If you’re in your 20s, investing might not be the first thing on your mind. Heck, it might not even be the second, third or fourth. You’ve probably graduated college, are living alone for the first time and working the first job that might be described as a ‘career’. That’s a lot on your plate!
But not thinking about investing in your 20s can be a costly mistake. Or at least, a big missed opportunity. Getting a jump start on investing for your retirement can give you a massive leg up in making sure you’re financially comfortable later in life.
If you’ve dreamed of a comfortable retirement later in life, the best way to make that happen is to begin planning for it now. But to do that, you need to know how to invest in your 20s.
Steps to Invest in Your 20s
If you’re planning to commit to starting to invest in your 20s, then kudos. You’re way ahead of 90% of your peers. And making this choice has the potential to set you up to make your money work for you.
In order to effectively invest as a young person, it’s important to understand your position and your goals. You’re not trying to make a quick buck. You’re not looking to find some miracle stock that quadruples overnight.
Instead, you’re going to leverage the advantage that being a long-term investor provides.
The Power of Compound Interest
Nobel Prize-winning scientist Albert Einstein called compound interest ‘the eighth wonder of the world. And it’s easy to understand why he felt this way. Compound interest is your greatest ally as a young investor.
The premise behind compound interest is simple, but it helps to understand the basics of investing to grasp the concept. First of all, let’s define the term ‘principal’. Principal is the initial amount of money invested or loaned out. So, if you bought $1,000 of stock, the principal is $1,000.
With any investment or loan, you’re looking for a return on the investment. This is the interest. Let’s say you get an 8% return on investment in the first year owning your stock. 8% of $1,000 is $80. If you were to sell your stock, you could take a one time profit of $80. The principal plus the interest.
Instead, let’s say you decide to reinvest the amount you made. Now, your principal is $1080. Again, you receive an 8% increase. This time, you’ve made $86. That doesn’t seem like much more, but we’re only getting started.
Flash forward 40 years. That initial $1,000 is now over $21,000. And the 8% gain is netting you more than $1,700 in yearly profit.
This is the key to investing while you’re in your 20s. When your investments increase in value, you don’t cash out and spend the profits. Instead, you reinvest those profits and continue to build your principal. In fact, the best thing to do is to invest even more of your money.
Let’s change the scenario so that now, you’re investing $1,000 each year, with the same 8% gain. Over the span of 40 years, you’ve invested $40,000 of money you earned, and you’ve made $280,000. Not bad!
They key to maximizing the power of compound interest is starting early. The sooner you begin to invest, the more work compound interest will do for you.
Probably the most important principle you need to accept as an investor in your 20s is that you’re investing for the future, not the present.
This means you’re not trying to pick a stock based on what you think its share price will be in six months. Your objective is to find investments that will steadily gain value over time, regardless of any temporary peaks and valleys.
This might be a different view of investment than the stereotype you’ve imagined. You’re not going to want to feverishly check the daily price fluctuations on your investments. The short term doesn’t matter. Instead, you want to choose investments based on strong, long term fundamental value.
This gives you a tremendous advantage as an investor. You’re not chasing fads or hoping for miracles. All you’re looking for is dependable long-term growth.
Of course, there are exceptions to this rule. Day trading rules reward the talented few who are disciplined enough to observe them.
Best Investments in Your 20s
Taking into account the above concepts, these are some of the best options for investing while in your 20s.
1. Taking Advantage of Your Company’s Help
Many employers offer 401(k) plans, which are retirement accounts in which you can contribute pre-tax money from your paycheck. A 401(k) essentially allows you to get away with paying less in taxes, as long as you’re willing to wait to access the money.
Even better, employers frequently offer to match your 401(k) contribution up to a certain percentage of your salary. In effect, they’re willing to give you free money if you’re willing to invest in a retirement account.
If you’re in your 20s, there’s a chance you’re working at your first ‘career path’ type of job. This means you’re probably making more money than you ever have before. There’s going to be a temptation to spend some of that money on entertainment, wardrobe upgrades, and improvements to your living space.
All that is fine, but be sure to contribute toward a 401(k) plan, especially if your employer is willing to kick in extra. By doing so, you’re increasing your paycheck even further. Plus, contributing to any investment vehicle while you’re young is going to start that compound interest accruing.
2. Getting Involved in the Stock Market
When it comes to investing, one of the biggest factors is volatility. Certain types of investments offer greater possibility for gain. The downside is the risk that they might stay stagnant, or even decline.
Stocks represent one of the more volatile types of investments, especially in the short term. Even massive companies like Apple, Walmart or Microsoft might gain or lose value in any monthly or yearly window.
In contrast, bonds are an investment with most of the volatility removed. A bond essentially allows you to lend money to a business or government, and pocket an interest fee at the term of the bond. The only danger with a bond is that the borrower will default on the loan. A US treasury bond is backed by the US government. That’s about as safe as you can get.
As an investor in your 20s, you’re investing for the long haul. The great thing about this is that you don’t have to be as concerned about volatility.
Consider a stock investor in their 50s or 60s. When they buy a stock, that investment is going to need to bear fruit relatively soon. If they’re expecting to cash in their stock in a short window and the stock happens to be in a down period, they’re in trouble. Bad markets happen, and in the short term you can get caught.
You, as a young investor not looking to touch your investment for decades, can play the long game. If you believe that Apple is going to remain a force in consumer electronics, you can buy Apple stock knowing that only the long-term future matters.
You don’t have to sweat Apple’s stock price on a weekly, monthly or even yearly basis. If you believe in the fundamentals of a company, you can buy that stock and hold on. Over time, you can reap enormous value as the cream rises to the top.
3. Investing in an Index Fund
If you’re in your 20s, it’s probably safe to say you’re not all that experienced when it comes to investing. Picking out stocks may seem like too tricky or risky a task. What if you pick a company who goes belly up? Plenty of once-strong businesses decline or even go out of business from year to year.
If you want to get involved in the stock market but want to limit your risk, index funds are a great choice. An index fund is a grouping of shares of a large number of individual stocks. Frequently, index funds try to mirror either the market as a whole or some sector within the overall market.
What this means is that you’re not putting all your eggs in one basket. If one company goes down, chances are it will be more than made up by two other companies rising. In effect, you’re betting on the market as a whole rather than one or two players within it.
This makes index funds excellent choices for investors in their 20s for two reasons: Number one, if you’re not all that confident in your investing abilities, the ease of index funds is a plus. Number two, markets have historically risen over time, and time is on your side.
4. Making Sure to Take Care of Existing Debt
We’ve talked a lot about the power of compound interest and the advantages of investing while you’re young. And all of that is true. But making investments doesn’t help you much if all your gains are eaten away by compounding interest on loans or other debt you owe.
Sadly, most college graduates are saddled with significant student loans. It’s not uncommon to owe tens of thousands of dollars upon graduation. You might also have auto loans, credit card debt or other forms of financial obligation.
It might be tempting to neglect or pay the minimum on debts in favor of investing. But this is almost always a mistake. You will eventually have to pay your debts, and in the meantime you’ll be paying interest on the sum of what you owe.
This isn’t to say you can’t invest any money at all until you’ve completely discharged your debts. However, focusing too much on spending or investing money while debt hangs over your head is penny wise but pound foolish.
Do the best you can within your means to pay down your existing debt while you’re young. The sooner you can pay off obligations like student loans, the sooner you can fully focus on securing a financial future that can lead to retirement.
Not to mention, as you transition into your late 20s and early 30s, you may begin to consider settling down and buying a house. While it’s not impossible to carry both a mortgage payment and student loans, it’s not easy. Spend your 20s eliminating debt and you’ll find it easier to take on other obligations if that’s the path you choose.
5. Investing in Yourself
So far, we’ve mostly focused on investing money in stocks, funds or other financial assets. But that’s not the only way to spend money in the short term for a future gain. Sometimes, the investment with the greatest payoff can be improving your overall skillset.
This is especially true when you’re in your 20s. Look at it this way – When you add a new skill or marketable qualification, that’s with you for your entire working life. Making an improvement when you’re in your 20s can bear dividends for as many as four decades.
Let’s say you’re a recent graduate with a bachelor’s degree who has recently entered the job market. There are so many ways you can boost your earning potential and make yourself available for different positions over the course of your career.
You can study for a Master’s degree or MBA. People working toward advanced degrees are frequently already in the workforce, meaning classes are offered at convenient times that won’t interfere with your 9 to 5. An advanced degree can often open doors down the road, especially when it comes to applying for senior and management level positions.
Another outstanding option if you’re not already a computer science major is to study software development. Our world gets more and more digital, and that trend is accelerating rather than slowing down. This means more industries find themselves incorporating coding and software development into positions previous not overlapping. Learning to code gives you another tool in your belt, one which happens to be increasingly valuable.
This kind of investment in yourself doesn’t have to be formal education. Any skill you can pick up which will increase your value as an employee is worth the time it takes to learn it. The key is to spend the time and money improving yourself as a person and a potential employee rather than vegging out in front of a screen.
The days where a person works at a single company along one career track are largely over. Instead, you can expect to work for many businesses, and the first career you start may very well not be the one you end up in. And who knows what the job market will look like 20 years from now?
The more you’re able to invest in yourself while you’re young, the better you set yourself up to seize the best opportunities available for you over your career.
If all this seems like a lot to take in, don’t worry. You don’t have to plan out an entire lifelong investment strategy by the time you reach 25 years old!
Investing for a comfortable retirement is a pursuit that will stretch across decades. And it’s OK to make the occasional slip or stumble. The key, though, is to begin investing as soon as you’re able. By tapping into the power of compound interest and betting on a gradually rising market, you can put yourself in a great position to retire on your own terms.