Recently, I was talking with Kevin, my coworker, who is 25 years old and debt free. His main focus right now is investing in the market – specifically in an investment account. His financial goals are completely different than mine – I’m so focused on paying off my student loan debt that I forget other people aren’t in the same boat as me!
SO, today I want to share with you a different kind of post – a post about how to start investing in your 20s! In conjunction with this post, I highly recommend reading two additional posts: 1) Asset Allocation: The Most Important Part of Your Investment Equation and 2) Getting Started With Retirement: The Roth IRA.
Why You Should Start Saving for Retirement in Your 20s
You should start investing in your 20s because of compound interest. This is a fancy term that means if you start saving now, you’ll earn a lot more money from the money you invest than if you start investing later, because of time. And in your 20s you have more time on your side than you ever will.
Example: At age 28, a $100 per month contribution ($1,200 annually) at a 3% annual interest rate will turn into nearly $80,000 by age 65. If you start at age 38, this same investment amounts to just $50,000. If you start at age 48, this same investment amounts to just $26,000.
If you’re not convinced, here’s an investment calculator – see for yourself!
How to Start Saving for Retirement (in 5 steps)
If you have your financial ducks in a row and you’re ready to maximize the time you have and take advantage of compound interest, here’s what you need to do.
- Determine your investment goals
Ask yourself why you are investing. Is it for retirement? Is it for a long-term goal? Is it for the short-term? Or is it just for fun to learn how to do it? The answers to these questions matter significantly because they require different investing strategies. If you’re investing for the long-term (i.e. for retirement), then you can move forward with opening a retirement account and an investment account that helps you serve this goal. But if you are dabbling in investing and want to trade individual stocks to learn more about the market, you would focus on an individual brokerage account that allowed you to do trade in the least expensive way and wouldn’t care much about your company’s retirement plan.
- Create an investment strategy
Don’t let the term “investment strategy” intimidate you. Investment strategy just means the rules by which you want to invest. It means that you will create somewhat of a plan and stick to that plan while you invest.
A couple questions to think about in this space to get you started: 1) how much money will you be investing, 2) how often will you invest (look up “dollar cost averaging”), 3) what period of time are you planning on investing for (20 years, 35 years?), and 4) what is your risk tolerance like (can you handle the ups and downs of the market?).
Once you get a sense of the answers to these questions, write them down and keep them handy as you open retirement and investment accounts. They should help guide you make better choices. For example, if you’re investing for the long-term and for your retirement, you will want to learn about mutual funds, index funds, and how they differ from investing and trading individual stocks.
- Invest in your employer’s retirement plan
If you want to save for retirement, then a good place to start is your company’s retirement plan. Your company may offer a 401k, 403b, or 457. If your employer offers one of these plans, then this is a good place to start — especially if there is a match. You may have heard people say that you should invest up to the employer match because if you don’t, you’re passing up on free money. I generally agree with this concept, unless there’s a legit reason not to (like you’d rather be debt free so you’re paying off your credit card bills). But otherwise, investing in your employer sponsored plan up to the match is a great way to start saving for retirement.
- Open a Traditional IRA or Roth IRA
If your employer doesn’t offer a retirement plan (or you want an additional plan), you can open a Traditional IRA or Roth IRA yourself. With a Traditional IRA, you don’t pay taxes until you withdraw your money — your contributions and earnings grow tax-deferred. Also, if you don’t contribute to an employer plan, and you contribute to an IRA, then you may be able to deduct your contributions on your taxes.
Similar to a Traditional IRA is a Roth IRA. With a Roth IRA, you pay taxes initially, then can withdraw your money tax free in retirement. There are income limits that changes annually with a Roth (meaning that if you making over a certain amount of money you won’t be able to open a Roth).
- Open your own brokerage account
If you have money to invest beyond retirement accounts, then you can consider opening your own brokerage account. The nice difference with having your own account compared to just an employer sponsored 401k is that you’ll have more investment options and flexibility with the investments you can choose.You can learn more about investing this way and be more involved in the process.
I see a lot of people in their 20s who just open an employer 401k and don’t open any additional investment accounts when they financially are in a good place to do so. It’s so easy to just fill out the paperwork at your job and do nothing else. But really, it’s just as easy to open your own investment account. On the other hand, I know people who have side hustles solely for the purpose of investing (i.e. they use all their side hustle money to invest). This is pretty awesome.
In terms of where to open a brokerage account, you have several options (Charles Schwab and Fidelity, for example). I opened my investment account through TradeKing because TradeKing doesn’t have a minimum balance requirement to open an account and requires no annual fee. Even better — all trades (stock and ETFs) are only $4.95. I like TradeKing because it’s inexpensive! My friends over at Club Thrifty have a great review of Tradeking if you want to learn more.
Your 20s is the best time to start making better financial decisions. When it comes to investing, your 20s is so important because you have so much time for your money to grow. If you have your finances in order (you’re out of debt, have an emergency fund, and are planning for your future), then investing in a 401k and a personal investment account is the next step toward building a strong financial foundation. Saving for retirement is something you can start now to really change your life.