A Complete Guide to Investing in Your 20s

Investing grows your money over time. When you invest, you allocate funds toward assets — such as stocks, bonds, mutual funds or real estate. Investors do this expecting a return or profit in the future.

All investments carry risk, but diversifying your portfolio hedges against unstable markets and potentially devastating losses.

Your 20s are the perfect time to begin your investment journey. You may have recently graduated college or landed your first well-paying full-time job. Allocating this new income wisely builds wealth and freedom to live the life you’ve always wanted.

Investing when you’re young is important — but so is laying a stable financial foundation.

Before you invest, improve your financial literacy and use that knowledge. This includes establishing savings, paying down credit card debt and creating long-term goals.

Most financial planners recommend reserving at least three to six months of living expenses in cash. Emergency savings cover essentials such as rent and food if you lose your job or your car breaks down.

A young investor should never rely on investments as a safety net, according to Robert Rosen, a Florida-based financial advisor with Edward Jones.

“The only way you can lose in high-quality, long-term investments is if you have to take that money out early for an emergency,” Rosen said.

Investments can be difficult to access quickly — and doing so ahead of schedule can result in stiff fees and penalties.

Liquid cash in your savings account lets you handle emergencies without tapping your investments or plunging into debt.

If you’re young, you probably have debt. You don’t need to eliminate all of it before you start investing — but paying down high-interest credit cards should be a priority.

Many experts recommend paying off your credit cards in full each month. But if you owe more than $1,000, this may be challenging.

Figure out how much you need to pay each month to delete this debt in a reasonable time, perhaps six months to two years. Chipping away at a credit card balance can make it feel more manageable.

The same rule doesn’t necessary apply to student loans. Federal student loan interest rates tend to be lower than private loans or credit cards and offer benefits such as income-driven repayment plans.

Never miss a student loan payment, but evaluate if eliminating this debt ahead of schedule significantly benefits you.

“In a perfect world, you should pay down all your debt — but everyone’s situation is different,” Rosen said. “You may not want to miss out on investing for retirement because you spend all your extra money paying down student loan debt.”

You can’t invest your way out of poor spending habits.

If it feels like your money goes out as soon as it comes in, create a budget.

List fixed expenses, such as your cell phone bill, rent, car payment and internet. Give yourself enough wiggle room for variable expenses such as utilities, food and entertainment to create a couple realistic spending goals each month.

Examining past debit and credit card statements can help you understand how much you really spend on new clothes, take-out or drinks with friends after work.

Where can you trim? Be honest and start cutting.

There are numerous resources online for budget management. The Federal Trade Commission offers a helpful resource guide on topics such as making a budget and paying for your first apartment.

Apps such as Mint or Wally are other tools you can use to track your spending habits.

Before you start investing, it’s helpful to develop some short-term and long-term goals.

Short-term goals can include saving up to buy a home, a new car or a dream vacation to Europe. Long-term goals can include retirement or creating a college fund for your future children.

Many financial planners offer this advice: Save for the short-term, invest for the long-term.

Investing can seem intimidating at first. There’s a lot to learn.

Start with the basics. Set aside time to learn about 401(k)s, stocks, mutual funds and asset allocation. Understand the relationship between risk and reward.

Once you’re familiar with these concepts, pick the best way to invest your money. Thanks to technology, there’s more choices than ever before.

Opening a 401(k) plan or other retirement savings account is one of the easiest ways to start investing in your 20s.

Retirement plans allow you to select specific investments within the account itself. This can include stocks, bonds and target-date funds.

Most employers offer either a 401(k) or 403(b) plan to employees. Some may even offer to match your contributions up to a certain percentage. This is essentially free money for your future.

Saving for retirement may seem unimportant in your 20s because it’s so far away. But retirement is expensive.

Many financial experts recommend allocating at least 10 to 15 percent of your salary to a retirement account. In 2021, you can contribute up to $19,500 a year to a 401(k) plan.

This may not be realistic for you right now, and that’s OK. Contribute what you can, even if it’s only $25 a paycheck.

As you get older and earn more money, chip in more. Increase your contribution percentage after each raise.

Always aim to contribute at least as much as your employer match. This can literally double your retirement nest egg.

To sign up for your 401(k) plan or learn more about what it offers, contact your HR department.

All employers may not offer a 401(k) plan. If that’s your situation, consider opening a traditional or Roth IRA. There’s also an option for self-employed people called a SEP IRA.

These retirement accounts offer many of the same benefits as 401(k)s but are available through a financial advisor, online brokerage account or micro-investment app. IRAs may offer broader investment choices than 401(k) plans.

The maximum amount you can contribute to an IRA if you’re under the age of 50 in 2021 is $6,000, which is $13,500 less than you can contribute to a 401(k).

Mutual funds, index funds and exchange traded funds allow you to buy small pieces of many different assets in a single purchase.

All three share similarities and a few key differences.

Mutual funds are managed by a professional and come with fees. They allow a group of investors to pool their money to purchase stocks and bonds. They offer convenience, diversification and access to professional money managers.

Index funds and ETFs are often used interchangeably. That’s because many ETFs track an index.

Unlike traditional mutual funds, index funds and ETFs are passively managed and mirror the rise and fall of an index, such as the S&P 500 or Dow Jones Industrial Average.

Index funds and ETFs offer lower fees than mutual funds.

Vanguard’s S&P 500 ETF, for example, has an expense ratio of 0.03 percent, which equals about 30 cents per year for every $1,000 invested. Fidelity’s 500 Index Fund has an even lower expense ratio at 0.015 percent.

Meanwhile, the average expense ratio for a mutual fund is generally between 0.25 and 1.5 percent. This doesn’t include shareholder fees and other costs.

You can purchase a mutual fund, index fund or ETF directly from a mutual fund company or online brokerage.

Purchasing individual stocks requires research. When you buy a share, you’re essentially stating that you believe in its future.

You should never purchase single stocks if you’re unfamiliar with the company or its earning potential.

“Buy what you like and what you know,” Rosen advises. “Don’t just buy stocks because people tell you they’re going to be a good investment.”

It’s always smart to review the company’s annual report and read recent news articles on its performance.

Use available tools on your brokerage account to gain a better understanding of how the business compares to similar companies. Explore its position within the overall industry.

When it comes to buying stocks, some financial experts suggest starting small. Purchase a small number of affordable shares to get an idea of what it’s like to own one. Grow and diversify your holdings over time.

Finally, don’t be intimidated by market crashes. Instead, Rosen says this volatility creates unique opportunities for young investors.

“Times of great economic uncertainty are great for long-term investors,” Rosen said. “There’s no better time to buy than when the market is down and stocks are cheap.”

Bonds and CDs are low-risk savings vehicles that offer a return of your investment plus interest.

Both work by paying interest for a specific time. When that time is up, you receive your initial deposit or investment back plus interest.

Banks or credit unions offer CDs. You can purchase CDs for various lengths of time, generally from six months to five years.

The interest rate for CDs, like bonds, tends to be low. Sometimes these rates are only slightly higher than high-yield savings accounts.

Bonds are a way for corporations and municipalities to borrow money, similar to an IOU. You purchase the bond, and after a set period of time, the issuer returns your initial investment plus interest.

Unlike CDs, bonds tend to pay interest in regular installments instead of in full at the end. A bond can be sold before it matures, whereas a CD typically cannot.

Bonds can be purchased online directly from a broker or the U.S. government, but many investors opt to buy portions of bonds inside a mutual fund or 401(k) plan.

CDs and bonds are solid ways to save and diversify your portfolio. However, since rates of return are low, many financial experts recommend focusing on stocks, index funds and ETFs when you’re young because these assets offer higher growth potential.

Real estate investment trusts, or REITs, allow you to invest in large-scale real estate without actually buying property.

Many REITs are registered with the U.S. Securities and Exchange Commission and are traded on the stock market. Non-publicly traded REITs carry more risk.

REITs let you add diversified real estate to your investment portfolio and may offer higher dividend yields than other investment options.

Buying a home is another way to invest in real estate.

Purchasing a home allows you to build large amounts of equity you can borrow against. Plus, most property values increase over time.

An initial $6,000 down payment on a $250,000 home can result in owning an asset worth $300,000 or more in 30 years.

However, purchasing a home in your 20s has its drawbacks. First, it’s expensive and high mortgage payments may limit your ability to invest elsewhere.

It’s also a major responsibility with ample upkeep and maintenance costs over time.

Finally, the permanence of homeownership makes it difficult to move quickly for a new job or marriage. It’s important to analyze the potential cost benefits before purchasing a home.

Investing in your 20s is like running a race. Starting early gives you a competitive advantage, similar to a 10 second head start over fellow runners.

Even when others join the race and begin investing later, they will have to work much harder just to catch up with you.

Albert Einstein once described compounding interest as the eighth wonder of the world.

It’s the phenomenon when the interest you earn on savings or investments builds on itself. It’s like a snowball effect.

Because compounding interest increases with time, young investors get a leg-up on those who wait.

Even with a higher monthly contribution and the same rate of return, Joe only nets about $574,376 by the time he’s 65 years old — about a third less than Sarah.

Time is on your side when you’re young. Retirement is still decades away and your investments have room to grow.

A time horizon is how long you plan to hold an asset. Time horizons can range from a few months to decades.

Investors with a longer time horizon tend to perform better than those who focus on short-term gains.

Maintaining a distant time horizon when you’re young can hedge against stock market volatility. You’re less likely to give into fear and sell when stocks plunge because your sights are set on the future.

Risk tolerance is your ability to stomach loss in exchange for greater potential returns.

Time is a safeguard against risk. Longer time horizons give young investors room to bounce back from loss long before retirement.

However, you should reduce your risk as you get older. Market volatility is a bigger threat as you prepare to leave the workforce.

Consider a financial concept known as the 120 rule.

It works by subtracting your age from 120. The resulting number is the percentage you should invest in stocks. The rest goes to bonds.

So, if you’re 25 years old, 95 percent of your investments would be in stocks with just 5 percent in bonds. However, when you’re 55, stocks would make up only 65 percent of your portfolio.

More conservative investors may prefer the 100 rule. In this case, a 25-year-old allocates 75 percent to stocks and 25 percent to bonds.

Pick the asset allocation you’re most comfortable with.

Your money is your future, so invest wisely.

One of the biggest mistakes young investors make is procrastinating. As we’ve discussed, waiting to invest can cost you.

But what other obstacles might you encounter on your path to financial independence?

You put off investing in your 20s and are now worried about your retirement nest egg.

It’s ideal to start young, but really, it’s never too late.

If you’re in your 30s or 40s, many of the same rules of investing apply. The big difference is how much money you must now allocate to reach your goals.

You’ll likely earn more money in your 30s and 40s than you did right out of college. That’s good — you need to save and invest at a higher rate to make up for lost time.