One of the best principles in investing is this: the earlier you start, the better returns you would likely reap. One reason for this is the genius of compound interest. It will allow you to grow your money exponentially. So, you may find that by the time you want to retire, the few hundred dollars you’ve invested when you were 20 years old has grown considerably as your nest egg.
If you are in your 20’s and want a running start in your investment journey, here are a few tips to remember:
1. Start Early. Make It Simple.
When you see certain company stocks shoot up like crazy, it’s normal to regret that you’ve not bought some shares. Or you have a few colleagues who bought a few cryptocurrencies and became overnight millionaires. It’s very tempting to jump into these schemes and hope that you’ll strike gold very soon. It’s the law of investing: take risks to earn rewards. But when you’re a novice in the market, it’s foolishness to go all in at once.
Many people don’t understand the difference between hindsight and foresight – they are poles apart. Take the case of ETF’s. They may seem drab and unexciting, but chances are, they will outperform the market in the long run. If you’re the fidgety type who is always checking your phone unsure of whether to buy or sell with a small amount of money, it’s not going to work for you.
As we said, there are many boring stocks that behave like snails attending a funeral. They move in a single direction but it’s so slow you can hardly notice it. However, this is where compounding interest works its magic. Take a good look at this. If you have $5,000 today and put it into an index fund that grows 6% every year, you’ll have about $50,000 in 40 years.
That, my friend, is why they say that time is gold. Every year that you’re not in the market is your loss and it materially lessens your returns down the road. People who invest early find that they are able to retire earlier than other people. For those who invest late in their lives, they have to work longer before they can consider retiring comfortably.
2. Think Long Term
The first major step in your investing journey is to take stock of your present circumstances and what you want to happen in the future.
If you’re not bent on investing consistently for a long time, then don’t even start. Don’t forget that investment is all about looking for long-term value in where you put your money. Forget about those “get rich quick” schemes because they can’t deliver what they promise and they’ll just take your money.
These are the questions to ask yourself first:
- Financially, where do I want to be in the next five years? What about the next 20 years?
- How much money do I have now that I can invest freely?
- How many contributions would I make over time?
- Taking into account my long-term goals and my current financial capacity, which investment options are the right ones to give me a head start?
- How long would this investment activity take?
- When my investments are in motion, what adjustments should I make over time for me to be on track towards my goals?
- How much do I want to earn over time?
One important thing investing can do to you is help you set up your money to grow in such a way that you’ll reach your goal after a certain time. For instance, you may aim for retirement at age 60, purchase a new home in the next 10 years, or take a year off from work to travel the world. Whatever it is, you want to synchronize the investment activities so that money from your investments becomes available as you need it.
3. Lower Your Taxes
When you’re a young investor, you’re probably in the low tax brackets and you don’t pay too much attention to tax strategies. But financial experts say it’s never too early to start taking advantage of some benefits from the tax laws.
It begins with the tax deferral provided by the traditional 401(k), or perhaps the tax-free status of the Roth 401(k). Unlike the traditional 401(k), the Roth does not give you an up-front deduction on your contributions. Nevertheless, experts recommend that young investors allocate at least half their 401(k) contributions into Roth accounts just the same. This is because much later, after decades of making your investments grow, your tax-free withdrawals will become much more valuable in a higher tax bracket.
Also, as you ponder where to put your money, invest in tax-efficient instruments such as bonds and anything that will give you numerous contributions in your tax-deferred account. This way, you get the money to work for you over 20-30 years. If you will put your money into your taxable account, it’s like giving 20% or 30% each year to the IRS. However, you should put tax-efficient investments in your taxable account.
4. Set Your Risk Tolerance
Risk tolerance may be psychological and genetic, but many factors affect it as a person grows. Things like education, income, and wealth positively influence it in such a way that when they increase, tolerance also increases. On the other hand, age negatively affects it such that as a person gets older, the less risk he would be willing to take. Your risk tolerance shows in the way you react to risk and the level of anxiety it brings you when you encounter it.
By getting a good grasp of your risk tolerance level, you can steer clear of investments that may become a source of worry for you. Ideally, you should never invest in anything that would make you lose sleep. Anxiety gives rise to fear and fear can make you take emotional reactions instead of logical responses to that which gives your stress. In times of financial uneasiness, the level-headed investor who can maintain an analytical decision-making process will definitely come out ahead.
5. Use Roth IRA
You might say that you’re already contributing to a workplace retirement plan but for as long as your household income isn’t over the annual limits, you can still contribute to Roth IRA. If you’re married, filing jointly and your household income is under $198,000 per annum, you can still put in a maximum of $6,000 to a Roth IRA for 2021.
If you’re single and your annual income is below $125,000, you can contribute the maximum amount to a Roth IRA. You can’t use your contributions for tax deduction purposes but your money in the Roth IRA will grow tax-free, as well as gains on your stocks after five years has elapsed since your first contribution.
If you’re already investing in a workplace retirement plan and prefer a tax break on your contributions up front, simply invest a maximum of $6,000 in a traditional IRA in 2021. You can then deduct the contribution later from your tax return. Take note that you can only do this is your household income is less than $103,000 (for married filing jointly) or $64,000 (for singles).
6. Paying Off High-Interest Debt
This is not an investment scheme, but this could be part of your overall financial strategy: have a plan to be debt-free in your 30s. The logic behind this is very simple. You might be able to find an investment that can give you an annual return of seven percent but if you’re paying off a debt that charges you 15% per annum, you’ll end up losing more.
So, why not use your money first to get rid of these high-interest debts? But it doesn’t strictly mean that you should wait to start investing until you pay off all your debts. In the finance world, sometimes it is more advantageous to keep low-interest debts. The main strategy is to get high-interest debts off your back before focusing on other investments.
7. Control Your Emotions
One of the biggest hindrances to investment success is the investor’s failure to control his emotions such that it interferes with his logical decision-making. If you think about it, the short-term prices of assets in the market reflect the collective emotions of the players in the investment community. When there’s a good number of investors who show concern or worry about a stock or an asset, its price is likely to decline. On the other hand, when they feel good and positive about the company’s future, its stock price tends to go up.
If you are an investor, it is but normal to feel some sort of stress and insecurity when asset prices go the opposite way of what you expect. Should you sell your position and cut your loss? Should you keep the stock, hope and wait that the price will turn around? Do you need to buy more?
Actually, even when the price is performing as you anticipate, it still gives rise to more questions. Should you take advantage now, sell and earn a profit? Should you wait a little more for the price to go higher? These thoughts will fill your mind, all the more if you keep on watching the price of a security moment by moment. It will create tension to a point where you will feel you need to do something. Often, when you let emotions drive your actions, you tend to make mistakes.
Before you invest in something, you should have already done your analysis that it’s a good buy. Of course, by this time you will already have an idea of what returns you expect from your choice. A good strategy is to benchmark a point at which you want to sell out your holdings especially when your analysis proves to be inaccurate or when the asset doesn’t go the way of your projections. What we’re saying is, you should have an exit strategy even before committing to an asset and execute that strategy regardless of what you feel.
8. Re-Evaluate Your Portfolio
If the recent downturn in stock prices has been giving you some sleepless nights, you should consider re-aligning your portfolio by trimming down the percentage of stocks. If you have a lower risk tolerance, this will help you sleep better at night and helps you prepare if the stock market continues to depreciate and turn into a bear market. This occurs when the decline in the stock prices reaches 20% or more.
A simple step of raising your stock-to-bond ratio by 10% to 20% is a lot wiser than adopting an “all in” or “all out” strategy in an asset class. Just make sure that a portion of your portfolio is in stocks or in investments that grow like stocks, so you can have a greater assurance of having enough retirement money. Otherwise, you’ll have to work longer or save more money for your retirement.
You might feel that the times call for some drastic decisions on your investment portfolio such as liquidating everything or most of them to have ready cash on hand. Any emotionally-driven move is almost always a bad idea. What is better is to have a logical long-term investment plan and stick to the game plan through the ups and downs of the market because they will surely happen. If you don’t follow this, you might end up being too emotional and lead you to buy stocks when they are almost at their peak prices or sell them when they are almost at their bottom.
9. Take Risks
You could be the type who wants to take too much risk such that you can put every cent in individual stocks. The other extreme is to be too conservative when investing. Keeping all your money in ‘safe’ investments such as money market account or Certificates of Deposits (CD’s) is an awful way to invest.
Yes, these investments can provide you with the security, but they can’t provide you with the high returns that you need. Their returns are often so low that they can’t keep your head above inflation and you’ll actually end up losing money over time with their mediocre returns.
By consistently investing 20% of your income every month, you can grow your wealth in a big way. Arrange an automatic transfer from your paycheck directly to your investment accounts. This is one good way to practice the discipline of investing and saving that will help you develop consistency.