For most of us, life in our 20s is about experimentation, change and growth. Often it’s where we make the biggest mistakes, and learn the most important lessons. It’s no different when it comes to our finances.
With student loans to pay off, first-time independent living expenses, and all those other costs that make being in your 20s so much fun, it’s too easy to fall into the trap of living paycheck to paycheck and sliding into debt. When we’re young we tend to dismiss messy money situations as temporary – something that can easily be solved by the next raise or bonus that’s on the horizon.
In reality, a flippant approach to personal finance in our 20s could cost us a whole lot more down the road. Getting into bad habits when it comes to budgeting, debt and investing can often push us into unsustainable patterns in our 30s and 40s.
The good news is there’s no better time than the present to turn it all around. People who start to invest in their 20s are not only taking proactive steps toward a stable future, they’re also cashing in on investing’s best friend: time.
Liz Weston over at MSN Money has done the math:
“Someone who puts $4,000 a year into retirement accounts starting at 22 can have $1 million by age 62, assuming 8% average annual returns. Wait 10 years to start contributing, and you’d have to put in more than twice as much – $8,800 a year – to reach the same goal.”
The younger you start investing, the more you can reap the benefits of compounding and long-term market gains. The time to invest is now. Here’s what you need to consider in taking this all-important leap.
Start with a Clean Slate
Before you start to invest your hard-earned dollars, it is vital that you pay off any outstanding high interest debts you may have (credit card debt, for example). Put together a debt elimination plan and commit. To pay down the debt you’ll need to create a realistic budget and stick to it, which means getting serious about cutting unnecessary spending. Try one of these online tools that help make budgeting a breeze.
The first step is working out how much you can afford to invest. This will differ depending on your age and the place in life you’re at. At 22, you might not be able to contribute a substantial portion of your salary just yet. That’s okay! What’s important is that you get in the game. Trim the fat from your budget wherever possible, decide you can spare, then set up auto-deposit to start building your portfolio.
At 28, if you’re in a stable place in both your life and career, committing at least 20% of your annual income (including retirement savings) to your investment portfolio is the way to go.
First-time investors should pay attention to these key factors when it comes to investing:
1) The right goals. It might seem like it’s a long way off, but the time to start saving for retirement is now. Is a 401(K) or other type of retirement plan offered by your employer? If not, open an IRA (or do both) and start making that money work for you. A smart investment plan when it comes to your retirement funds will build you a healthy nest egg and help you beat inflation. But it’s not just about retirement. Start thinking about your short and long-terms goals and how much money you’ll need to achieve them. Whether it’s a European holiday in two years or a house down-payment in ten, a goal-driven approach to investing will go a long way in helping you to succeed.
2) The right investment. It’s tempting as a newcomer to want to find “the next big thing”, but trying to play the stock market in your 20s is a waste of time and money. It’s widely recommended that you start out by investing in ETFs. ETFs trade like stocks and replicate indexes, allowing you to invest in a diverse range of stocks or bonds, at a much lower cost than a mutual fund.
3) The right amount of risk. Setting your risk level is crucial in allowing you to reach the monetary goals you have in the time frame you’ve planned. If you’re investing in ETFs, setting risk is about deciding the right asset-allocation between stocks and bonds. As an investor in your 20s, you should be setting up your portfolio to maximize the returns you will receive in the long-term. As a general rule of thumb, you can find risk in stocks and safety in bonds.
Stay on Track
The main ingredient in any well-executed plan is commitment. Automate contributions toward your investment funds each month to stay on track with your long-term goals for the future. The time you’ll save through automation will be much better spent on all those things you’d rather be doing in the present.
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This article was published on January 28, 2013