Building a Strong Financial Foundation

Young adults in their 20s who are in a position to save money have a unique opportunity to enter the world of investing at a time when doing so can maximize its long-term financial impact. Thanks to the power of compounding gains, money invested in your 20s can achieve much more significant growth over the remainder of a lifetime than investments started later on.

At just an annual 4% return, not counting inflation, a single dollar invested at age 20 would grow to $5.84 at age 65, while a dollar invested at age 30 would only be worth $3.95 by retirement age.  Because young people today may expect to spend 20 years or more in retirement, every extra dollar saved counts. 

Starting to invest early on can help to ensure a stable financial future. However, the world of investing can be daunting for newcomers because of the plethora of resources and information and all of the decisions investing entails. Below, we take an in-depth look at various considerations to keep in mind to help you start investing in your 20s.

How To Invest in Your 20s

If you’re a 20-something, you can make the most of your money if you learn how to set financial goals, understand risk and return, make financial plans, differentiate between investment vehicles, and more. Here’s how.

Set Financial Goals

Young adults may be eager to start allocating their money toward investments. Before doing so, however, it’s essential to examine your financial goals, considering both short- and long-term plans.

Some of the most common things that young investors save toward in the short term include a vehicle, housing, and discretionary costs like entertainment or travel. Long-term goals may include retirement, a home, expenses related to medical care or care for a loved one, and expenses related to children, among other things. 

After listing your financial goals, you’ll want to take note of the expected time horizon of each one. A smaller goal, like a vacation, will require different financial resources and potentially different investment choices compared with a larger one, like buying a home. If in doubt, calculators like the ones at Investor.gov can help determine how long it may take to reach a specific goal. 

With your goals and time frames in mind, you can then go about prioritizing. Some things—like an emergency fund to cover expenses if you unexpectedly lose your job, or various types of debt—are generally seen as the most important to take care of first. Beyond this, your financial priorities will depend upon your preferences and situation. You may want to prioritize a couple of smaller goals in order to achieve them sooner, or you may wish to begin planning right away for a longer-term goal to get a head start. 

Charlene Rhinehart, CPA and editor-in-chief of the Wealthy Women Daily, says that “while you’re in your 20s, you should check in with yourself and think about the type of life you want to live now and what you envision for your future self. Then do some reverse engineering to make sure your current actions align with your vision.”

Undoubtedly, some things will change over time, and you may find that a goal you set for yourself years ago is no longer relevant, or perhaps the ways that you are going about planning toward that goal will need to change as well.

Understand Risk and Return

One axiom of investing is that the higher the risk, the greater the potential reward (and, by the same token, the lower the risk, the smaller the possible reward). Consider a highly speculative area of the investing world like cryptocurrencies.

If you invested all of your savings in Bitcoin when it first launched, you may have seen your initial investment grow by many orders of magnitude. However, though this may seem like a wise move in hindsight, it would nonetheless have been incredibly risky. After all, there was no guarantee in 2009 that Bitcoin would usher in the highly popular cryptocurrency trend, nor even that it would continue to exist beyond that time.

Investors should always be mindful of the level of risk of a particular investment, as well as of their own risk tolerance.

Younger investors can afford to have a higher risk tolerance than older investors, particularly when it comes to retirement planning. For a young investor, a bet that doesn’t pay off now leaves plenty of time in the future to make corrections; someone just a few years out from retirement may be far less able to recoup the loss of a significant percentage of their retirement savings on a risky investment.

That means an older investor may be more likely to opt for a low-risk, low-reward investment like bonds or T-bills than a speculative one like crypto.

Start With a Plan

Once you’ve determined your risk tolerance, a strong investment plan is necessary to ensure your money has the best chance of growing. An investment plan factors in considerations such as asset allocation, diversification, and investment timeline to make the best possible decisions for you based on your current situation and goals.

Some young investors may feel overwhelmed at the prospect of coming up with a plan on their own. Rhinehart recommends consulting a professional for guidance, suggesting that a new investor “consider reaching out to a financial planner who can help you think about your future goals and put a plan in place to achieve them.”

Whether you work on your own or with a planner, you’ll need to begin with a good sense of what you own and what you owe—in other words, what your current financial situation is—in order to plan. A budget for your income and expenses is essential to determine how much you have to work with in your investment activities.

Asset allocation is the process of dividing your investments among different types of assets, such as stocks, bonds, or real estate. Properly allocating your assets will help to ensure that you have a broadly diversified portfolio, essential in case an asset class suddenly loses value (as in a stock market crash, for example).

Choose the Right Investment Vehicles

Some of the most common investment options for young investors include stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Let’s look briefly at some pros and cons of each.

• Stocks: Stocks tend to be higher risk than bonds, although the level of risk depends greatly on the sector, industry, and specific company. Over a long time horizon, a buy-and-hold strategy like the one employed by Warren Buffett can yield tremendous returns, although it depends on how you go about selecting stocks for investment. On the other hand, with thousands of stocks available, this can also be a daunting area of the investing world for young investors.
• Bonds: Bonds provide a low-risk access point for investors. These investments often require less day-to-day management than stocks, although they also are limited in their potential for payout. One common approach is to allocate a percentage of your portfolio in bonds equal to your age, which means that many young investors may not focus heavily on this asset class.
• Mutual Funds: Mutual funds are an excellent choice for many new investors. They provide broad diversification while minimizing the amount of trading and oversight required. They are also good for a buy-and-hold strategy. However, mutual fund returns tend to be relatively modest.
• ETFs: ETFs are a highly popular option among both new and seasoned investors. Baskets of other securities, ETFs provide a one-stop-shop approach for investors not eager to manage individual stocks or other assets. ETF risk and return profiles also vary considerably, allowing you to tailor your investment strategy to your risk tolerance.

Start Investing Early

As mentioned above, compounding growth means that assets invested in your 20s can potentially yield far greater returns over a lifetime compared with those invested even just a few years later.

To achieve this long-term growth potential, you’ll need to gain access to the investing world as early as possible. One of our top-rated brokerage accounts is a good place to start. When you select a brokerage, opening and funding an account can often be accomplished quickly and in many cases entirely online.

Some brokerages use robo-advisor tools to automate a large portion of the investment process, further reducing barriers to access for inexperienced investors.

To choose a suitable investment platform, be sure to look at fees, the types of assets offered, educational resources provided, customer support, and the user interface, as well as any other factors that may be important to you. Choosing the right platform can make a big difference in your experience as an investor.

Manage Debt and Build an Emergency Fund

For many young people, debt is a major hurdle to investing. Student loan debt, credit card debt, and many other types of debt can present a financial burden.

To manage your debt, consider a debt-reduction system like the snowball method: List your debts in order of balance size, make all minimum payments necessary, and then allocate any extra money available to pay off the smallest debt first. This may achieve more immediate results in reducing the number of debts you have than other methods. And “paying off high interest debt will allow you to save more and can help you boost your credit score,” Rhinehart says. 

If you have student loans, be sure to pay close attention to federal programs that may help you reduce this burden. Staying on top of your payments will ensure you don’t default on your loans, which can have a detrimental impact on your credit score.

Rhinehart also points out that an emergency fund can protect your retirement savings.

“Creating an emergency fund and building your savings account will decrease the odds of you dipping into your retirement account to fund unexpected expenses,” she says. However large your emergency fund is, you’ll want to make sure it’s in liquid assets that can be converted to cash quickly if need be.

Open Retirement Accounts

Employer-sponsored retirement plans such as 401(k) and 403(b) accounts are a must for any young investor. Many employers offer a contribution to those accounts without any input from an employee, meaning that this is free money for you to set aside to compound over many years.

Even if you are unable to reach the annual limit in retirement contributions, making regular payments of any amount is a good way to start. And, “if you want to retire early,” Rhinehart says, “you’ll want to look into investing strategies that help you generate income so that you have a steady flow during retirement.”

Keep Short-Term Savings Accessible

You never know what type of unexpected expense may come up, and the last thing you want is to have your money stuck in a place where it’s not readily accessible when you need it quickly. Maintaining a liquid savings account or emergency fund is essential, even if you don’t anticipate any upcoming expenses.

Continuously Educate Yourself

There is always more to learn about investing. Whether it’s keeping up to date on the latest market trends, learning about emerging asset classes and opportunities, or finding a more ideal portfolio strategy for your shifting needs over time, you will benefit if you continuously educate yourself on investing strategies. 

At the same time, be sure to vet your sources: Look for educational resources provided by federal agencies like the Securities and Exchange Commission (SEC) and the Federal Reserve, or by your brokerage. Books by leading investors and economists, such as “The Intelligent Investor” by Benjamin Graham, daily podcasts by publications like The Wall Street Journal, and similar tools can also be valuable.

Frequently Asked Questions (FAQs)

The Bottom Line

While many young adults feel they are not able to begin to invest because of financial instability, debt burden, and other factors, beginning to take hold of your finances at an early age can pay off considerably down the line.

One of the first things to do is to set clear financial goals for yourself, both short- and long-term, as this will help to determine the best investment strategies for you. Always keep in mind that risk and return go hand-in-hand in investing, and know what your personal risk tolerance is. Taking stock of your expenses and income allows you to be aware of how much money you can reasonably invest after setting aside a liquid savings account and emergency fund for unexpected expenses. 

Finally, learn about the host of different investment vehicles available to you so that you can make an informed selection based on your risk tolerance, diversification needs, and investing time frame.