Young Investors: Embrace High-Risk, High-Reward Strategies

Investing in your 20s is a great way to prepare for your future. While it may seem daunting, starting early can have a huge pay off. The power of compound growth means that the earlier you start, the less you have to save each year. For example, if Madison starts investing $5,000 a year from the age of 20, by the time she turns 65, she will have accumulated over $1,000,000. However, if she starts at 40, she would need to save $20,000 a year to achieve the same nest egg.

- Determine your investment goals and risk tolerance

- Contribute to an employer-sponsored retirement plan, such as a 401(k) or Roth 401(k)

- Open an individual retirement account (IRA)

- Find a broker or robo-advisor that meets your needs

- Keep short-term savings somewhere easily accessible

- Increase your savings over time

Understand risk and return

When it comes to investing, it's important to understand the relationship between risk and return. This is a key concept for making informed investment decisions and creating a personalised investment plan. Here's what you need to know about risk and return:

• The higher the risk, the greater the potential reward. Similarly, lower-risk investments tend to offer smaller rewards. This means that if you're willing to take on more risk, you may have the potential for higher returns. However, it's important to remember that higher-risk investments also come with a greater possibility of loss.
• Younger investors like yourself can generally afford to take on more risk than older investors, especially when it comes to retirement planning. As a 20-year-old, you have a longer time horizon, which means you have more time to recover from any potential losses. This makes it a good time to consider riskier investments that could lead to higher returns over the long term.
• It's important to assess your own risk tolerance. How comfortable are you with the possibility of losing some or all of your investment? If you're investing for the long term, such as for retirement, you may be able to take on more risk. However, if you're investing for shorter-term goals, you may want to consider more conservative investments.
• Different types of investments come with varying levels of risk. For example, stocks are generally considered riskier than bonds, while money market funds and certificates of deposit (CDs) are typically seen as low-risk, low-return investments.
• Diversification can help you manage risk. By spreading your investments across different asset classes, such as stocks, bonds, and cash, you can reduce the impact of any single investment loss. This is often achieved through asset allocation, which involves dividing your investments among different types of assets based on your risk tolerance and investment goals.
• Your investment plan should also take into account factors such as your financial goals, time horizon, and current financial situation. It's important to periodically review and adjust your investment plan as your circumstances change.

Start investing early

Starting to invest early in life can have a significant impact on your long-term financial goals. Here are some reasons why you should start investing early:

Compounding Growth

Compound interest is a powerful tool for growing your wealth over time. The earlier you start investing, the more time your money has to grow and benefit from compound interest. Even with a modest amount of money, investing early can lead to substantial returns over several years. The power of compounding growth means that your investments can yield far greater returns over a lifetime compared to starting a few years later. This is because the interest earned gets added to the principal amount, and the new total then earns interest. As a result, your wealth grows at an accelerated rate.

Time is on Your Side

When you start investing in your 20s, time is on your side. The longer you invest, the more potential your investments have to grow. This means that you don't have to save as much each year to reach your financial goals. By starting early, you can contribute smaller amounts over a more extended period, which can be more manageable, especially if you have other financial priorities.

Higher Risk Tolerance

As a young investor, you can afford to take on more risk in your investment portfolio. Generally, younger people can tolerate higher-risk investments with higher rates of return because they have more time to recover from any potential losses. Higher risks can lead to higher rewards, and starting early gives you the advantage of being able to ride out any market volatility.

Financial Freedom

Investing early gives you more control over your financial future. It allows you to build a substantial investment portfolio over time, which can provide financial freedom and security when you're older. Starting early means you may not have to work as hard to achieve your financial goals, and you'll have more options when it comes to retirement planning.

Building Good Financial Habits

Starting to invest early in life helps you develop good financial habits. It encourages you to be more intentional with your money and can lead to better financial discipline. By setting financial goals and creating a spending plan, you can ensure that you're saving and investing effectively.

In conclusion, starting to invest early in life can be a wise decision due to the power of compounding growth, having more time on your side, a higher risk tolerance, and the potential for achieving financial freedom. It also helps you build good financial habits and sets you up for a more secure future.

Manage debt and build an emergency fund

As a 20-year-old, you may be eager to start investing, but it's important to manage your debt and build an emergency fund first. Here are some steps to help you get started:

Manage Debt

• Make a list of all your debts, including credit card debt and student loans.
• Create a debt repayment plan by listing your debts in order of balance size and making minimum payments on all of them.
• Allocate any extra money to pay off the smallest debt first. This is known as the snowball method and can help you reduce the number of debts you have quickly.
• Stay on top of your student loan payments to avoid defaulting on your loans, which can negatively affect your credit score.
• Consider debt relief options such as debt consolidation loans or refinancing if you're struggling to make payments.

Build an Emergency Fund

• Calculate your monthly expenses, including rent, car payments, student loans, groceries, and utilities.
• Aim to save enough to cover at least three months' worth of expenses, ideally six months' worth.
• Set up two emergency funds: one for short-term emergencies (e.g., car repairs) with $500 to $1,500, and another for long-term emergencies (e.g., job loss) with at least three months' living expenses.
• Open savings accounts specifically for your emergency funds, preferably at a different bank from your checking account to reduce the temptation to spend it.
• Look for banks with high annual percentage yields (APY) to earn interest on your savings.
• Use tax refunds, part-time income, or cost-cutting measures to build your emergency fund faster.
• Automate your savings by setting up recurring transfers from your checking account to your savings account.
• Keep your emergency fund in a safe and accessible place, such as a bank account, prepaid card, or cash at home.

By managing your debt and building an emergency fund, you'll be in a stronger financial position to start investing. Remember to educate yourself about investing, set clear financial goals, and understand your risk tolerance before diving into the world of investing.

Open retirement accounts

Opening a retirement account in your 20s is a great way to maximize your earnings with compound interest and avoid the risk of outliving your savings. There are several options to consider when choosing a retirement account, each with its own pros and cons. Here are some things to keep in mind as you think about opening a retirement account:

Types of Retirement Accounts

• Employer-Sponsored 401(k) or 403(b) Accounts: These accounts have a higher annual contribution limit ($23,000 as of 2024) compared to other options like IRAs. Contributions are typically made on a pre-tax basis, reducing your taxable income.
• Roth IRA: With a Roth IRA, you make contributions on a post-tax basis, meaning you don't get an immediate tax benefit. However, your earnings and withdrawals will be tax-free in retirement. The maximum contribution for a Roth IRA in 2024 is $7,000 per year.
• Traditional IRA: Similar to 401(k) plans, contributions to a Traditional IRA are made on a pre-tax basis, reducing your taxable income. If you don't have an employer-sponsored plan, you can take a deduction when you file your taxes. The maximum contribution for a Traditional IRA in 2024 is $7,000 per year.
• SIMPLE IRA: A SIMPLE IRA is a type of employer-sponsored retirement plan designed for small employers who don't offer a 401(k) plan. Employers are required to match employee contributions up to 3% of their compensation.

Things to Consider

When deciding whether to open a retirement account, there are a few advantages and potential disadvantages to keep in mind:

• Tax Benefits: All retirement accounts offer tax benefits. Pre-tax contributions reduce your taxable income, resulting in more money in your pocket. While contributions to a Roth IRA are made after taxes, your earnings and withdrawals will be tax-free in retirement.
• Compound Interest: Starting to save early allows you to take advantage of compound interest over a longer period. This means you won't have to contribute as much each year to reach your retirement savings goals.
• Early Retirement: By saving early and consistently, you may be able to consider early retirement without worrying about having enough money.
• Reduced Take-Home Pay: One downside of contributing to a retirement account is that it may result in lower take-home pay, which could impact your ability to pay rent or mortgage, save for a house, or have children.
• Slower Student Loan Debt Repayment: Contributing to a retirement account may slow down your progress in paying off student loan debt, especially if your goal is to get out of debt as quickly as possible.

How Much to Contribute

The amount you should contribute to your retirement account will depend on your budget and financial situation. It's recommended to save at least 10% of your income, if possible. For IRAs, try to max out your contributions if you can. For 401(k) plans, contribute enough to get the full benefit of your employer's matching contributions.

By opening a retirement account in your 20s, you're taking an important step toward securing your financial future and ensuring you can make the most of your earnings over time.

Keep short-term savings accessible

Keeping short-term savings accessible is a crucial part of financial planning. Here are some reasons why you should keep your short-term savings accessible and some of the best options available to do so:

It is important to keep your short-term savings accessible for several reasons. Firstly, you never know what type of unexpected expense may come up, and having your money tied up in an illiquid investment can be problematic. Additionally, maintaining a liquid savings account or emergency fund ensures that you have funds readily available when you need them. This can help you avoid dipping into your retirement savings or taking on high-interest debt to cover unexpected costs.

Best Options for Keeping Short-Term Savings Accessible:

• High-yield savings accounts: These accounts offer interest rates significantly above the national average, and some currently offer annual percentage yields of 4% or higher. They are convenient to open and manage, and most have no fees or minimum balance requirements.
• Brokerage cash sweeps: Some brokerage firms offer high-interest rates on uninvested cash in your account, such as dividend payments or profits from sales. This can be an easy way to earn a high return on idle money.
• Cash management accounts: These accounts, typically offered by robo-advisors or online brokerage firms, provide features like check writing, mobile check deposit, bill payment, and overdraft programs. They often offer higher interest rates than traditional checking or savings accounts.
• Short-term bond funds or Treasury accounts: Bonds are considered a safer investment option than stocks, and Treasury accounts invest in low-risk Treasury Bills. Short-term bond funds can provide a diversified portfolio of government or corporate bonds with varying terms.
• Bank certificates of deposit (CDs): CDs offer a guaranteed interest rate if you commit to keeping your money in the account for a specified term, usually ranging from three months to five years. Longer terms generally offer higher interest rates, and CDs can be a good option if you are sure you won't need the money during that time.

Frequently asked questions