Young Investors: Where To Begin?

Investing in your 20s can be a great way to build wealth and prepare for the future. With time on their side, young adults can take advantage of compound growth to maximize their investments over the long term. Here are some key considerations for people in their 20s who are looking to invest:

- Set clear financial goals: Determine your short- and long-term goals, such as saving for a car, housing, travel, or retirement. Prioritize your goals and create a plan to work towards them.

- Understand risk and return: Investing involves risk, and the potential for reward increases with the level of risk. Younger investors can typically tolerate more risk as they have more time to recover from losses.

- Choose the right investment vehicles: Some common options include stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Each has its own pros and cons, so it's important to understand the risks and potential returns of each before investing.

- Start investing early: The power of compounding means that the earlier you start investing, the more your money can grow over time. Even small investments can make a significant difference in the long run.

- Manage debt and build an emergency fund: Focus on reducing high-interest debt and build an emergency fund to cover unexpected expenses. This will help protect your retirement savings and ensure financial stability.

- Open retirement accounts: Contribute to employer-sponsored retirement plans, such as 401(k) or 403(b) accounts, to take advantage of tax benefits and any employer matching contributions.

- Educate yourself: Investing can be complex, so it's important to continuously learn and stay up-to-date with market trends, investment strategies, and emerging opportunities.

Start with a plan

Starting with a plan is the first step to investing in your 20s. It is important to set clear financial goals and understand the relationship between risk and return. Here are some key considerations for creating a financial plan:

• Short-term and long-term goals: Determine your short-term and long-term financial goals. For example, saving for a vehicle, housing, travel, or retirement. Prioritize your goals based on their importance and the time horizon for achieving them.
• Risk tolerance: Assess your risk tolerance, which is your ability to handle potential losses. Younger investors can generally tolerate more risk than older investors as they have more time to recover from any losses.
• Investment plan: Develop an investment plan that aligns with your goals and risk tolerance. Consider seeking professional advice if needed.
• Budgeting: Create a monthly budget that outlines your income, expenses, and savings. This will help you identify areas where you can cut back on spending and increase your investments.
• Emergency fund: Build an emergency fund to cover unexpected expenses, such as job loss or medical bills. This will help you avoid dipping into your retirement savings or taking on credit card debt.
• Debt management: Make managing your debt a priority. Focus on paying off high-interest debt first to free up more money for investing.

By starting with a plan, you can make informed and strategic decisions about your investments, maximizing your chances of achieving your financial goals.

Make managing debt a priority

For many young people, debt is a major hurdle to investing. Student loan debt, credit card debt, and other types of debt can present a significant financial burden. To build a secure financial future, it's important to make managing debt a priority in your 20s. Here are some strategies to help you manage your debt effectively:

Create a debt repayment plan

Develop a clear and realistic plan to pay off your debts. One approach is to list your debts in order of balance size, make all the minimum payments necessary, and then allocate any extra money to pay off the smallest debt first. This method, known as the snowball method, can help you stay motivated by showing quick results. Another strategy is to focus on paying off high-interest debt first, which will save you money in the long run.

Take advantage of federal programs

If you have student loans, stay informed about federal programs that may help reduce your debt burden. Keeping up with your payments will also ensure you don't default on your loans, which can damage your credit score.

Protect your retirement savings

An emergency fund is crucial to protect your retirement savings. It's recommended to have at least three to six months' worth of salary in an emergency fund to cover unexpected expenses. This will reduce the likelihood of having to dip into your retirement savings.

Boost your credit score

Paying off high-interest debt can help improve your credit score. A good credit score is beneficial for qualifying for financial products like credit cards and loans, as well as getting better interest rates and terms.

Prioritize debt over savings

While saving for retirement is important, it's generally recommended to prioritize paying off debt first. Focus on making regular payments towards your debt and work towards increasing the amount you can contribute over time.

Automate your debt payments

Automating your payments can help you stay on track with your debt repayment plan. Set up automatic transfers from each paycheck or arrange for minimum payments to be deducted directly from your account.

By managing your debt effectively, you'll be in a better position to invest and build your financial future. It's important to be patient and consistent in your efforts, as it may take time to see progress.

Save for retirement today

Retirement may seem like a distant prospect when you're in your 20s, but the earlier you start saving, the better. Here are some reasons why you should start saving for retirement today and some tips on how to do it:

Compound interest is your friend

The power of compound interest means that the earlier you start saving, the more your money can grow over time. Even if you can only save a small amount, the effects of compound interest mean that it will be worth much more by the time you retire. For example, if you invest $1,000 in a bond that earns 3% interest per year, by the end of the first year, your investment will have grown by $30. In year 39, your investment will be worth around $3,167, and by year 40, it will be worth $3,262.04 – that's a one-year difference of $95. The longer you leave your money invested, the more it will grow.

A little now vs more later

The longer you wait to start saving for retirement, the more you'll need to invest each month to reach your goals. By starting to save today, you can afford to put away less money each month as compound interest will be on your side.

Make the most of employer contributions

If your employer offers a retirement plan such as a 401(k) or 403(b), be sure to take advantage of it, especially if they match your contributions. This is essentially free money, and it will give your savings an extra boost. With pre-tax deductions, you won't even notice your money being put away, and it will grow tax-free until you withdraw it at retirement.

Open a Roth IRA

A Roth IRA is a great option for those looking to amass wealth. You fund it with money that's already been taxed, but when you withdraw it in retirement, you won't pay any taxes on it – including all the money your contributions earned over the years. There are income limits on who can have a Roth IRA, and these limits depend on your tax-filing status (married or single). For 2023, if you're single, you can't contribute to a Roth IRA if your income exceeds $153,000, and in 2024, the limit is $161,000.

Be aggressive with your investments

When you're in your 20s, you can afford to be aggressive with your investments as you have a long investment horizon. Put a high percentage of your portfolio in stocks, as they have a great long-term track record. As you get older, you can move your assets into less volatile investments, such as bonds.

Build an emergency fund

Start building an emergency fund so you don't have to rely on credit cards or your retirement savings for unexpected expenses. Aim to save up to six months' worth of living expenses in a high-yield savings account, so you'll be prepared for any surprises.

Don't miss out on employer contributions

If you're in your 20s and your employer offers a 401(k) plan, signing up for it is one of the best investment decisions you can make. A 401(k) is a tax-advantaged retirement account, which means you can contribute directly from your paycheck pre-tax.

Many employers will also match your contributions up to a certain percentage of your salary. This is essentially free money that you can take advantage of to grow your retirement savings. Even if you can't afford to contribute a lot, consider contributing enough to get the maximum employer match.

For example, let's say your employer matches half of your 401(k) contributions, up to 6% of your total salary. If you start contributing 6% at age 22 and assume a 7% return with annual salary increases of 3%, you could have over $1.2 million by age 65. Without that employer match, you would only have around $800,000.

It's important to note that employer matches may come with a vesting schedule, which means you'll need to stay at your job for a certain period before receiving the full amount. Some employers may allow you to keep a percentage of the match after a year, gradually increasing until you're fully vested after a few years.

If your company doesn't offer a 401(k) or you've already maxed out your contributions, you might consider other options like a Roth IRA. With a Roth IRA, you won't get an immediate tax break on contributions, but your investments will grow tax-free, and you typically won't pay federal taxes when withdrawing in retirement.

By taking advantage of employer contributions and investing early in your 20s, you can set yourself up for a more secure financial future.

Keep it simple

Investing legend Charles Ellis advises keeping it simple when it comes to investing. He equates it to parenting teenagers, where fewer instructions and decisions work better. Ellis is an advocate of passive investing, such as index funds, over active investing. Starting slowly and understanding the importance of diversification and asset classes is crucial.

• Start with the basics: Ellis suggests starting with the "plain vanilla" of investing, which is either the total market index or the Standard and Poor's 500 Index, representing a substantial fraction of the total market.
• Choose a broad market fund: This can be based in your home country, such as the Footsie 100 in the UK or the ASX 200 in Australia.
• Consider a global index fund: This will give you exposure to emerging markets and a more diverse range of companies.
• Add a bond fund: This can be based on your home country as well. You can adjust the percentage allocation of each fund type based on your risk tolerance and investment goals.
• Understand your risk profile: Know how much risk you are comfortable taking. Younger investors can generally take on more risk as they have more time to recover from potential losses.
• Avoid speculation and leverage: While it may be tempting to try and make quick gains, focus on solid companies with long-term upside potential. Speculation and highly speculative trades can be detrimental to your portfolio and may scar younger investors.
• Make a plan and stick to it: Create a written investment plan that aligns with your risk appetite and investment goals. Automate your contributions to make investing a seamless habit and ensure you don't neglect your investments.
• Invest regularly: Take advantage of compound interest by investing regularly, even if it's a small amount. The earlier you start, the more time your money has to grow.

By keeping your investment strategy simple and starting early, you'll be well on your way to building a solid financial foundation for the future.

Frequently asked questions