As young adults, you face many questions as you age, not least among them is how to handle your money.
Understandably, if you haven’t had extensive exposure to personal finance or sound financial planning while growing up, you might not have a clear answer to several burning questions you likely face right now.
Some of the most common questions young adults face regarding money include the following 4 items:
- “Should I invest aggressively just because I’m young?”
- “Should I pay off debt before investing?”
- “Should I contribute to a Roth or Traditional retirement account?”
- “How long does it take to see results?”
Let’s explore these 4 top-of-mind questions and you can develop a clearer answer to each with sound investment advice for young adults.
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1. “Should I invest aggressively just because I’m young?”
When you have time on your side, the common advice for young investors is to invest aggressively. This usually holds true because you have little to lose and need a path for accumulating wealth with higher returns.
To accomplish this task, the typical portfolio recommendation includes investing in a high percentage of stocks and a small percentage of bonds or cash. Undoubtedly, in a vacuum, this logic proves sound but only truly represents half the story young investors face.
In fact, the missing half should serve as the most important part of your financial decision-making: your financial foundation.
Before proceeding in earnest with building a long-term investment portfolio, such as funds set aside for retirement, you will need to build other financial accounts important for financial security.
While retirement accounts and other excess money you want to invest should bias toward riskier assets (e.g., stock index funds), learning the best ways to invest money in your 20s should also include building these account balances to accomplish other nearer-term goals.
Before we throw everything in a retirement account and wait 40 years to withdraw, let’s look at some examples of goals which should not have aggressive risk-taking, high return investments just because we’re young.
→ An Emergency Fund.
You know what’s more important than holding a low-cost index fund which doubled in value over a five year period? A fully funded emergency fund capable of covering at least 3-6 months of expenses.
Depending on the nature of your work, reliability of paycheck, and lifestyle you may opt to hold more or less in this account.
While specifically recommended below as two of the best short-term investments for young investors, consider holding these funds in a high-yield savings account or money market fund.
In either type of account, your emergency fund can earn considerable interest while being held for a rainy day.
→ Wedding Costs.
If you haven’t yet tied the knot and have plans to do so in your 20s, you’ll fall in line with your peers according to data provided by the U.S. Census Bureau. In particular, the median age of a first marriage for men is 29, and 27 for women.
When it comes time to say your vows, you will want to have access to some liquidity and conservatively-invested funds so you won’t have to worry about what to do when stocks go down during a market crash.
You don’t want to delay formalizing your union because these funds get tied up in a bear market, so you’ll want this money set in conservative investments.
→ A Home Down Payment.
My wife and I bought our first home together in 2020 during the COVID-19 pandemic. We were at an age where we’d saved enough money for a down payment to buy a house where we could raise our young (and growing!) family.
While I purchased a condo by myself shortly after graduate school, I knew it would always serve as an investment property long-term. Investment property is often a good investment idea for young adults who do not need the money immediately and have excess funds to invest.
I made the decision to withdraw money from the stock market about 6 months before I entered the market and missed out on a decent stretch of market gains. However, I could just as easily had the opposite market environment give my home down payment fund a haircut of 10% or more. If that had happened, I might not have had enough money to buy a condo, forcing me to continue renting.
We were around the median first-time home buying age (32) seen today. That means most people saved for a house in their twenties, likely in conservative investments to provide certainty the funds would be there when needed.
As highlighted above, thinking about how to invest money for these shorter-term goals should involve keeping a considerable amount in cash in some conservative income-generating assets like certificates of deposit, high-yield savings accounts, or the like. Both of these accounts tend to earn a higher rate than traditional savings accounts.
2. “Should I pay off debt before investing?”
As touched upon above, young adults struggle to decide where their financial priorities should lie in terms of paying off debt quickly and starting to invest as soon as possible. Many are faced with the dilemma of deciding whether to invest or pay off student loans, and the answer can be complicated. When making this decision, consider the type of loan, the interest rate, your risk tolerance, and your overall expected return from an investment.
Credit card debt routinely carries double digit interest rates, usually between 15%-20%. Furthermore, this debt is guaranteed, whereas most investments are not.
It’s almost always smarter for young adults to pay off credit card debt first than investing. This is because you are more likely to receive a lower rate of return on the investment than you would avoid by paying off the high interest from a credit card.
Whether you should invest before or after paying off student loans is trickier. That’s become a key decision young adults must make when learning how to invest in your 20s or 30s.
The average interest rate for student loans is between 5% and 7%, which is much lower than credit card interest. Paired with the fact that you can use interest payments on student loans as a tax write off (subject to certain income limitations), this means that for many people, it’s a good move to be investing and paying off student loans simultaneously.
However, some people are stuck with higher interest rates on their student loans and might desire the mental relief of paying down loans first. Should you qualify, there may be several great offers on the market for refinancing your student loans.
Depending on the amount of student loan taken on and the profession you chose to pursue, student loans may act as a cost-effective way to invest in yourself. If you stand to make substantially more income from your decision to take on student loans and you come out ahead, you can safely consider your student loans to count as “good debt.”
Another form of “good debt” comes from pursuing a mortgage on a home appreciating in value. However, in the world of investing, we must look at how you invest in terms of opportunity cost. Meaning, how else could you have invested your money which may have led to better returns?
Some people face the decision of investing or paying off their mortgage faster. Usually, people can achieve higher returns by investing rather than the reduced interest expense they would pay by paying off their mortgages a bit earlier.
Additionally, because of the possibility of housing bubbles bursting, it’s strategic to have a diversified portfolio. In many cases, most people agree that you should begin investing before paying off a mortgage.
3. “Should I contribute to a Roth or Traditional retirement account?”
Another common question young investors ask themselves involves deciding which type of retirement account they should choose for investing.
Specifically, should you choose a Roth retirement account (e.g. Roth 401(k), Roth IRA) in your twenties when your tax burden is lower? Or should you use a traditional account to save more money now and pay taxes later?
In general terms, these two retirement account types works as follows:
- Traditional: Contributions to these accounts are usually pre-tax, meaning you set aside tax-deferred money now and pay taxes on this money when you withdraw it later.
- Roth: Contributions to these accounts generally occur after-tax, meaning you take advantage of lower tax brackets today and keep all gains from these investments when you withdraw them later.
In either scenario, you face a tax consequence. The question comes from when you think you will face a higher tax rate: now or later.
If you think your income is set to rise over your career and push you into higher tax brackets as you go, investing in a Roth account might serve as a good option.
Likewise, if you expect your tax bracket to drop in retirement, a traditional retirement account could also lead to beneficial results. As a general rule:
- If you currently have a higher tax bracket than your expected tax bracket in retirement, you should choose the Traditional option.
- If you currently have a similar or lower tax bracket than your expected tax bracket in retirement, you should choose the Roth option. Roth options also come with the ability to withdraw contributions without facing a tax penalty under certain scenarios.
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4. “How long does it take to see results?”
Undoubtedly, waiting is the hardest part when it comes to long-term investing. Because humans seek instant gratification, something Millennials have a notorious reputation for possessing, waiting to see the fruits of your labor might appear difficult. The same challenge applies to the investments we pick to hold over long-periods of time as we want to see overnight results. Who doesn’t?
While we have learned about the magic of compounding interest, remaining motivated can prove a tall task. Perhaps the marketing behind Acorns, another popular Millennial investing app, can help to teach us about how the mightiest investments start small and take time to grow.
In fact, having a measured approach to investing expectations is likely best because most of the investment growth happens later in life. Very little growth occurs when you initially invest your money.
How to Invest Money in Your 20s
When it comes to investing, the sooner you start, the better. Young adults have the opportunity to make simple investments now which will appear smart with significant time added. The only exception would be if you have a substantial amount of high-interest debt to pay off first.
If the amount of debt held overwhelms your personal finances and leaves little room for investing, allocating more money early on toward rapid debt repayment might serve you better.
As an alternative, you can also consider investing small amounts through investing apps to deploy small amounts of money into diversified investments.
Young adults have a need to own and hold both short-term and long-term investments. The right combination ensures you’re prepared for major purchases, as well as retirement, down the road.
Many investment apps today were created with young adults in mind and make it easy to get started investing with little money. Start your investing journey now and improve it along the way.
You will see how your net worth grows and can track your stock portfolio progress across time with a free app like Empower (Personal Capital is now Empower). Your future self will thank you.
