IRA.  Likewise, your company may not offer a pre-tax retirement plan like a 401(k) or 403(b).  However, if you have both types of retirement plans available to you, then Dave recommends that you invest in them in this order:

Pre-Tax Retirement Plan With Company Match: If your company matches any portion of your savings into a pre-tax retirement plan, then you should invest enough to get all of the match that they offer.  Most companies match between 3-6% of employee contributions.

Roth IRA: Currently, the limits for Roth IRA contributions are $5,000 for an individual or $10,000 for a married couple who files a joint tax return.  Invest into your Roth until either you reach 15% of your income, or until you max it out, whichever comes first.

Pre-Tax Retirement Plan Without Company Match: If you have invested enough in your pre-tax retirement plan to get all of the match that your company offers and then you have maxed out your Roth IRA for the year and you still haven’t reached 15% of your household income, then you should go back and top off your retirement savings in your pre-tax retirement plan until you reach a total of 15% of your income.

As an example of how to determine the order of priority for your retirement investing, assume that your situation matches the profile below:

Household Income:  $100,000
Retirement Contribution for Baby Step 4:  $15,000 ($100,000 x 15%)
Company Offers Pre-Tax Retirement Plan with 3% Match
Married Filing Jointly

You should invest $3,000 ($100,000 x 3%) into the Pre-Tax Retirement Plan in order to take advantage of the company match.  That leaves $12,000 to be invested.

Next, open two Roth IRA accounts (one for each spouse) and max them out for the year by investing $5,000 in each one for a total of $10,000.  That leaves $2,000 to be invested.

Finally, return to your Pre-Tax Retirement Plan and invest the remaining $2,000.

When my wife and I arrived at Baby Step 4 in Spring 2009, we scheduled an appointment with one of Dave Ramsey’s ELP’s (Endorsed Local Providers) for Investing.  There was no charge to meet with them and there was no pressure to buy anything.  They explained all of our options with the heart of a teacher, and worked with us to select mutual funds with low expense ratios and long track records of great returns.  We opened our two Roth IRAs that day and have been very pleased with the results.

My company matches 6% of our 401(k) contributions, so we already had 6% going into that.  After maxing out the Roth IRAs, we added another 2% to my 401(k) to reach our 15% goal.

Investing for retirement can be a very complicated matter because of all of the choices out there.  Be sure to visit daveramsey.com for more information about Dave’s Investing Philosophy.