If you’re in your early 20s, you’ve probably already got a lot on your mind: college graduation, student loans, car payments, job applications and apartment hunting. One thing that often doesn’t make the list of top priorities for 20-somethings? Investing.
But the truth is, your 20s is the perfect time to start investing because you have time on your side. “When it comes to investing, time in the market is one of the most powerful predictors of future growth,” says Jennifer Raess, CFP®, planning experience integration lead at Northwestern Mutual. “And that means the younger you get started, the better off you’ll be.”
The value of investing in your 20s
To illustrate the point, let’s look at two people and assume their investments will provide a 7 percent average return over time.
Our first investor, Jess, starts saving $250 each month when she’s 20. She saves the same amount for 10 years and then never contributes another penny to her investment account, but she allows it to continue growing until she’s ready to retire at age 67. She has contributed a total of $30,000 to her investment account.
Our second investor, Dave, waits until he’s 30 to start investing. He also invests $250 each month. However, he invests every month until he’s ready to retire at age 67. Dave has contributed a total of $111,000 to his investment account.
Who has more money at retirement? Jess does, with about $579,000. Despite all his extra contributions, Dave’s account increased to only about $528,000. That’s due to the time value of money and the benefits of compound interest. And had Jess just kept saving that $250 every month from the time she was 20 until retirement, she’d have more than $1.1 million.
What to know about investing while in your 20s
As you start investing, it’s important to learn a few key concepts.
What are investments?
The simplest way to define investing is the act of using your money today with the hope of achieving future profit or some other desired result. But most investing refers to the purchase of securities, which is a fancy way to define something that you can easily buy, trade or sell. Though there are a number of types of securities-based investments, the two most common are stocks and bonds.
- Stocks provide a way to buy a share of a company. As the value of the company rises, so does the value of your stock. As an owner of the company, you may receive a share of the profits in the form of a dividend. While stocks are usually a riskier investment (as the value of any individual stock can rise and fall quickly), they typically offer the most potential for growth over time.
- Bonds are essentially a loan to a government or company. As the bond holder, you get interest payments (called coupons) for a set period of time. At the end of that period the bond matures, and you get all the money you invested back (plus the interest payments you received). A key risk to bonds is that the borrower is unable to pay the loan back; however, in most cases with high-grade bonds, this is a low risk. Additionally, the value of a bond can rise and fall if you want to sell it before it matures. While high-quality bonds are generally safer than stocks, they tend to grow your money at a slower rate than stocks can over the long term.
Determining your capacity for risk tolerance
Unlike money that you put in a savings account, the value of investments rises and falls all the time. While the stock market generally moves higher, it’s not a straight line.
Risk tolerance is a measure of how much risk you are comfortable taking in your investments. It impacts the types of investments you might consider. There are really two key factors to consider with risk tolerance. One is your time horizon. When will you need your money? If you need it in a few years, you probably don’t want it to lose value, and you’d look for safer investments, like bonds. But if you’re in your 20s and won’t need the money for decades, then you might be able to take more risk for the possibility that you’ll enjoy more growth over time.
The second consideration for risk tolerance is your ability to stomach losses. This is completely emotional. But it’s a key component to consider — and it can be tough to determine. If your investments dropped 20 percent, would you be OK knowing that they’re likely to regain value in the future? Or would you lose sleep? If you believe it would be the latter, you may want to consider less risky investments.
Diversifying your investments
As you begin investing, it’s important to ensure that you are properly diversifying your portfolio. It’s generally not a good idea to put all your investment dollars into a single stock, as the price of that one stock could fluctuate wildly. Diversification basically means that you’re spreading your investment among a variety of stocks and bonds, including wholly different types of stocks and bonds (offered by large, medium and small companies; companies in the U.S. and international companies).
Diversification can help to lower your risk of loss (even total loss). In other words, it’s the financial equivalent of not putting all of your eggs in one basket.
While this may sound overwhelming, it’s actually pretty easy. There are any number of funds that allow you to make a single investment and automatically get a diversified portfolio of stocks, bonds and (potentially) other assets. This may include mutual funds or exchange-traded funds (ETFs).
Investing in your 20s is just one part of a financial plan
It’s great that you’re thinking about investing while you’re in your 20s. You’re getting off to a strong start. But investing for the future is really just one part of a broader financial plan.
A financial plan looks at your goals in life and shows you how to get there financially. Common goals that have a financial tie include:
- Buying a house
- Building an emergency fund
- Protecting your income
- Starting a business
- Getting married
- Growing your family
- Building wealth
- Paying for children’s education
- Pursuing a dream
A financial plan will certainly include investments and help you figure out how much you should be saving for each goal. But it will also show you how to prepare for things that may not go exactly as planned. And don’t worry if you have debt; a financial plan can help with that, too.
A financial advisor can get to know you and your financial situation. He or she can help you balance your needs for today with future goals and bring everything together in a plan. In addition, an advisor can help you use the right mix of financial options (including investments and other financial tools) to help you confidently reach your goals.
Quiz: How Much Do You Know About Investing and Your Finances?
No investment strategy can guarantee a profit or protect against loss. All investing carries some risk, including loss of principal invested.