Setting an investing plan and strategy in your 20s can be one of the lucrative financial decisions you will ever make. If you take the simple steps to become an investor and begin contributing to retirement and brokerage accounts early on, you can generate incredible wealth based on the amount of time your portfolio will be invested.
For most of us, our 20s define the building blocks of the adults and parents we will eventually become. The financial choices that we make today will have a lasting impact on our financial position 30 or 40+ years down the road. Unfortunately, for most young adults, the discipline of investing has not quite founds its place on their list of priorities partly due to immense financial pressure stemming from student loans and stagnant wage gains, coupled with the ever-increasing cost of housing and expenses. However, by making sacrifices today, you have the potential to build incredible wealth over the longer-term.
For investors in their 20s, you obviously have an abnormally long time horizon compared to the average age of the investing population. While those of us in our 20s may not have the substantial capital to invest in the stock market compared to older Americans, we have been dealt an incredible hand for the small amounts of money that we can invest due to the time horizon our portfolio can grow.
Consider the average historic market rate of return of 10%. At this rate, every dollar you invest will double automatically every 7 or 8 years. If you leave this single dollar invested for 45 years, you will have nearly 73x your initial investment. Instead, if you had waited 10 years and reduced your time horizon to 35 years, you would only have around 28x your initial invested, which cuts your returns by more than half. Therefore, the earlier you start, the more time you will have to compound your returns in the market.
For most young adults, building wealth sounds like a great idea. However, unless you get a business, finance, or accounting degree, the chances that you have been taught anything about finance and investing are slim to none. This presents are fairly significant challenge for beginning investors. After all, most of the stories young people have heard about investing are the negative highlights such as market drops, scams, and fraud. Often, these stories paralyze investors who are on the fence for if they should start investing or keep their hard-earned money in cash.
In order to get comfortable with investing, you have the ability to fill in that knowledge gap through education and learning which will help you understand that investing in a well-diversified portfolio is much less risky than you may think.
What is investing?
What is investing and how can your personal view affect your returns?
As an investor, you are a part owner in the businesses that are traded on public markets. Even if you do not own individual stocks but opt to own mutual funds or exchange-traded funds, these funds are comprised of slivers of ownership in hundreds of different companies. Therefore, as a part owner, you are entitled to your equity share percentage of the profits these businesses generate.
Therefore, investing is a means to generate financial freedom through the appreciation of your ownership as well as the dividends companies that you own will pay. Eventually, the dividends and gains will eliminate your need to trade your time for compensation through an ordinary 9-5 job.
Investing allows you to put away less over time as the smaller amount of money grows to a substantial sum that you would have otherwise needed to borrow or save to make that big purchase. In retirement, your investments are meant to replace your income from your job. The portfolio income from your investments may be more of a necessity as we age and since we may not have the capability to go back to active work. Therefore, your investments can act as a safety net to sustain you if you are unable or do not wish to work.
While retirement can seem like ages away for recent high school or college graduates, putting aside money early on will pay fortunes in the future thanks to the wonderful world of compound interest. Even just a few hundred dollars at a young age will turn into a portfolio worth millions down the road. If you delay into your 40s or 50s, you would have to put away substantially more or work later into your life. Because of the power of compounding, automating your investments early on will surely result in a fruitful retirement.
Learn how to be an investor
Learning about investing and the stock market in your 20s is hands down the best decision you can make to secure your financial future.
Your 20s can be one of the most expensive times of your life. You may be saddled with student loan debt, have a desire to travel or socialize, purchase a new car, or find a spouse and get married. However, when you factor in the opportunity cost of delaying your investing because of these other expenses, the financial consequences can be fairly severe.
Even if you do not have the money today to invest, the best decision you can make in your early 20s is to invest in yourself by gaining the knowledge necessary to make prudent investing decisions when the time comes that you have additional money. By understanding the stock market, mutual funds, and ETFs, you can avoid pitfalls that often entrap ignorant investors who fall victim to “get rich investing schemes” or panic-sell when the market drops.
Invest in yourself first
Chances are that if you are in your 20s, you have never bought or sold a mutual fund or stock. You may not even have very much interest in following the stock market on a daily basis. However, because you are reading this post, you are obviously ready to take the plunge or at least learn more about investing before you take the first steps.
Minimize your expenses
While you may not have money today to put away in the market in your early 20s, you do have the ability to minimize your expenses, limit your debt burden, and save up enough cash over the next few months or years to begin your investing journey.
Learn from all the free media available on investing
While you are working on paying off high-interest debt and saving excess cash to invest, spend time investing in yourself by consuming as many books, YouTube videos, podcasts, or other free materials as possible on investing or the stock market. Thankfully, there is a nearly unlimited source of good, free financial information and sources to help you get started.
Begin by following financial news and select ticker symbols
One of the best ways to start learning about investing is to download market news apps and podcasts. Find a few ticker symbols for stocks and funds you would consider investing and simply watch their price movements and read the associated news articles and commentary. By reading news articles that are published about companies in different industries, you will begin understanding how macroeconomic themes affect the companies and funds you’re observing and may eventually buy.
Understand what makes up index and mutual funds
Ask what the big picture mechanics and drivers of this fund such as whether the index fund is market capitalization weighted where the investments are allocated to companies based on their relative size. Alternatively, the fund could be equal-weighted and the money you put in is split evenly across each company regardless of size.
For instance, suppose you’re interested in purchasing a fund that mimics the Dow Jones Industrial average. You should understand that the biggest driver of this fund will be the overall economy and consumer demand (as is the case with most stocks and funds). Additionally, understanding that the Dow is price-weighted rather than market-weighted will help you understand why the fund is up or down on any particular day – say if the largest weighted company (the one with the highest stock price) reports a slowdown in sales in China or if other larger components report a beat in earnings and revenue.
For other mutual funds, understand what the largest holdings are by looking at their prospectus and top holdings will help you understand the mechanics of which individual companies may be contributing to volatility on a particular day.
As a caveat, you do not necessarily need to understand these items outlined to get started, and a lack of knowledge should not be an impediment to getting started. However, you may find it helpful just to understand how your money is allocated.
Use technology to help you learn
Spending a few minutes each day reading through market news articles and understanding what effects your particular stocks and funds is fairly easy thanks to all of the free finance apps out there.
Here are a few of the apps that could be used on a daily basis to get started:
- Yahoo Finance
- CNBC
- Bloomberg
- Morningstar
- Seeking Alpha
- Business Insider
- CNN Money
- The Wall Street Journal
Reading a few big picture articles on market themes each day will help you understand the direction the market is heading over time and the macro themes propelling it up or down. However, take each with a grain of salt as some articles are better than others as many authors are looking to grab readers’ attention by exploiting fears and increasing viewership.
Podcasts are a great free method to begin learning about markets, investing, and saving money.
Consider downloading the following podcasts to listen to while exercising or driving.
- Mad Money with Jim Cramer
- Motley Fool
- Masters in Business
- We Study Billionaires
- The Economist
Read books on investing
Here are a few of the best books to read when starting out investing:
- The Little Book of Common Sense Investing by Jack Bogle
- The Intelligent Investor by Benjamin Graham
- A Random Walk Down Wall Street by Burton Malkiel
- Beating the Street by Peter Lynch
- The Snowball: Warren Buffett and the Business of Life by Alice Schroeder
- Business Adventures by John Brooks
Find an investing mentor
Another great step to take to further you knowledge is to find an experienced mentor that is willing to talk or teach you about markets.
Because of your age, if you have any interest in investing, most people will look at you like you a unicorn. Because investing is such a rare hobby or practice for young people, older investors will more than likely jump at the chance to talk to you about their investing portfolio, strategy, or mistakes they have made along the way.
Even if you cannot find someone to mentor you one on one, there are plenty of alternative ways to get in the circle of other investors who could mentor you. For instance, you could join an investment club or local finance group that meets to discuss the market or their personal investment ideas. Additionally, hundreds of free forums, Facebook groups, and social media accounts exist that cater to those who love to converse about the stock market.
As an example, the Motley Fool Facebook group is a vibrant community of like-minded, long-term investors who enjoy discussing current market moving news as well as their personal philosophies.
Develop a long-term mindset
As a new investor in your 20s, before you invest a single dollar, you must first come to the conclusion that money invested will not be touched and will stay invested for the long-term. Unlike a savings account which offers liquidity in case of emergency, you should treat you investments as if they are restricted for a minimum of 5 years. Having a long-term mindset will help ensure you do not sell in panic when the market drops. Over the course of the market’s history, the overall market has risen over 85% of the time over 5-year periods. Therefore, if you buy and hold a mutual or index fund for a minimum of 5 years, you have a substantial likelihood of earning positive returns.
While 5 years may seem like a relatively long time horizon, you should develop the mentality that even this is the bare minimum time period to think about investing. At 20 years old, you should view your investments as 20, 30, or 40+ year commitments depending upon your personal investing goals for your capital.
Therefore, you should not put more than you’re willing to restrict for this long to reduce both volatility and the chance of losing money.
Define your investing purpose
Now that you have invested time to learn about the stock market and have the mindset that invested money is not to be used in the near-term, you must determine your purpose for investing and why you want to invest. Your purpose for investing should work in conjunction with your savings goals. Setting clear goals that are measurable will help drive your purpose, and allow you to hold yourself accountable for achieving your financial dreams.
Developing your overall purpose for investing will determine how much you should put away as well as the types of accounts you should open in order to maximize returns by minimizing the tax impacts on your capital gains and dividends.
As an example of types of savings goals that individuals in their 20s typically come across relate to these financial goals: paying off debt, purchasing vehicles, saving for engagements or weddings, buying a home, and retirement.
Investing to pay down debt or make purchases
Let’s say the reason you want to invest is to earn enough money to pay off substantial high-interest debt.
Student loans
While some debt like student loans may have seemed necessary at the time, taking on any form of debt is the opposite of investing. Instead of increasing your net worth through an asset that appreciates and pays dividends over time, the interest payments and principle that you pay contribute to the bottom line of the investors in banking institutions.
Unless the debt you are hoping to repay is at very low interest rates, the best bet is to use any excess cash to throw towards your debt rather than beginning your investing journey in hopes you will earn a spread in the market that could be used to eliminate your debt burden. After all, any excess returns you may gain by investing in the market would not be worth the added risk you assumed to invest considering the market can always go down over a period of one or two years.
Credit card balances
While arguments could be paid to delay paying off very low interest loans, virtually no financial advisor would recommend investing in hopes of earning enough to pay off credit cards.
This is because paying off credit cards with a 20%+ interest rate is a guaranteed rate of return that is more than double what the stock market has historically returned. While there have been years where the market has earned 20%+, these years represent anomalies and are certainly not to be expected. Therefore, you should consider delaying investing until you eliminate credit card balances rather than hoping you can hit it big in the market to get out from under your obligations.
Investing for a new car
If you’re like most young college graduates or people in their 20s, you are probably driving an older model vehicle and are anxious to upgrade given you now have a steady paycheck.
While purchasing a vehicle is clearly not an investment and should be considered an expense and minimized, it’s never too early to begin saving for the next vehicle in a sinking fund each month where you put away cash in a different savings account. If you do not anticipate buying a vehicle in the next several years, you could use some of the money and put it in a low-cost, no load mutual fund or index fund to help grow your money over time until you’re ready to buy the next car. As the time to buy the vehicle gets nearer, begin selling down the fund and raising cash incrementally.
Even though you may be ready to upgrade your ride after saving an investing for a period of years, consider delaying this purchase and continuing to drive your older car until it becomes absolutely necessary to drive something newer. Even when the time comes, avoid spending too much on your vehicle which will depreciate each year rather than growing in value like your investments would have otherwise performed.
According to Nerdwallet, the average new car loan is around $31,000 for between 5 and 6 years at 5.73% interest.
Let’s consider than instead of paying around $520/month or $6,240/year for 6 years in car payments, you decided to invest that amount from age 20 to 65 at the average S&P 500 return of 10%. By the time you would have paid the car off, you would have over $53,000 in your account comprised of principal you paid and compounded gains over the 6-year period. If you forgot about the fund and never touched it, by the time you’re 65, you would have over $2.1 million in your index fund. Hope you like your car!
While purchasing a vehicle is inevitable and a necessity, considering the opportunity cost of large purchases that degrade in value is imperative to build wealth – especially, given the consequences of having such a large amount of time to compound. Thinking about the total cost will help shape your mindset and influence decisions to opt for a less expensive purchases such as on vehicles.
Investing for a home
Saving enough money to use as a down payment for a house can be difficult – especially when coupled with car payments, student loans, and credit card debt which you may be facing in your 20s.
If you’ve managed to avoid these debt pitfalls in your 20s, you are well on the way to saving for a down payment for a house. In order to help you achieve your goal of saving for a down payment, consider opening an index fund or brokerage account to supplement your savings if you have a long enough time period.
Consider using an S&P 500 index fund
Opening an S&P 500 index fund through Vanguard or buying a similar fund that’s commission-free through companies such as Fidelity, will allow you to track the market over the next few years.
While index funds are great tools to help supercharge your savings, you should also consider keeping a certain amount of cash outside of the market’s volatility by opening a money market fund in conjunction with your brokerage account. You can then put money in both funds since the market has the potential to decline in value over the time. However, over a 5+ year period, this risk can be mitigated and probably worth the ability to generate extra returns.
Example of saving for a down payment
Let’s say you are 25 and saving for a $300,000 house by the time you are 35. In order to avoid Private Mortgage Insurance (PMI) which can cost between $90 and $210 per month in this example, you’ll need at least $60,000 or 20% of the purchase price. Clearly, you’ll have to save $6,000/year for 10 years to accomplish this goal which can be difficult to do for most starting out as rent and basic expenses can eat up the majority of discretionary income.
While you may have found homes that you like in the $300,000 price range now, these homes will have appreciated in value over the 10 years that you saved. If you are not diligent about saving even more, you may be priced out of the market unless you’re savings appreciate alongside the real estate values you are wanting to buy. For example, property values for that $300,000 in a good area probably appreciated around 4%/year and are now worth $444,000 10 years later. Because of the appreciation, a 20% down payment would require more than an $88,000 down payment. Meanwhile, you only saved $60,000 in cash.
Instead, let’s say you invested the $6,000 you saved per year in an index fund tracking the market. At a 10% annualized rate of return, you’d have over $95,000 before taxes to put down on the house due to the stock market’s appreciation alongside real estate values.
Saving for retirement
Perhaps the biggest mistake young people make early on is simply not saving money in tax-advantaged accounts for retirement.
Because of time and compounding interest over the decades, the dollars that are invested in your 20s will have the biggest impact on your overall financial well-being come retirement. For instance, for every $1 you are able to invest at age 20 in the S&P 500, you’ll have close to $73 by the time you’re 65 if the market simply matches the historical norms.
How to retire a millionaire
Let’s say you’re 20 and decided your investing purpose is to retire at 65 with $1 million in the bank. Now that you have set this goal, you should determine the monthly steps to take to incrementally reach this goal over the next 45 years.
To save $1 million on your own without investing and compounding interest, you’d need to save $1,851.85 each month or over $22,000 per year for the 45 year period. However, by putting cash aside in the S&P 500 on a consistent monthly basis and earning a 10% rate of return, you will only need to save around $1,500 per year starting at age 20 in order to retire a millionaire by 65.
Let’s say you decided to wait until your 30th birthday to begin investing. Even though 30 is still a relatively young age to begin investing, you will need to save substantially more to achieve the same goal of become a millionaire at 65. Instead, if you invest the same $1,500 per month, you will only have around $400,000 which is more than 50% less than you would have accumulated by starting 10 years earlier. To reach the same goal of becoming a millionaire by 65, you will have to invest $4,000/year or 260% more to have the same net worth.
Best ways to start your retirement savings in your 20s
Because you’ve determined that retirement is one of your purposes, you should open accounts that will best help you accomplish this goal.
Contribute to an employer-sponsored 401(k) Plan
One of the best ways to save for retirement is by contributing to an employer-sponsored 401(k) plan at work. Depending on your employer, you will hopefully have a matching contribution that is invested alongside your own savings. Typically, 401(k) plans allow employees of the organization to contribute to either pre-tax, Traditional 401(k) plans or Roth 401(k) plans.
If you contribute to a Traditional 401(k) plan, you receive a deduction on your current year income taxes for the amount you invested. The invested balance will will grow tax-deferred. Eventually, you will pay ordinary income taxes on the withdrawals when you retire after 59 1/2. Alternatively, the Roth 401(k) plan does not allow for a tax deduction when you make contributions. However, the balance grows completely tax-free, and you will owe no taxes upon distribution in retirement.
You will need to decide for yourself which plan is best for you.
Contribute to IRAs
Even if your employer does not offer a 401(k) plan at work, you still have the ability to contribute to a Traditional or Roth Individual Retirement Account (IRA). In both plans and similar to 401(k)s, the government will not be taxing your dividends and capital gains which allows your dividends and gains to compounding over the time. However, both Traditional and Roth contributions are treated differently for taxes as discussed below.
Key differences in Traditional and Roth IRAs
As mentioned in the 401(k) discussion, Traditional contributions allow for a deduction on your taxes now, while Roth contributions require you to pay taxes on your earned income today.
However, the money you invested in the Roth option grows completely tax-free and there are no taxes on withdrawals after you turn 59 1/2. For most individuals in their 20s, their income is as low as it will ever be and therefore, so are the tax rates – ignoring any governmental or legislative changes. Therefore, for most individuals who have the potential for income growth, the Roth 401(k) or Roth IRA represent the best vehicles in which to open accounts to save for retirement.
The benefits of the Roth option
By opening a Roth account, you are effectively contributing even more money because the money has already been subjected to tax. While you should consider retirement investments as spent money, as an added benefit, the Roth allows for individuals to pull out their contributed amount tax and penalty free. While the government would not be applying a penalty or additional tax, there still would be the opportunity cost of not letting this money grow sheltered.
For instance, let’s say you contribute $6,000/year in a Roth 401(k) or Roth IRA compared to a Traditional 401(k) or IRA. From age 20 to 65, invested at a 10% rate of return, you’d have around $4.3 million even though you only contributed $270,000 over your lifetime. With a Roth 401(k) or IRA, you would have access to 100% of this money tax-free.
However, if you had chosen a Traditional account, most of the money, or around $4 million would be subject to taxes. If you were in a 25% tax bracket in retirement, you’d pay over $1 million in taxes just because of the account you initially set up when you were 20. By choosing the Roth option, and delaying the tax deduction you would have gotten with the Traditional 401(k) or IRA, you would have over $1 million more in your account balance to spend on travel or give away.
Choose and implement an investment strategy in your 20s
After you gain an understanding of the market and your purpose for investing, the next step in your investing journey is determining a strategy to accomplish your goal.
Consider prudent higher-risk/higher-return investments in your early investing years
At a younger age, many experts recommend taking more risk in earlier stages of life since you will have time to recover from any losses you may incur. Additionally, your longer-term time horizon may also allow for more speculative companies to achieve their industry-changing strategy and reap the benefits of outsize returns. However, as you age, the recommendation most financial advisers give is to steadily reduce risk and focus on maintaining the wealth that has been accumulated over the decades – especially as you near the end of your income-earning life.
Avoid extreme speculation and market fads
For many young people, over-eagerness to get rich quickly, coupled with inexperience in investing can lead to decisions that amount to gambling rather than investing.
While you may have time to financially recover from a small loss in speculative ventures like Bitcoin, pot-stocks, or high-risk, development stage biotech companies, the opportunity cost at a young age can compound this loss. The key is to not take irrational and delusional risk where the probabilities are working far against you. Instead, take calculated risks on great, established companies that have a solid management team and may represent long-term outperformance.
Opportunity cost example
As an example, let’s say a 22-year old was making $50,000 as a first year out of school and decides to take a month’s pay to “play with” and loses it all on a failed speculation in penny stocks or the current fad.
The $4,167 lost in the first year of work ended up having an opportunity cost of over $250,000 or over 5x the starting annual salary. The opportunity cost assumes the amount had been invested in a simple index fund following the S&P 500 over a 43-year period which is a much easier investment to watch. While taking additional risk at a younger age can be perfectly advisable, putting money in extremely speculative, untested and unfounded investments where the only investment thesis is “hope” can have an opportunity cost much greater than the potential rewards.
Examples of calculated risk in your 20s
Rather than shooting from the hip and speculating on brand new technology or current fads, consider buying a diversified portfolio of growth stock funds or the NASDAQ composite in addition to index funds that track the S&P 500.
Should you feel the need to add additional risk/reward to your portfolio, consider adding international stock funds, or small and mid-capitalization funds to incorporate smaller public companies that may one day become the next Amazon. Once you have followed stocks and have created mock portfolios where you practiced picking individual stocks and have a track record of beating the market, you can then consider purchasing individual shares to compliment your diversified funds.
Buy a basket of growth stocks or growth-oriented mutual funds
While each person’s risk-tolerance varies, a good strategy to consider would be to buy a basket of growth companies in particular segments of the market that you believe will outperform due to global trends. Pick companies that have established track records of shareholder returns and have consistently generated revenue and/or earnings growth that outpaces the average company in the S&P 500. Many of these companies are on the leading edge of technology in their particular industries but have established sales and clients and are innovating or streamlining our everyday life.
As a younger investor that is willing to assume more risk, consider adding a basket of growth companies that are attempting to disrupt the business these companies are involved. Typically, these companies have more sophisticated technology or online platforms, reduce the friction in the payments sector from person to person or charge fees for each swipe. For the financial sector, you can also consider the companies behind the payment methods, security and encryption of the transaction, and technology behind marketing and hosting these payment methods that you use on a daily basis and whether they would make a good investment.
Generally, individuals in their 20s have longer time horizons to ride the rollercoaster of the stock market and individual companies that are still in the early stages of growth and disrupting the status quo to become tomorrow’s mature companies. Picking higher growth companies that are disrupting the mainstays in the market to become the next leading player over the coming decades should be a good strategy to hopefully outperform the broader index. However, investors willing to take on more risk must also be willing to lose money on certain investments while others pay off.
Increase your portfolio allocation to certain segments you believe will outperform
For instance, let’s say you believe that financials will outperform based on economic growth and a rise in interest rates from the Federal Reserve’s policy. In addition to your diversified fund that tracks the market, you’re wanting to buy individual stocks to weight this sector more heavily. Consider purchasing the shares of one or two “bell-weather companies” such as the big-name banks on every corner in order to hedge or mitigate risk of buying higher growth, more volatile companies in the sector. If the thesis was correct that the trends affecting the financial industry are positive, the big-name, chartered institutions chosen should generally perform at least in line with the market or better if the financial industry as a whole outperforms, pending any company specific issues.
Track your wealth and investments
Tracking and monitoring your investment decisions is crucial in order to reassess how your portfolio performs relative to your goals and the overall market as a benchmark. If you prepare a monthly budget, you should also track your investment allocation and returns as a part of your monthly budgeting process.
Knowing how your investments have performed can help you determine if you are on track for your savings goals or if you should adjust your monthly contribution amounts to take advantage of lower prices in market downturns. Especially if you invest in individual stocks, you should consider keeping an investment journal that outlines your thesis for why you picked the stocks. In this journal or document, include the price you paid per share as well as the price of the S&P 500 so that you can compare the performance of your picks. If you consistently underperform the stock market, consider moving into a strategy comprised of index funds rather than individual stocks.
If you do choose to track your wealth starting in your 20s, implement a sound investing strategy, and stick to that strategy despite market volatility, you should see your net worth steadily increase from year to year.