Where Should You Invest When You’re in Your 20s?
When it comes to investing, the earlier you start, the more time you have to build a solid financial foundation that will serve you well decades in the future. But what investments should young people in their 20s be considering now to ensure a lifetime of financial success?
The short answer: It depends. The long answer: No two people are alike, and neither are their investment goals.
But that doesn’t mean investing early and often isn’t a good idea.
Benefits of investing early
The earlier you begin planning for financial security and retirement, the higher your potential return on investment will be. Take advantage of your youth by prioritizing investment today so that you can get a head start on building your financial future. Why exactly?
Time is on your side: As a 20-something, chances are that you don’t make a lot of money. And while you may not have tons of cash coming your way, what is on your side is time.
Compounding is when you grow your investment by reinvesting the earnings. For young investors, compounding allows you to generate wealth over time by making your money work for you.
Consider this scenario. Based on a 5% interest rate, an investment of $10,000 at the age of 20 would grow to a little over $70,000 by the time you reach the age of 60. Making the same investment at age 30 would grow to just $43,000.
The longer money has to grow, the more wealth it generates.
You can make riskier moves: Your age has a direct influence on the amount of risk that your portfolio can withstand. People in their 20s have years of earning ahead of them, along with plenty of time to make up for any losses. This means that young people can afford to take on riskier investments.
As you get older and near retirement age, you’ll want to gravitate towards low or no-risk investments. However, young adults can absorb more risk, which enables them to build more aggressive portfolios.
Be prepared to face plenty of volatility, but in the end, risky investments often yield the largest gains.
Other benefits: Compounding and the potential for higher gains thanks to risk only scratch the surface as to why younger generations should embrace investing. Other notable benefits of getting started with investing early on in life include:
- Tax benefits
- Improved spending habits
- Ability to set yourself up for financial stability in the future
Even if you’re investing just a couple hundred dollars each month, something is better than nothing!
Best investments for young investors
Before you can get started with investing, you’ll need to first decide which types of accounts to use. Traditional and Roth IRAs, along with 401(k) accounts, are the go-to options for retirement planning.
If your employer offers a 401(k) plan, set up an account and contribute as much as you comfortably can. Most employers match your contributions up to a certain percentage. This is free money, so take advantage of it!
After choosing an account (or several), you’re ready to invest. One of the most important things to remember is that there’s a tradeoff between risk and reward. You won’t find an asset that offers low risk and high reward.
Typically, higher risk comes with the possibility of higher reward. Your 20s are the perfect time to invest in higher-risk assets because it’s money you won’t need for decades.
An equity (aka a stock) is a small piece of ownership in a publicly traded company. When investing in stock, you can earn money through capital appreciation and from paid dividends. Stocks can range from low risk to extremely volatile.
Stock prices fluctuate based on supply and demand. Stocks with higher volatility may offer higher long-term returns over time. Data from 1926 to 2018 for the S&P 500 shows stocks have an average annual return of 10-11%.
Interested in other types of equity investments? Consider investing in limited partnerships, real estate investment trusts (REITs), direct real estate investments, and gold.
A bond involves lending a company or the government money for a set period of time. Any money that’s earned on the investment is interest paid to you. Though not risk-free, bonds are less risky than stocks.
Bonds have a set rate of return, which means that you’re guaranteed to receive a certain amount of money. Treasury bonds, which are backed by the government, are the safest type. Investors only lose money with bonds if the company, or government, goes bankrupt.
Because there are many different types of bonds, performance and return rate varies. However, long-term government bonds usually have returns between 5-6%.
Mutual funds and ETFs
Looking to gain exposure to certain asset classes? Consider using mutual funds and/or exchange-traded funds (ETFs). A fund is a combination of many different investments, including stocks, bonds, and others.
Funds are beneficial for young investors because they offer immediate portfolio diversification. They also mitigate the risk of having too much of your money invested in a single stock or sector.
Funds can be actively or passively managed. Active management involves actively buying and selling stocks in efforts to outperform the market. Most fail to do so.
If you want to invest in passively managed mutual funds, choose index funds. Indexes are used to track the overall performance of an entire market. What’s beneficial about index funds is that they have very low fees, which means more money for you.
Target date funds
Want to take a hands-off approach to investing? Consider a retirement target date fund. These investment packages are based on your projected year of retirement. They tie together several funds and then shift into bond exposure as your retirement date nears.
With a target date fund, your investments automatically (and gradually) shift. It’s like putting your retirement into cruise control.
With retirement decades away, it can be hard for 20-somethings to see the advantage of investing now. However, time, compounding interest, and tax benefits are all extremely beneficial. Starting now is how you ensure yourself a solid nest egg that will serve you well during your later years in life.