The period right after your college graduation is a unique one, for several reasons. In many ways, you’re now a full-fledged adult, tasked with many new, exciting and (potentially) scary responsibilities, such as going to college, getting a job, and being responsible with your finances. With so many things being thrown at you at once, it’s easy to push investing to the side.
However, if you can commit to starting your investing career early, the payoff may be substantial.
This article will dive into more in-depth detail regarding the benefits of investing in your 20s, along with what you should keep in mind as you begin to build for your future.
Why Invest In Your 20s?
As mentioned earlier, your 20s are not typically known as a period where you’re banking a substantial income and investing in the stock market. Many young adults struggle to make ends meet when they’re first getting started professionally.
However, if you take a moment to understand the point of investing in the first place, it may give you the motivation and perspective necessary to sacrifice a portion of your income early on.
The entire point of investing is to accumulate assets for a future financial need or goal. For most people, this need is retirement. Whether it’s the “traditional” way of retiring (working into your 60s before riding off into the sunset) or retiring earlier in life, both retirement pictures have a common variable: the need for assets to provide liquidity to supplement or replace your salary/income.
With this in mind, it’s important to mention how compounding interest works. If you’re not familiar with the formula, time is the exponential variable. By getting started investing in your 20s, you are building up the initial principal that will snowball over time.
To see for yourself, take some time to play around with an online compound interest calculator. While $20,000 may not exactly help you retire when you’re 30, you’re in a much better position than someone who doesn’t have a dime saved up.
What Investment Accounts Should I Be Using?
Retirement accounts offer the benefit of tax-deferred growth. This is a big deal because any time you sell an investment at a gain or receive interest from bonds or dividends from equities, you are not responsible for any taxes, as long as the funds remain in the account.
By contrast, in a brokerage (taxable) account, all transactions that result in a gain are subject to taxation. The same goes for bond interest and dividends.
Look First to a 401(k)
Therefore, for the majority of people, a company 401(k) is an ideal place to begin your investing journey for a few reasons.
Chief among these is the fact that the contributions come directly from your paycheck without you even having to think about it. After a couple of pay cycles, you’ll forget the money is leaving your paycheck. This makes it less likely that you’ll stop investing your money in the account, thereby guaranteeing growth as long as you remain with the employer.
However, the real value-add in a 401(k) is the employer match. Remember how we just described the importance of dedicating money to acquiring assets for the future? Most 401(k) plans offer a match that is based on a formula built around the amount you contribute.
Let’s assume your plan offers a 100% match on the first 5% of your salary that you contribute. If 5% of your salary is $2,000, your employer will contribute $2,000 on your behalf. So, instead of only contributing $2,000 in the year, you’re actually adding $4,000 to the account. If you do that for an entire decade, it can really give you a massive head start on your future financial goals.
Consider an IRA
If you don’t have access to a 401(k), you can always contribute to an IRA, as long as you have what the IRS considers earned income. IRAs are individual retirement accounts that offer many of the same benefits as a 401(k), minus the employer match. They also have lower contribution limits.
If you’re at the point where you are maxing out both your 401(k) and IRA, it may make sense to begin investing within a taxable (brokerage) account. These accounts have no contribution limits and are not subject to any early withdrawal penalties like retirement accounts.
How Much Should I Be Investing?
The short answer, is as much as possible. One of the most common rules of thumb is to invest at least 20% of your after-tax income; however, everyone’s circumstances are different. The best thing you can do is do some work upfront to budget around your lifestyle and needs.
Ideally, you should be cutting down on unnecessary costs to free up cash flow in order to invest more money over time. If you are primarily investing in your company’s 401(k), you should make it a goal to at least benefit from the entire employer match. Not everyone can max out their 401(k) contributions at this stage. That’s okay!
Many 401(k)s offer automatic annual contribution increases. This is yet another way of forcing yourself to save more without having to think about it. The way this works is every January, your contribution percentage increases by a specified percentage. In most cases, this can be elected at any time.
How to Approach Investing in Your 20s
As mentioned earlier, your 20s are a unique period in your life for a number of reasons, not the least of which is your ability to get a head start on investing for retirement. However, as it relates to your asset allocation (investment mix), this stage of your life has a characteristic that stands out: your ability to take on risk.
Your Risk Capacity
If your financial goal is decades away, you have the unique advantage of being able to take on more significant levels of risk within your portfolio. Swings in the market matter much less for a young adult that is in the accumulation phase versus someone that is older and is approaching retirement. The statistical term for this is risk capacity.
Risk capacity measures how much risk you can afford to take without putting your entire financial plan in jeopardy. Even if we were to see another severe downturn (i.e. recession), in the grand scheme of things, it would have minimal impact on your overall financial future.
Generally speaking, it makes the most sense to take risk early, because without taking on risk, you will not see the appreciation in your investable assets necessary to start making a dent in your future financial goals.
Risk Vs Return
Keep in mind that risk versus return is one of the foundational laws of finance. Over time, the market tends to reward (responsible) risk. All things being equal, an aggressive asset allocation (primarily equities over bonds and cash) is most suitable early in life compared to later.
All of that being said, it’s still important that you stay true to your risk tolerance. Seeing swings in the market can be very difficult to stomach. You should always be mindful of the amount of risk that you’re okay with taking on, regardless of the amount of risk you can afford to take.
Do I Need A Financial Advisor?
Traditionally, financial advisors have been most suitable for people that have accumulated plenty of assets over a lifetime. In most cases, a full-service financial advisor may not be the cheapest option.
The good news is, you probably don’t need a full-service financial advisor when you’re working hard to establish yourself in your 20s. If you want assistance with your asset allocation, a Robo advisor may be a viable option.
What is a Robo Advisor?
The advent of technology has changed the investing world, making professionally managed portfolios much cheaper and easier to access for the everyday investor or young adult. Just keep in mind, that if you go with a Robo advisor, you may not have a direct (or human) point of contact to go to with your specific investment-related questions.
This is what makes Robo advisors much cheaper than the traditional financial advisor.
If you’re finding yourself in a position where your income is increasing, and you are starting to see value in planning for your future, but you don’t have a large chunk of investable assets, a fee-only financial advisor may make sense for you. A fee-only advisor charges a flat rate for their financial planning services, and investment management in some cases.
Choose Based On Your Needs
However, everyone is different. Some people require more assistance with others. There is nothing wrong with that, especially throughout such an unstable period in your life.
Like anything in finance, it’s essential to know where you stand, what your needs are, and to explore what options make the most sense for you.
A Final Word on Investing in Your 20s
Without question, your 20s are an exciting time in your life. The urge to spend all of your excess money may be tempting, but if you can commit just a portion of it to invest, you can start getting ahead on your financial goals. There are a few things to keep in mind during this topsy-turvy time in your life:
1. Your 20s Are for Learning and Growing
As you go through this period in your life, learn about what is important to you and start mapping out the vision that you want for yourself in the future. Having a target in mind will keep you focused and will give you the motivation that’s necessary to do the difficult things in life (like investing instead of buying that nice pair of shoes every paycheck).
2. Keeping the Big Picture in Mind is Important
Keeping the big picture in mind helps you have the context necessary to start building the financial life that you want and deserve. Context is key with investing. If you know you have decades to build, thoughts of the next recession should not keep you up at night.
3. You Don’t Have to Know it All
You don’t have to have everything figured out at this stage. The most important thing you can do is get started and develop great habits along the way. Success in investing is more about consistently doing the right thing versus “trying to find the next Amazon.”
4. Your Education is Your Greatest Asset
Study what it takes to be successful. Build relationships with people that have seen success in investing. You’d be surprised how many people are willing to share their stories: their wins, and their losses.
5. Keeping Investing in Your 20s – and Beyond
Keep investing in yourself. Keep improving your skillset.
Most importantly, keep accumulating assets.