Do you want to start investing in your 20s, but don’t know when, how or where to begin? Investing in the stock market can be overwhelming for novice investors, but it doesn’t have to be that way! Yes, those who are more experienced may be more comfortable and those who have more money have the option to hire professionals. However, that doesn’t mean you should not invest in your 20s or start as early as possible. Here are the best ways to start investing and saving for retirement.
Investing Over Time
Learning how to invest in your 20s is critical because starting early takes advantage of time. Between 1900 and 2015, the stock market returned over 11.50% per year, on average. During this time, the Unites States – and frankly the world – experienced two World Wars, the Great Depression, the Vietnam and Korean War, multiple terrorist attacks and natural disasters, an oil embargo, and a number of financial crises.
The point is that, despite recessions, wars, and boom and bust cycles, the stock market earned investors significant gains. Investing over a long time horizon is one of the best ways to minimize risk and ensure stable, long-term returns.
Time in the Market vs Timing the Market
One way investing early can help you minimize risk and maximize long-term gains is the fact that “time in the market” is more important and influential than “timing the market”. Some young adults or professionals who are investing as beginners get the impression that timing the market is easy, believing they can actively day-trade with an online brokerage account to maximize gains.
The chart below, which represents data compiled by JP Morgan Asset Management, compares the returns of an investor between 1993 and 2013. A fully-invested individual would have earned a 9.22% annual return, whereas a day-trader who may have missed the top 10 best performing days of the stock market would have lowered his returns by over 40%.
Ultimately, you have to ask yourself – as a new investor – are you so good at online stock trading that you would be able to pick the top 10 or 20 best days for returns out of over 2,500 trading days?
Similarly, investing young also allows you to take advantage of compound interest. Time will take your investment and grow it year over year, and that growth will yield more growth, resulting in a compounding effect. This is the basic idea behind compounding returns – your returns will earn more returns. You want to take advantage of this as much as possible.
While it may seem like investing with little money will result in small gains, taken over a period of time, small returns can snowball into huge gains. It doesn’t matter if you start investing with $100, $500 or $1000 – when you start saving and investing is more important than how much.
Here is a perfect example. Let’s assume Susan invests $5,000 per year for 10 years between the ages of 25 and 35, for a total of $50,000. Then Bill invests $5,000 annually between 35 and 65, for a total investment of $150,000. Assuming an average annual 7% return, Susan ends up with significantly more wealth compared to Bill despite investing much less.
However, the real winner is Chris, who invests consistently over the course of his life. By investing $5,000 per year between the ages of 25 and 65, for a total of $200,000, Chris eventually becomes a millionaire with a nest egg that allows him to retire.
Time is your greatest ally in investing, but it can be your biggest enemy as well. The longer you put it off, the more you will have to save in a shorter time period. The Center for Retirement Research states that you must put away 3 times more money if you wait to start saving for retirement at 45 as opposed to 25. Listen to the math and start investing as early as possible.
Start With Your 401(k) Plan
The best way to start investing in your 20s is through an employer-sponsored 401(k) plan. There are a few simple reasons for this, such as:
- The money comes right out of your paycheck – making it simple to invest and saves you money on taxes.
- Your employer likely offers some kind of match on what you contribute, allowing you to increase your overall compensation and save even more for retirement!
- Because a 401(k) is a tax-advantaged account, your returns are tax-free and you won’t have to pay capital gains taxes.
- When you change jobs or make a career move, you can always rollover your 401(k) contributions.
When you start a job, the company’s HR department should provide you a packet of information regarding your employer’s 401(k) plan. Read as much of it as possible and look up anything you don’t understand. At the very least, you can always ask a HR representative for help since many companies offer seminars or meetings with financial advisors to help you understand the plan and investments offered.
How To Choose A Brokerage Account
If you don’t have access to a 401(k) through your employer or want to diversify, invest and build a private portfolio, you will need to open a brokerage account. Whether you need a broker for a Traditional IRA to lower your taxes, a Roth IRA for tax-free capital appreciation, or a standard account to grow your wealth, here’s how to choose the best discount broker for your needs.
Factors To Consider
There are many stock brokers to choose from, but the best discount brokers offer:
- Low fees and cheap pricing structures
- An easy-to-use website and interface
- Fast and powerful trading platforms
- Access to investment research and educational resources
- Excellent customer service
Another determining factor is the type of investments you are interested in. For example, you may want to trade stocks, buy and hold mutual funds, or invest in commission-free ETFs. Fortunately, almost every major online stock broker nowadays offers access to all the investment options you will likely need.
The Best Discount Brokers
While each has its own pros and cons, the best online brokerage accounts for 2016 are:
Brokerages like TradeKing and TD Ameritrade even have no minimum balance requirements to open an account, meaning you have little excuse to not start investing in your 20s. Again, don’t let the amount you have hold you back – you can start investing with a little money and contribute to your account on a monthly basis.
If you’re searching for a tax-advantage account, check out our list of the best IRA providers.
Use A Robo-Advisor
If you’re thinking “…but I don’t know how to invest in the stock market”, the investment community has a solution for you. There are several ways you can start investing with little knowledge and still do quite well, and none involve hiring an expensive financial planner or investment advisor.
Instead, young investors can start with robo-advisors, such as Wealthfront and Betterment. Robo-advisors are online wealth managers that rely on technology to provide automated investment and portfolio management. By asking you a few questions regarding your personal financial situation, investment and retirement goals, and risk tolerance, robo-advisors create an investment plan made up of low-cost mutual funds (primarily index funds).
These recommended investment plans allocate funds based on the need for diversification across multiple different asset classes, geographies, and mutual fund managers. Investors can even tweak their allocations by changing their risk tolerance or investing needs. The best part is that, because robo-advisors bypass individual financial advisors, they minimize fees, biased fund selection, and human error.
The Best Robo-Advisors
The two top robo-advisors are Wealthfront and Betterment. With either option, new investors get a custom portfolio as well as automatic rebalancing and optimization of your fund selections and allocations. Ultimately, you get the benefits of a best-in-class asset manager at a fraction of the cost.
You can open an account with Betterment with $0 to start or you can open an account with Wealthfront for as little as $500. For a detailed comparison, check out our in-depth analysis of Betterment vs Wealthfront to get an idea of which is better for your needs.
Investing in your 20s may be a challenge for many, but it doesn’t have to be. With a little research and diligence, you can build a foundation that will grow your wealth into something sizable over the years. As Victor Kiam said, “Procrastination is opportunity’s assassin.” Starting early is the key to successful investing and will be the reason you achieve financial independence sooner than later.