Investing In Your 20S: A Guide For Indians

Investing in your 20s can be a daunting task, especially with the wide range of investment options available and the various strategies to choose from. However, starting early in life gives investors a key advantage – time. Here are some tips to help you get started on your investment journey.

Start investing immediately: The most common mistake young investors make is delaying their investments. A good way to start is by enrolling in the Employees Provident Fund (EPF) to begin saving for retirement. You can also start a Systematic Investment Plan (SIP) in a Mutual Fund with a small amount like Rs. 500 per month.

Learn the basics of personal finance: Subjects like money, investing, and personal finance are not taught in Indian schools, so it's up to individuals to educate themselves about essential financial skills.

Set financial goals and plan investments: It's important to set both short-term and long-term financial goals. Short-term goals could include creating an emergency fund or saving for a vacation, while long-term goals might be buying a house, saving for children's education, or retirement.

Save first, spend later: Focus on saving a portion of your salary first and then spending what's left. Even if you can only save a small amount each month, it will help you get closer to your financial goals.

Take advantage of the Employees Provident Fund: Salaried individuals can subscribe to the EPF scheme through their employer. This is a retirement account where employees contribute a part of their salary each month, and the employer makes a matching contribution.

Automate your investments: One way to simplify the investment process is by starting a Systematic Investment Plan (SIP) in a Mutual Fund. SIP allows investors to invest a specific amount of money at regular intervals and purchase units of a Mutual Fund.

Manage debt and build an emergency fund: Debt can be a major hurdle to investing for young people. Consider using a debt-reduction system like the snowball method to list your debts in order of balance size and allocate any extra money to pay off the smallest debt first. It's also important to build an emergency fund to cover unexpected expenses.

Open retirement accounts: Employer-sponsored retirement plans such as 401(k) and 403(b) accounts are ideal for young investors. Many employers offer contribution matching, which means free money for your retirement savings.

Keep short-term savings accessible: Maintain a liquid savings account or emergency fund to ensure you have easily accessible funds when unexpected expenses arise.

Continuously educate yourself: Stay up-to-date on market trends, emerging asset classes, and investing strategies to make informed decisions about your investments.

By following these tips, you can build a strong financial foundation and work towards achieving your financial goals.

Start investing early

Investing early in life has a key advantage: time. The earlier you start investing, the more time you will have to grow your wealth and the better your chances of achieving your financial goals.

• Set financial goals: Before you begin investing, it's important to have clear short- and long-term financial goals in mind. Common short-term goals include saving for a vehicle, housing, or discretionary costs like travel, while long-term goals may include retirement, buying a home, or expenses related to medical care or children's education.
• Understand risk and return: In investing, higher risk typically leads to greater potential rewards, while lower-risk investments tend to offer lower rewards. Younger investors can generally afford to take on more risk, especially when investing for retirement, as they have more time to recover from any losses.
• Choose the right investment vehicles: Some common investment options for young investors include stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Stocks tend to be riskier but can yield higher returns over time, while bonds provide low-risk access to the market but with limited payout potential. Mutual funds and ETFs offer broad diversification and are a good choice for new investors.
• Start investing as soon as possible: To achieve long-term growth, it's important to gain access to the investing world as early as possible. Consider opening a brokerage account, which can often be done quickly and easily online. Robo-advisor tools can also automate the investment process, making it more accessible for inexperienced investors.
• Manage debt: Debt can be a major hurdle to investing for many young people. Focus on reducing high-interest debt, such as credit card debt, and consider using a debt-reduction strategy like the snowball method to help you pay off multiple debts efficiently.
• Build an emergency fund: In addition to investing, it's important to have liquid savings set aside in case of unexpected expenses. Most professionals recommend having at least three to six months' worth of salary in an emergency fund.

Understand risk and return

Understanding risk and return is essential for making informed investment decisions. One axiom of investing is that the higher the risk, the greater the potential reward. Conversely, the lower the risk, the smaller the possible reward. For example, consider cryptocurrencies. While investing in Bitcoin when it first launched may have resulted in significant gains, it would also have been an incredibly risky move.

Younger investors like those in their 20s can typically afford to take on more risk than older investors, especially when it comes to retirement planning. This is because they have a longer time horizon, allowing them to make up for any losses incurred along the way. On the other hand, older investors closer to retirement age may opt for more conservative investments like bonds or T-bills to preserve their capital.

It's important to assess your own risk tolerance when investing. This involves evaluating how you would react if an investment performs poorly. By understanding your risk tolerance, you can create an investment plan that aligns with your goals and comfort level.

• Asset Allocation: Diversifying your investments across different asset classes, such as stocks, bonds, real estate, etc., can help manage risk. Proper asset allocation ensures your portfolio is not overly concentrated in any one area, reducing the impact of potential losses.
• Time Horizon: Your investment time horizon refers to the amount of time you plan to hold an investment before selling it. Generally, a longer time horizon allows you to take on more risk, as short-term market fluctuations are less of a concern.
• Emergency Fund: Before investing in riskier assets, it's crucial to have an emergency fund in place to cover unexpected expenses. This will help ensure that you don't have to sell your investments at a loss if you need cash quickly.
• Research and Education: Investing in risky assets without proper research and understanding is speculative and akin to gambling. Take the time to educate yourself about different investments, their risks, and potential returns.

Remember, investing always carries some level of risk, but by understanding and managing that risk, you can make more informed decisions and improve your chances of achieving your financial goals.

Choose the right investment vehicles

When it comes to choosing the right investment vehicles, there are several options available to young investors. Here are some of the most common ones:

• Stocks: Stocks tend to be riskier than bonds, but the level of risk varies depending on the sector, industry, and specific company. Over the long term, a buy-and-hold strategy can yield significant returns. However, with thousands of stocks available, this can be a daunting area for young investors.
• Bonds: Bonds provide a low-risk entry point for investors. They often require less day-to-day management than stocks, but their potential for payout is limited. A common approach is to allocate a percentage of your portfolio to bonds that is equal to your age, which means young investors may not focus heavily on this asset class.
• Mutual Funds: Mutual funds are an excellent choice for many new investors. They provide broad diversification while minimising the amount of trading and oversight required. They are also good for a buy-and-hold strategy, but the returns tend to be relatively modest.
• Exchange-Traded Funds (ETFs): ETFs are highly popular among both new and seasoned investors. They are baskets of other securities, providing a one-stop-shop approach for investors who don't want to manage individual stocks or assets. ETF risk and return profiles vary, allowing you to tailor your investment strategy to your risk tolerance.
• Retirement Accounts: Employer-sponsored retirement plans, such as 401(k) and 403(b) accounts, are a must for young investors. Many employers offer contribution matching, which means free money for your retirement savings. Individual Retirement Accounts (IRAs) are another option, with traditional and Roth IRAs being the two main types.
• Robo-Advisors: Robo-advisors are computer-based investment management services that provide automated investment advice and portfolio management. They charge a percentage of your account balance and can simplify the investment process, making them attractive to new investors.
• Brokers: Online brokers, such as Fidelity and Schwab, offer low fees, reasonable minimum investment requirements, and educational resources for new investors. They provide an accessible way to invest in various assets, including stocks, bonds, mutual funds, and ETFs.

Manage debt and build an emergency fund

For many young people, debt is a major hurdle to investing. Student loan debt, credit card debt, and other types of debt can be a financial burden. To manage your debt, consider a debt-reduction system like the snowball method: list your debts in order of balance size, make all minimum payments, and then allocate extra money to pay off the smallest debt first. This may achieve more immediate results in reducing the number of debts you have. Paying off high-interest debt will allow you to save more and boost your credit score.

If you have student loans, stay on top of your payments and keep an eye on federal programs that may help you reduce this burden. It is important not to default on your loans, as this can have a detrimental impact on your credit score.

An emergency fund can protect your retirement savings. Financial planner Charlene Rhinehart says that "creating an emergency fund and building your savings account will decrease the odds of you dipping into your retirement account to fund unexpected expenses." Your emergency fund should be in a safe place where you can access it quickly in case of an emergency. A fixed deposit account is a good option.

How much you need in your emergency fund will depend on your personal circumstances. In India, it is recommended that you have at least three to six months' worth of living expenses saved. This will give you peace of mind knowing that you have money set aside to cover unexpected costs, such as a job loss, medical emergency, or vehicle accident.

Once you have determined your monthly expenses, try to create a cash fund that can help you survive three to six months without any income. Given the current situation, most people will agree that six months of basic living expenses stashed as an emergency fund is a must.

You can reach this goal faster by using a debt mutual fund. With low risks and the opportunity to earn good returns, these funds can help you create the corpus in a shorter period. You can consider starting a Systematic Investment Plan (SIP) and automating your savings and investments. You can also invest your annual bonus in these funds to reach the target sooner.

There are a few different options for where to invest your emergency fund in India. These include fixed deposit accounts, liquid funds, short-term debt funds, and recurring deposits.

Open retirement accounts

Opening a retirement account in your 20s is an important step towards achieving financial security in your later years. Here are some key considerations and steps to help you open a retirement account in India:

Types of Retirement Accounts

• Employer-Sponsored 401(k) or 403(b) Accounts: These are recommended for full-time employees whose employers sponsor a retirement plan. The annual contribution limit is higher for 401(k)s ($23,000 compared to $7,000 for IRAs), and 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, so there's no immediate tax benefit. However, your earnings and withdrawals are tax-free, which is advantageous if you anticipate being in a higher tax bracket when you retire.
• Traditional IRA: Similar to 401(k) plans, contributions to a traditional IRA are usually made on a pre-tax basis, reducing your taxable income.
• SIMPLE IRA: A Savings Incentive Match Plan for Employees (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.

Pros and Cons of Opening a Retirement Account in Your 20s

Pros:

• Tax Benefits: Contributions to retirement accounts often reduce your taxable income, resulting in lower tax obligations and more money in your pocket.
• Compound Interest: Starting early gives your savings more time to grow through compound interest. This makes it easier to build a substantial retirement fund, even if you don't contribute large amounts.
• Early Retirement: By starting early and taking advantage of compound interest, you may be able to consider retiring early without compromising your financial stability.

Cons:

• Reduced Take-Home Pay: Contributing to a retirement account will lower your take-home pay, which could impact your ability to cover essential expenses or other financial goals, such as saving for a house or starting a family.
• 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

There is no one-size-fits-all answer, as it depends on your budget and financial situation. However, it's generally recommended to contribute as much as you can afford, even if it's less than the maximum allowed. Remember that small amounts saved at an early age can add up to more substantial savings than larger amounts contributed later in life.

Steps to Open a Retirement Account

• Assess Your Financial Situation: Understand your income, expenses, and financial goals. Create a budget that allocates money for essential needs, discretionary spending, and savings.
• Choose the Right Retirement Account: Consider the different types of retirement accounts available and select the one that best aligns with your financial goals, risk tolerance, and tax considerations.
• Compare and Select a Provider: Research different financial institutions and compare their fees, investment options, customer support, and other features. Choose a provider that suits your needs and preferences.
• Open and Fund the Account: Once you've selected a provider, follow their process to open and fund your chosen retirement account. This often involves completing an application and setting up contributions, which can often be done online.
• Monitor and Adjust: Regularly review your retirement account and make adjustments as needed. Stay updated with market trends, seek financial advice if needed, and ensure your retirement plan aligns with your long-term goals.

Remember, the key to successful retirement planning is to start early, be consistent with your contributions, and make informed choices that fit your financial situation and goals.

Frequently asked questions