The trouble with investing in your 20s isn’t that you’re a slacker who really wants to start a rock band.
The decade after you graduate is, for most people, an incredibly productive one: you’re launching your career, maybe a family or a new business. And many 20-somethings are already saving for the future, according to a 2012 study by Fidelity, which found that the average IRA owner aged 20-29 has about $5,800 socked away.
The challenge is overcoming the perception that your resources are tapped out and you can’t possibly save more. In fact, your 20s are a crucial stage when you probably have more control over your cash flow than you will later (when kids and college plans kick in). Let’s take a look at how you can use these truly golden years to set yourself up for decades to come.
Step 1: Leverage the years
You’ve heard it before, but listen up now: When you’re in your 20s, time is truly your ally. The power of compounding can help your cash grow in a way that it never will again—because right now you’ve got decades on your side.
Consider this: If you start saving just $1,200 a year—a mere $100 per month—starting at age 25, by age 65 you’ll have about $185,700 (assuming a 6% return).
But say you delay by 10 years, and start saving $1,200 a year from ages 35 through 65, earning the same 6% return. You’ll end up with only $94,800, nearly 50% less, according to David McPherson, a fee-only planner in Falmouth, MA.
Step 2: Save time
You’ve got a lot going on, but if you don’t feel like an expert in the stock market, don’t use it as an excuse to postpone investing, says Kimberly Palmer, author of Generation Earn and the Alpha Consumer blogger for U.S. News & World Report.
Assuming you have a 401k, save time and put your money into an index fund that mirrors the stock market (like an S&P 500 index fund). Or if index funds aren’t available in your 401k, use a low-cost target date fund (keep the expense ratio at 0.5% or lower). Note that these funds can be problematic, but—like having training wheels on a bike—an inexpensive TDF can get you started.
As you learn more, and you will, you can choose other investment vehicles. If you don’t have a 401k, you can get moving in the right direction by opening a Roth or traditional IRA (or a SEP-IRA if you’re self-employed).
“The key, really, is simply to open an investing or retirement account and regularly transfer money into it, preferably automatically from your paycheck so you don’t forget or get side-tracked,” says Palmer.
Step 3: Save more
It might seem like a sacrifice to save 20% of your income right now. But think about it this way: By saving as much as you can while there are fewer demands on your income (compared to your 40s or 50s, when you may have kids in college, say) you put yourself ahead.
Then, if you lose your job at some point—or raising kids and running house means you temporarily have to save a little less—you’re not giving up as much ground.
One no-brainer way to save more is to sign up for auto-increases in your 401k, so that every year you’re automatically raising your contribution rate.
Step 4: Be aggressive
Palmer notes that among 20-something investors, two in 10 have their money in a money market or stable value fund. “There’s not much chance that those accounts will keep up with inflation, which makes them just slightly more useful than stashing the money in a freezer,” she says.
While putting your money into equities does entail more risk, it also provides you with more growth—at a time of life when you need the growth and can probably handle the risk. By being more conservative, you risk losing out on market gains and jeopardizing your savings.
“There are plenty of examples of young people who are saving for retirement and they put it all in cash,” says Brooks Herman, head of data and research for BrightScope, an industry analytics firm. “That’s not going to move the needle in your retirement account.”
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This article was published on October 24, 2013