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 in Your 20s
When preparing to invest in your 20s, it’s important to consider how much money you can afford to commit to investing. To determine the amount, you might create a budget, which includes your income and your cost of living expenses, such as rent, utilities, and food. Using your budget as a guide can help you get started in finding some wiggle room in your funds to invest.
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 preparing for life’s uncertainties. 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 backup 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
One of the best investment approaches in your 20s is to pay off high-interest debt. If you owe money on credit cards, it may be helpful to pay off the balance before investing. Think about it: If you’re paying 25% 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 in Your 20s
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.
Risk Tolerance
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.
Time Horizon
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. It’s important to consider your time horizon and the financial goals that you are trying to achieve through investing. A short-term financial goal might include saving for a new car, which would likely be better served by a savings account or relatively low-risk money market fund. However, a long-term financial goal, such as retirement or buying a home ten years from now, might allow you to take on more risk since you have a longer time horizon to recover from any market downturns. Developing both short and long-term financial goals can help you stay on track with your saving and investment strategy allowing you to build wealth in your 20s and beyond.
Tax Benefits
It’s also important to 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.
Choosing Investment Options in Your 20s
Your investment portfolio in your 20s will likely involve achieving diversification, which is a key aspect of an investment strategy. By diversifying, you’re spreading your money out across various types of investments to reduce risk. In order to diversify, 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 exchange traded funds (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, 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.
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.
Getting Started in Your 20s
To get started investing in your 20s, dream big, but start small. You can make small investments on a regular basis to get started.
Online Brokerage Account
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. Also, it’s helpful to establish an automated saving plan so that a portion of your income gets direct deposited into a brokerage account that automatically invests in an ETF, such as one that tracks the S&P 500 index.
Enroll in a 401(k)
If you’re in your 20s, a 401(k) is one of the best investment options for building wealth over the long term. If you have access to a workplace retirement plan, take advantage of the employer match. The match is typically a percentage of your income that is contributed to your 401(k) by your employer as long as you contribute a minimum amount. For example, your employer may match 50% or your contributions up to 6% of your pay, meaning they add 3% as long as you contribute 6%. An employer match is essentially free money and can help young people build wealth over the long term. Also, the contributions to a 401(k) can provide tax savings since the money comes from your paycheck before you pay income taxes. When investing in your 20s, it’s important to 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.
