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How to start investing in your 20s: 7 tips for beginners
Kickstart your portfolio now to wield the power of compound interest.
Investing in your 20s can be equal parts thrilling and daunting. The good news? You don’t need to be debt-free to start building your investment portfolio. Even if you don’t have much to contribute, a little can go a long way.
1. Analyze your finances
First thing’s first: you’ll need to get an accurate picture of your finances. And the best way to do this is to sit down and document your current income, expenses, debt and available savings. If the thought of plotting your finances feels daunting, opt for a budgeting app to help you navigate the process.
Once you have a better idea of where your finances stand, you’ll know exactly how much you can afford to allocate toward potential investments. Thanks to compound interest, a little can go a long way — especially when you start early.
Doing the math: the magic of compounding interest
Think you need a lot of cash to start investing in your 20s? Think again. Enter the power of compound interest.
Let’s say your goal is to build a $1 million dollar nest egg by the age of 65. At 20 years old, if you put $188 per month into a tax-deferred investment account with an interest rate of 8%, you’ll have over $1 million to your name by the age of 65.
Now, let’s say you wait until you’re 30 to start investing. To reach that same $1 million dollar milestone by age 65, you’d need to bump your monthly investment up to $433 — more than double the amount required of your 20-year-old self.
That’s compound interest at work. And it’s at its most powerful when given ample time to perform.
2. Start an emergency fund
An emergency fund is a powerful, practical investment for your future. Before opening an IRA or self-directed brokerage account, consider building out your emergency fund.
An emergency fund can help you cover unexpected expenses, from medical bills to the sudden loss of a job. It can act as a financial safety net, lending reassurance that your expenses will be covered should you need a sudden influx of cash or find yourself without a consistent source of income.
The question is: how big does your fund need to be? Many advisers suggest an emergency fund that is capable of covering three to six months of living expenses. Break down your monthly accounts and isolate your expenses. Aim for a minimum of three times that much in your emergency fund.
Where should I store my emergency fund?
While the movies would have you believe stashing cash under mattresses or floorboards is a viable approach, it may not be the most practical option. Especially since mattresses and floorboards don’t generate interest.
3. Open a 401(k) or IRA
Once you’ve assessed your finances and established an emergency fund, it’s time to take a look at opening a retirement account. Think it’s too early to worry about retirement? Remember: compound interest is your friend, and retirement accounts can be a powerful asset as you begin the process of building a nest egg.
A 401(k) is a retirement account that offers tax-advantaged savings. They’re offered exclusively by employers, which means the only way to get a 401(k) account is if you’re offered one through an employer. (If you’re self-employed, you can open one for yourself.)
Employees contribute to their 401(k)s through automatic payroll withholding. Some employers will match all or part of employee contributions — but this isn’t always the case. If your employer offers contribution matching, make the most of your 401(k) by contributing at least enough money to maximize your employer’s match.
If you don’t have access to a 401(k), consider opening an individual retirement account (IRA). These accounts can be opened through online trading brokerages and come in two types: traditional and Roth IRAs.
The biggest difference between traditional and Roth IRAs is how they’re taxed. Traditional IRAs allow for tax-deductible contributions, but you’ll pay taxes on any withdrawals you make at retirement. For many 20-somethings, the Roth IRA is the way to go, as it taxes your contributions but allows for tax-free distributions — an important distinction if you suspect you’ll be in a higher tax bracket come retirement and will save for a long time before you retire.
4. Apply for a self-directed brokerage account
Self-directed brokerage accounts have fewer limitations than retirement accounts. You can move money into and out of a brokerage account at any time and for any reason. The biggest drawback is that it isn’t equipped with the type of tax advantages offered by 401(k)s and IRAs. Namely, you’ll owe capital gains tax on any profit you turn from selling an asset in your brokerage account.
But if you’re looking for free rein to invest in stocks, bonds, ETFs and the like, you may want to explore your brokerage account options.
When assessing your platform options, consider:
- Fees. Commission-free stock trades have become the norm, but be on the lookout for fees when swapping mutual funds, options or futures. Account transfer fees are also common, typically ranging from $50 to $75.
- Available securities. What do you plan to trade? Most platforms offer access to stocks and ETFs, but if you’re seeking something a little more niche — like forex or crypto — your platform options may be limited.
- Learning curve. Some platforms, like SoFi, were designed with the beginner investor in mind. Others, like Interactive Brokers, are tough for newbies to navigate.
- Customer support. If you’re new to trading, you may want to opt for a platform that offers robust, round-the-clock support, like Fidelity.
- Research tools. Experienced traders rely on sophisticated research tools to help inform their trades. If you anticipate making numerous trades, opt for a platform with powerful charting tools, like TD Ameritrade.
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5. Explore robo-advisors
If making your own trades sounds overwhelming but you’re still interested in investing, you can always place your investments with a robo-advisor. Robo-advisors are digital, algorithm-driven programs designed to manage your portfolio on your behalf. When you sign up, you answer questions about your risk tolerance and investment goals. And based on your responses, the robo-advisor will pick investments on your behalf and rebalance your portfolio as it sees fit.
Some trading platforms — like SoFi — offer robo-advisors, but not all. Others, like Betterment, offer robo-advisors and nothing else. Either way, if you decide to use one, be prepared for an annual advisory fee of 0.25% to 0.5% of your account balance.
6. Increase your risk tolerance
When it comes to investing, there’s a lot of talk about risk tolerance. And all risk tolerance means is the level of risk you’re willing to carry with your investments. Older investors who are closer to retirement typically have low risk tolerance: they prefer safer investments, like bonds and CDs, that offer consistent returns — although the relative safety of these investments is typically accompanied by less competitive earnings.
Younger investors, on the other hand, can often afford to carry more risk. Why? Because in the event you suffer a loss — even a sizable one — you have plenty of time to recover. Increasing your risk tolerance means your asset allocation strategy becomes more heavily weighted with high-risk, high-reward investments, like growth stocks.
While your age factors into your risk tolerance, keep in mind that it all comes down to your investment goals and preferences. If you prefer to play it safe, dial back your risk exposure. It’s your money, and they’re your investments.
7. Monitor your investments
No matter the size or location of your portfolio, you should regularly monitor your investments to see how they’re doing. And the frequency with which you check your investments depends on your trading strategy. If your portfolio is managed by a robo-advisor, you may want to check in once per quarter. If you’re an active investor tracking volatile stocks, you may find yourself wanting to check in more frequently.
But be careful: financial experts warn that over-monitoring your investments is potentially harmful. There’s nothing wrong with keeping an eye on things — but don’t get consumed. Too-frequent checking can lend itself to impulse trading, and frequent buying and selling tend to damage returns — at least for new traders.
Investing in your 20s offers the opportunity for growth and gain. It’s never too early to start thinking about your future, and an investment portfolio is a practical way to start building up your financial security. To get started, explore your brokerage account options by features and fees to find the platform that can help you meet your financial goals.
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