When you’re in your 20s, it can be difficult to envision what life will look like several years down the road. However, it’s important to lay the groundwork for the rest of your life when you’re young, especially when it comes to personal finance and investing. By building a nest egg early, time is on your side, enabling you to grow your wealth for longer.
In this article, you’ll learn habits and tips to consider when starting to invest in your 20s, ultimately setting you up for a successful financial future.
Preparing to Invest
Before investing, you have to consider how much money you want to put forward. To decide that, consider if you’ll base the amount on your predetermined budget, your income, or long-term financial goals, for example. Using your budget as a guide can be a beneficial way to get started, and to have a sound budget, you should be aware of your cost of living and the regular expenses that impact it. That way, you’ll find more wiggle room in your funds to invest.
A practical budget can provide security through savings, ample disposable income, and the extra cash you need to invest for the short and long term.
Keep an Emergency Fund
Investing involves more than simply buying stocks, opening an individual retirement account (IRA), or enrolling in your employer’s 401(k). Like any other big life decision, investing requires preparation. The U.S. Securities and Exchange Commission (SEC) advises taking several steps with your personal finances prior to investing, including creating an emergency fund.
Open a savings account and label it an emergency fund, then determine how much money you want to keep in it. This portion of funds will act as a back-up plan, should you run into unexpected financial upheaval, such as needed hospital care or losing a job. How much to keep in the fund is an individual decision based on a variety of factors, including how much money you need to survive each month (cost of living), and how comfortable you are with the consistency and sustainability of your income. Look back on your budget and expense history as one way to decide how many months' worth of expenses you will keep in an emergency fund.
Pay Down Debt
As the SEC puts it, there’s no better investment approach than paying off high-interest debt. If you owe money on something like credit cards, the best approach is to pay off the balance in full as quickly as possible. Think about it: If you’re paying 20% interest on a credit card or loan balance and only earn 8% on investments, you’re drawing the short straw each month.
Also assess your lower-interest debt, such as student loans. Does the monthly payment prevent you from investing as much as possible? If you reduce your debt, you will likely free up cash in your budget that can be used to invest.
Factors to Consider When Investing
By preparing to invest, you have put yourself in the best personal financial situation you can. With a low cost of living, a stocked emergency fund, and debt paid off or managed in a realistic way, you’re already in a better position than most people, let alone most people in their 20s.
Now that you’re ready to invest, consider the following factors.
You often hear that the younger you are, the more investment risk you can take on. While this is generally true, it’s not specifically (or circumstantially) true for everyone. It really comes down to risk tolerance—your ability and willingness to lose a portion or all of your investment in exchange for the possibility of greater returns.
As a younger individual, you generally have less to lose, as compared to, say, a 35-year-old saving money to buy a home for his growing family. However, if you can’t sleep at night because you’re in investments that don’t match your risk tolerance, no matter your age, it’s simply not worth it; you may want to make adjustments to lower your exposure to investment risk. At the same time, accepting some financial risk often delivers greater rewards.
Historically, stocks, bonds, and mutual funds have higher risks and potentially higher returns than savings products, making them the most common investment products. Stocks are considered one of the riskiest investments, as there is no guarantee of making a profit.
As someone in their 20s, your time horizon—the amount of time (measured in months, years, or decades) you need to invest in order to achieve your financial goal—is automatically greater than someone in their 50s. If you have a shorter time horizon, you’re more likely to take less risk.
Consider that, as well as the goals you are trying to achieve, when making investments. A short-term target, such as saving for a new car, for example, tends to be better-served by a savings account or relatively low-risk money market fund.
Consider taxes. If you keep your money in an online brokerage account without a tax-friendly designation, you’ll pay taxes on dividends and capital gains. With this in mind, you should always consider tax-advantaged investment vehicles, such as an IRA and workplace 401(k) programs. The sooner you start investing for retirement, the better.
Depending on what vehicles you have available and the choice you make, you might be able to contribute pre-tax income to a retirement account. Another option is investing after-tax money, but not paying taxes on withdrawals.
When thinking about the impact of taxes on your investments now and as you get older, consider reaching out for guidance. Your employer’s human resources department, a financial advisor, or a tax advisor are good resources to speak with.
Choose Investment Options
For most people, diversification is a key aspect of their investment strategy, and that simply means spreading your money out across various types of investments to reduce risk. To be able to do that, it’s important to understand the level of risk associated with each type of investment, according to the SEC.
- Most risky: Individual stocks, relatively aggressive mutual funds or ETFs, real estate.
- Risky: Mutual funds or ETFs that track broad stock market indexes such as the S&P 500, Nasdaq 100, or Dow Jones Industrial Average (DJIA).
- Less risky: Bonds and bond funds.
Most investors achieve diversification by keeping money in several of these options. You might own a basket of individual stocks you like, mutual funds that span indexes and sectors, and a relatively conservative bond fund. The most important tactic is to not put all of your eggs in one basket, and not get caught up in broad trends as you invest in your 20s.
Consider how the global health crisis impacted spending and consumer interest in various industries, such as internet gaming and household cleaning supplies. While stocks in these sectors captured the limelight in 2020, that can easily change and fluctuate. Oftentimes, broad economic conditions make dividend-paying stocks more popular.
Don’t get too caught up in fads or trends, such as meme stocks, as you invest in your 20s. Find an allocation plan across various types of investments that works for your long-term goals and appetite for risk. Again, consider consulting a financial advisor to help you diversify and find your sweet spot.
Deciding When to Sell
When the market crashes or drops considerably, it’s normal to get nervous. However, if you’re in your 20s and you have the factors discussed in this article in order, resist the urge to sell. Stay the course.
Let’s take a look at a real-life example. Over the course of four days in March 2020, the Dow plummeted roughly 26% with news of the pandemic spreading across the globe; however, not all sectors experienced such wrenching volatility. Some companies, such as those tied to the stay-at-home economy, performed incredibly well during and after this period.
In hindsight, staying in the market would have allowed investors to participate in significant upside after the early market crash. This has been the case when we look back on the history of major market declines and subsequent rebounds. Buy and hold—then buy some more—tends to be a sound strategy, particularly when you’re young.
To get started investing in your 20s, dream big, but start small.
You can make small investments on a regular basis to get started. Most online brokerages have low or no account minimums, allowing you to hit the ground running with as little as a few dollars a month.
If you have access to a workplace retirement plan, such as a 401(k), take advantage of the employer match. Once you enroll in a 401(k), the contributions you make come from your paycheck before you pay taxes. Often, your employer will match your contributions, typically offering up to a percentage of the amount, so getting this boost is like receiving free money.
Using an investing app may be a good way to get started, too. For extra help, consider discussing your investment strategy with a financial advisor.
Bottom line? First, get your financial ducks in a row. From there, consider the life you want to live now and in the future. Structure your investments to match these realities, your desires, and how comfortable (or uncomfortable) you are with taking on the risk that comes with most types of investing, particularly in a sometimes-volatile stock market.