Investing as a young adult is one of the most important things you can do to prepare for your future. You might think that you need a lot of money to start investing, but it’s easier than ever to get going with small amounts. Once you set up your investment accounts, you’ll be well on your way to saving for goals like retirement, purchasing a home or even future travel plans.
But before you dive headfirst into the market, it’s important to prioritize paying off any high-interest debt that might be straining your finances and then build up an emergency fund with savings that could meet at least three to six months of expenses.
Once that is handled you can get a jump on investing, even if you’re starting small. Developing a consistent approach to saving and investing will help you stick to your plan over time.
How to start investing in your 20s
Money invested in your 20s could compound for decades, making it a great time to invest for long-term goals. Here are some tips for how to get started.
1. Determine your investment goals
Before you dive in, you’ll want to think about the goals you’re trying to achieve by investing.
“It’s ultimately looking at all the experiences you want to have over your lifetime and then prioritizing those things,” says Claire Gallant, a financial planner at Commas in Cincinnati. “For some people, maybe they want to travel every single year or they want to purchase a car in two years and they also want to retire at [age] 65. It’s crafting the investment plan to make sure that those things are possible.”
The accounts you use for short-term goals, like travel, will differ from those you open for long-term retirement goals.
You’ll also want to understand your own tolerance for risk, which involves thinking about how you’ll react if an investment performs poorly. Your 20s can be a great time to take on investment risk because you have a long time to make up for losses. Focusing on riskier assets, such as stocks, for long-term goals will likely make a lot of sense when you’re in a position to start early.
Once you’ve outlined a set of goals and established a plan, you’re ready to look into specific accounts.
2. Contribute to an employer-sponsored retirement plan
20-somethings who begin investing through an employer-sponsored tax-advantaged retirement plan can benefit from decades of compounding. Most often, that plan comes in the form of a 401(k).
A 401(k) allows you to invest money on a pre-tax basis (up to $22,500 in 2023 for those under age 50) that grows tax-deferred until it’s withdrawn in retirement. Many employers also offer a Roth 401(k) option, which allows employees to make after-tax contributions that grow tax-free, and you’ll pay no taxes when taking withdrawals during retirement.
Many companies also match employees’ contributions up to a certain percentage.
“You always want to contribute enough to at least get that match, because otherwise you’re just walking away from more-or-less free money,” Gallant says.
But the match might come with a vesting schedule, which means you’ll have to stay at your job for a certain amount of time before you’ll receive the full amount. Some employers allow you to keep 20 percent of the match after one year of employment, with that number steadily increasing until you receive 100 percent after five years.
Even if you can’t max out your 401(k) right away, starting small can make a huge difference over time. Develop a plan to increase contributions as your career progresses and income climbs higher.
Bankrate’s 401(k) calculator can help you figure out how much to contribute to your 401(k) in order to build up enough money for retirement.
3. Open an individual retirement account (IRA)
Another way to continue your long-term investment strategy is with an individual retirement account, or IRA.
There are two main IRA options: traditional and Roth. Contributions to a traditional IRA are similar to a 401(k) in that they go in on a pre-tax basis and are not taxed until withdrawal. Roth IRA contributions, on the other hand, go into the account after-tax, and qualified distributions may be withdrawn tax-free.
Investors younger than age 50 are allowed to contribute up to $6,000 to IRAs in 2022, but that number will jump to $6,500 in 2023.
Experts generally recommend a Roth IRA over a traditional IRA for 20-somethings because they’re more likely to be in a lower tax bracket than they will be at retirement age.
“We always love the Roth option,” Gallant says. “As young people make more and more money, their tax bracket is going to increase. They’re paying into those funds at that lowest tax rate today, so that when they retire they can take that money out without tax.”
Ross Menke, a certified financial planner at Mariner Wealth Advisors in Sioux Falls, South Dakota, advises investors of any age to consider their personal situation before making a decision. “It’s all dependent on when you want to pay the tax and when it’s most appropriate for you based on your personal circumstances,” he says.
4. Find a broker or robo-advisor that meets your needs
For longer-term goals that aren’t necessarily retirement-related, like a down payment on a future home or your child’s education expenses, brokerage accounts are a great option.
And with the advent of online brokers such as Fidelity and Schwab, as well as robo-advisors like Betterment and Wealthfront, they’re more accessible than ever for young people who may be starting out with little money.
These companies offer low fees, reasonable minimums and educational resources for new investors, and your investments can often be made easily through an app on your phone. Betterment, for example, charges just 0.25 percent of your assets each year with no minimum balance or 0.4 percent for their Premium plan, which requires at least $100,000 in your account.
Many robo-advisors simplify the process as much as possible. Provide a bit of information about your goals and time horizon and the robo-advisor will choose a portfolio that matches up well and periodically rebalances it for you.
“There’s a lot of good options out there and each of them have their own specialty,” Menke says. Shop around to find the one that best fits your time horizon and contribution level.
5. Consider leveraging a financial advisor
If you don’t want to go the robo-advisor route, a human financial advisor can also be a great resource for beginning investors.
While it is the more expensive option, they’ll work with you to establish goals, assess risk tolerance and find the brokerage accounts that best fit your needs. They can help you choose where to direct the funds in your retirement accounts as well.
A financial advisor will also use their expertise to steer you in the right investment direction. While it’s easy for some young investors to get caught up in the excitement of daily market highs and lows, a financial advisor understands how the long game works.
“I don’t believe investing should be exciting, I think it should be boring,” Menke says. “It shouldn’t be seen as a form of entertainment because it is your life savings. Boring is okay sometimes. It’s coming back to what your time frame is and what your goal is.”
6. Keep short-term savings somewhere easily accessible
Like your emergency fund, which you may need to access at a moment’s notice, store your short-term investments somewhere easily accessible and not subject to market fluctuations.
“If you need the money available in a couple years, then it shouldn’t be invested in the stock market,” Menke says. “It should be invested in those more secure vehicles like a CD or money market where, yes, you might be giving up some potential growth, but it’s more important to have the return of your money instead of a return on your money.”
7. Increase your savings over time
Establishing a savings amount that you can stick to and having a plan to increase that over time is one of the best things you can do in your 20s.
“Committing to a specific savings rate and continuing to increase that year after year is what’s going to have the biggest impact early in your savings career to get you started,” according to Menke.
By starting this habit in your 20s, you’ll make it easier on yourself as you get older and won’t have to worry about taking extreme savings measures later to meet your long-term financial goals.
Investment options for beginners
ETFs and mutual funds. These funds allow investors to purchase a basket of securities at a fairly low cost. Funds that track indexes such as the S&P 500 are popular with investors because they easily provide broad diversification for fees that are close to zero. ETFs trade throughout the day like a stock does, while mutual funds can only be purchased at the day’s closing net asset value (NAV).
Stocks. For your long-term goals, stocks are considered one of the best investment options. You can buy stocks through ETFs or mutual funds, but you can also pick individual companies to invest in. You’ll want to thoroughly research any stock before investing and be sure to diversify your holdings. It’s best to start small if you don’t have much experience.
Fixed income. If you’re a more risk-averse investor, fixed-income investments such as bonds, money-market funds or high-yield savings accounts can allow you to ease your way into the investment landscape. Fixed-income securities are generally less risky than stocks, though you’ll also earn lower returns. These investments can still end up losing value, however, thanks to rising interest rates or elevated inflation.
Diversification is key
One way to limit your risk in investing is to make sure your portfolio is adequately diversified. This involves making sure you don’t have too many eggs in one or similar baskets. By maintaining diversification, you’ll be able to smooth out your investing journey and hopefully make it more likely that you can stick to your plan.
Remember that investments in stocks should always be made with long-term money, which allows you to have a time horizon of at least three to five years. Money that could have a short-term use is better invested in high-yield savings accounts or other cash management accounts.
Ready to get started?
Begin your investment journey by thinking through what your short-term, intermediate and long-term goals are, and then find the accounts that best fit those needs.
Your plans will likely change over time, but getting started with at least a retirement account is one of the most important things you can do for yourself in your 20s.
Not only will you ensure your money keeps up with inflation, but you’ll also reap the benefits of decades’ worth of compound interest on your contributions.
Note: Kendall Little wrote the original version of this story