Young investors who want to begin a savings plan face a bewildering array of investment options but putting your money to work for you isn't as hard as it may seem. Consider starting a retirement savings plan or buying a home. There are thousands of products and services to choose from and almost as many firms and vendors that market them in various capacities.
Key Takeaways
- Young investors have the most valuable resource on their side: time.
- Compound interest and dividend reinvestment are proven methods of building long-term wealth.
- Day trading can yield above-market returns but most investors who utilize this strategy lose their retirement accounts entirely.
- Real estate can be a solid investment choice if the investor plans to stay there for longer than five years.
- SIMPLE IRAs and 401(k)s are extremely good investment choices if your employer will match your contributions.
Saving for Retirement
Your greatest financial assets are time and compound interest if you're still young. Your primary investment objective for long-term savings at this point in your life should be growth. Investors in their twenties have at least 40 years over which to accumulate retirement savings.
Consider putting as much of your savings as possible in some form of equities, such as common stocks and stock mutual funds. You might also consider real estate, either in the form of a personal residence or a REIT, a mutual fund that invests in real estate holdings. It's important to be able to increase the purchasing power of your retirement savings throughout your lifetimebecause you'll need every penny you can muster after you stop working.
Real estate and stocks both tend to gain value faster than the rate of inflation. Real estate prices don't grow as quickly as stock prices but real estate also has fewer booms and busts.
401(k)s and IRAs
IRAs and employer-sponsored retirement plans are great ways to start saving for retirement. Employer-sponsored plans often provide matching contributions and this can give your retirement savings a tremendous boost. A 50% match on the first 5% of your contributions can result in tens of thousands of extra dollars in your pocket at retirement.
Most financial experts tell young people to use a Roth IRA instead of a traditional IRA because their contributions and everything they earn will grow tax-free until retirement. You won't pay any tax onwithdrawals although you don't get a tax benefit from your contributions.
Roth features are also available in many qualified plans such as 401(k) plans. Money in traditional IRAs and 401(k)s is taxed at your income tax rate when you withdraw it at retirement and you're required to withdraw a certain amount starting after age 73 regardless of whether you need the money.Ultimately, the Roth combination of tax-free growth and no required withdrawals coupled with the superior returns posted by equities is virtually impossible to beat over time.
Buying a Home
Traditional financial wisdom usually dictates that a house is one of the best investments you can buy but this depends upon several variables. The duration of your residence and the housing market will factor heavily into this issue, as will the current interest rate environment, rental prices, and your financial situation.
It's probably cheaper to rent in most cases if you plan on living in the home for less than five years because it usually takes at least five to seven years to accumulate enough equity in a home to justify buying one rather than renting.
Saving for College
There are several other savings vehicles to consider for your money if you're still trying to get through school or haven't started yet.
529 Plans
Nearly every state has this type of college savings plan that allows you to put money away for higher education. The funds can be allocated among various investment choices and will grow tax-free until they're withdrawn to pay for qualified higher education expenses. The contribution limits for these plans are quite high and they can also provide gift and estate tax savings for wealthy donors who are looking to reduce their taxable estates.
Coverdell Education Savings Accounts
This type of college savings account is another option for those who want to take a more self-directed approach to their investments. The annual contribution limit as of 2024 is $2,000 per beneficiary per year but it may still be a viable alternative if you want to purchase a specific investment that's not offered inside a 529 Plan.
U.S. Savings Bonds
Savings bonds are yet another alternative to consider for conservative investors who don't want to risk their principal. The interest earned on U.S. Savings Bonds is also tax-free if it's used for higher education expenses.
Short-Term Investments
The alternatives for your short-term cash are pretty much the same regardless of your age. Money market funds, savings accounts, and short-term CDs can all provide safety and liquidity for your idle cash. The amount you keep in these investments will depend on your financial situation but most experts recommend keeping enough to cover at least three to six months of living expenses in an emergency fund.
Investing in exchange-traded funds (ETFs) that track the market and letting dividends and interest build almost always beat a short-term stock trading strategy over a long period, such as your working years. Returns can be high although most day traders bust within a year. They lose their entire principal in a worst-case scenario and can even end up owing their brokerage interest on margin trades.
What Are the Easiest Investments for Young People?
Exchange-traded funds and mutual funds provide an easy way to keep pace with the overall growth of the stock market and you don't have to go to the trouble of picking stocks on your own.
Why Should You Start Investing When You're Still Young?
It's said that the only true miracle is compound interest. Young people may earn less money but investing in your twenties will give your savings several decades to grow. Tax-advantaged retirement accounts and employer-matching contributions give you even more reason to take advantage of these benefits.
What Are the Best Short-Term Investments for Young People?
Investing can be a challenge for younger people because they tend to have little disposable income and they may encounter unexpected expenses. However, putting your savings in the bank isn't ideal. These accounts don't accumulate significant interest. Short-term investments such as money market funds and certificates of deposit are a great way to put your money to work but still be able to withdraw it at relatively short notice.
The Bottom Line
The most important financial decision you can make when you're young is to get into the habit of saving regularly. Where you invest matters less than the fact that you've decided to invest. The right investments for you will depend largely upon your personal investment objectives, risk tolerance, and time horizon.
