Investing In Your 20S: Exchange-Traded Funds For Beginners

Investing in your 20s is a great way to build a solid financial foundation for the future. The power of compounding means that even small amounts of money invested in your 20s can grow into large sums over time. For example, at just a 4% annual return, a dollar invested at 20 would be worth nearly $6 by age 65, compared to $4 for a dollar invested at 30.

There are a few key steps to starting investing in your 20s. First, it's important to set clear financial goals and understand your risk tolerance. Then, you can choose the right investment vehicles for your goals and risk profile, such as stocks, bonds, mutual funds, or exchange-traded funds (ETFs). It's also crucial to start investing early, manage debt, and build an emergency fund. Additionally, opening a retirement account, such as a 401(k) or IRA, is an important step towards investing for the long term.

ETFs are a popular investment option for beginners as they are easy to understand and can generate impressive returns without requiring much expense or effort. They allow investors to buy a diverse range of stocks or bonds at once and are typically low-cost and highly liquid. However, ETFs may not have the same return potential as individual stocks and do come with management fees.

Overall, investing in your 20s can be a great way to build wealth and secure your financial future, but it's important to educate yourself and seek professional advice when needed.

Understand risk and return

Understanding risk and return is essential for making informed investment decisions. The general rule of thumb is that the higher the risk, the greater the potential reward, and vice versa. For example, investing in cryptocurrencies is highly speculative and therefore very risky, but it can also lead to huge gains.

Younger investors can afford to take more risks than older investors, especially when it comes to retirement planning. This is because they have a longer time horizon, so if a risky investment doesn't pay off, they have plenty of time to make corrections. On the other hand, someone closer to retirement age may not be able to recoup the loss of a significant percentage of their retirement savings on a risky investment.

It's important to understand your own risk tolerance, which involves thinking about how you'll react if an investment performs poorly. Your 20s can be a great time to take on investment risk because you have a long time to make up for losses.

When it comes to exchange-traded funds (ETFs), they are generally considered a lower-risk investment option. ETFs provide exposure to a diverse range of stocks, bonds, and other assets, which helps to mitigate risk. However, since ETFs own a diverse assortment of stocks, they don't have as much return potential as buying individual stocks.

ETFs also charge fees, known as expense ratios, which can eat into your returns. The expense ratio is listed as an annual percentage, so for every $1,000 invested, a 1% expense ratio means you'll pay $10 in fees.

Overall, understanding the relationship between risk and return is crucial for making smart investment decisions. Younger investors may be able to take on more risk, but it's important to carefully consider your own risk tolerance and investment goals when deciding how much risk to take.

Choose the right investment vehicles

When it comes to choosing the right investment vehicles, there are several options available to young investors, each with its own set of pros and cons. Here are some of the most common investment vehicles for those in their 20s:

• Stocks: Stocks tend to be riskier than bonds, but the level of risk depends on the specific company and industry. 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 new investors.
• Bonds: Bonds provide a low-risk entry point for investors. They often require less day-to-day management than stocks, but the potential for high payouts is limited. A common strategy 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 beginners as they provide broad diversification and require minimal trading and oversight. However, mutual fund returns tend to be modest.
• Exchange-Traded Funds (ETFs): ETFs are a highly popular option for both new and experienced investors. They provide a one-stop-shop approach, allowing investors to access a basket of securities without the need to manage individual stocks or assets. ETF risk and return profiles vary, enabling you to tailor your investment strategy to your risk tolerance.
• Index Funds: Index funds are a type of passive ETF that tracks a particular stock market index, such as the S&P 500. They are typically cheaper than actively managed funds and are designed to match the performance of the index they track.
• Robo-Advisors: Robo-advisors are online platforms that use algorithms to construct and manage investment portfolios based on factors such as risk tolerance, investment goals, and time horizon. They are appealing to young investors due to their low initial deposit requirements and the lack of need for market expertise.
• Real Estate: Investing in real estate can be a good way to diversify your portfolio, but it requires financing and the time and ability to manage a property.
• Cryptocurrency: Cryptocurrency is a digital or virtual currency that can be used for transactions. While it is a risky investment, allocating a small portion of your portfolio to cryptocurrencies can be an option for those who want to explore this emerging asset class.

It's important to note that the choice of investment vehicles depends on your individual goals, risk tolerance, and investment horizon. Diversification is key to managing risk and maximizing returns, so it's recommended to spread your investments across different asset classes and sectors.

Start investing early

Starting to invest early on can help to ensure a stable financial future. The power of compounding gains means that money invested in your 20s can achieve much more significant growth over the remainder of your lifetime than investments started later on.

For example, at just an annual 4% return, not counting inflation, a single dollar invested at age 20 would grow to $5.84 at age 65, while a dollar invested at age 30 would only be worth $3.95 by retirement age.

To achieve this long-term growth potential, you’ll need to gain access to the investing world as early as possible. One of the easiest ways to start investing in your 20s is through an employer-sponsored retirement plan, such as a 401(k) or 403(b). Many employers will match employee contributions up to a certain percentage, so it's important to contribute enough to get the maximum.

If you don't have access to an employer-sponsored plan, you can open an individual retirement account (IRA). There are two main types: traditional and Roth. Contributions to a traditional IRA are made on a pre-tax basis and are not taxed until withdrawal. Roth IRA contributions, on the other hand, are made after tax, and qualified distributions can be withdrawn tax-free.

If you're a beginner investor, you might want to consider using a robo-advisor, which is a computer-based investment management company that charges a percentage of your account balance for its services and investing tips. Many robo-advisors simplify the process by choosing a portfolio that matches your goals and risk tolerance and periodically rebalancing it for you.

When choosing a broker or robo-advisor, look for one with low or no fees to maximise your investment returns. It's also important to consider the technology and user experience offered by the platform, such as a robust and user-friendly mobile app.

Another way to start investing early is through exchange-traded funds (ETFs). ETFs are an easy way to begin investing and can generate impressive returns without much expense or effort. They allow investors to buy many stocks or bonds at once and are traded just like stocks on major exchanges such as the NYSE and Nasdaq. ETFs are typically bought and sold through online brokers, many of which offer commission-free trades.

When investing in ETFs, it's important to keep in mind that they are generally designed to be maintenance-free investments. Newer investors often have a bad habit of checking their portfolios too frequently and making emotional, knee-jerk reactions to market moves. The best advice is to leave your ETFs alone and let them produce excellent investment growth over long periods.

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 the smallest debt. This will help you reduce the number of debts you have. Paying off high-interest debt will allow you to save more and boost your credit score.

Stay on top of your payments to ensure you don't default on your loans, which can negatively impact your credit score. If you have student loans, keep an eye out for federal programs that can help reduce your debt.

It's also important to build an emergency fund to protect your retirement savings. This will ensure that you don't have to dip into your retirement savings to cover unexpected expenses. Your emergency fund should be in liquid assets that can be quickly converted to cash if needed.

Most professionals recommend having at least three to six months' worth of salary in an emergency fund to cover unexpected costs. This will provide a financial cushion in case of job loss or other financial setbacks.

Open retirement accounts

Opening retirement accounts is one of the most important things you can do for yourself in your 20s. The earlier you start saving for retirement, the more time your money has to benefit from compounding investment returns. Here are some steps you can take to open retirement accounts:

Contribute to an employer-sponsored retirement plan:

If your employer offers a 401(k) or a similar plan, this is a great place to start. Many employers will match a certain percentage of your contributions, so you benefit from having an extra boost to your savings. Contribute enough to get the maximum match, as this is essentially free money for your retirement. The money you save in a 401(k) is also often deducted pre-tax, so you get a tax break today while saving for the future.

Open an Individual Retirement Account (IRA):

If you don't have access to an employer-sponsored plan or want to save even more, consider opening an IRA. There are two main types: Traditional IRAs and Roth IRAs. Traditional IRAs allow you to contribute pre-tax dollars, which lowers your taxable income now, but you will pay taxes when you withdraw the money in retirement. Roth IRAs, on the other hand, are funded with after-tax dollars, and qualified distributions can be withdrawn tax-free in retirement.

Understand the benefits of a Health Savings Account (HSA):

If you're eligible, an HSA can be a great way to save for both medical expenses and retirement. You can contribute pre-tax dollars, and the money can be spent tax-free on qualified medical expenses. Any unspent money rolls over year after year and can be invested to grow your savings. Starting at age 65, you can use the funds for anything without penalty, similar to a traditional retirement account.

Take advantage of employer benefits:

When considering job offers or hunting for a new position, look beyond just the salary. Factor in retirement benefits, such as employer contribution matches, and other perks that can help you save for the future, such as student loan repayment assistance. Maximizing these benefits can give your retirement savings a boost.

Practice good financial habits:

Keeping your overall finances in good shape will help you save more for retirement. This includes balancing your income and spending, staying on top of your debt, and building an emergency fund to cover unexpected expenses. By managing your debt and expenses effectively, you'll have more money to contribute to your retirement accounts.

Bump up your contributions over time:

Once you have a solid financial foundation, consider increasing your retirement contributions by a small percentage each year. Most people can aim to save around 15% of their pre-tax income annually for retirement. You may not be able to contribute this much right away, but by increasing your savings rate gradually, you'll be able to save more without feeling a significant impact on your budget.

Frequently asked questions