Welcome to the Invest By The Decades series! Every Wednesday, I'll break down how members of each decade should be managing their money to set themselves up for sustained success with their cash. This week, we'll be looking at your 20's and why it could be the most important time of your financial life. This article is for entertainment purposes and should not be interpreted as investment advice. Each situation is different, so please contact a professional for your own individual needs.
No decade is scarier than your 20's. At least, that's what I hear. I'm 29, so this is the only one I've known from the perspective of being an adult that has to rely on myself to eat and have a roof over my head. But being in your 20's is scary as hell! You're likely coming out of college or are only a few years into a job or a career, and you're not quite sure what you're doing or where you're going. You're getting a paycheck, but you're spending it on Jagerbombs every Saturday and brunch every Sunday and you aren't sure how you're supposed to pay your skyrocketing rent and have enough left over to...invest? Is that what that's called? Well that's where I come in. Today, let's look at the best way to approach your money in your 20's to make sure you're ballin' in your 30's.
1. Just Start to Start Compounding
OK, so you've taken the all-important step of making it past the intro paragraph and the annoying as shit blue "Sign Up For My Email List!" button, Kudos! You're still here, which means you want to get started. And weirdly, that's the first step: just starting. Realizing that you want to get better with money is hardest part of this whole process, and you've already done it! Not to go all AA on you, but telling yourself that you don't know what you're doing is a powerful thing. So that's why I'm here.
Being in your 20's is actually the most powerful time in your life to set yourself up for success because of something called "compounding interest." Compounding interest is the closest thing we have to magic that isn't named Criss Angel. Basically, it measures how fast your money is able to make itself more money. Cool, right? So here's how it works:
You invest $100 in an index fund that grows 10% per year (I'll explain this in a bit). At the end of year 1, you'll have $110. At the end of year 2, you'll have $121, and so on. If you expand this out over 40 years, you'll have $4,526, without having contributed one single dollar yourself over your initial $100 investment. Not bad huh.
2. Let Your Employer Pay for Future You
So how do you grab this compounding interest? You start investing! The best way for most 20 year old's is to invest with their employer through what's called a 401(k). You probably got this speech from HR on your first day, but you were in the middle of figuring out the difference between an HMO and PPO insurance plan to figure out what the hell they were talking about.
Basically, a 401(k) is an employer-provided retirement plan that takes money out of your paycheck pre-tax (before taxes are applied by state and federal government) and sets it aside for retirement. Many employers also offer a "match" which is a contribution your employer makes to your 401(k) based on how much money you contribute each paycheck. This is what's known in the industry as "free money" and you should accept it as quickly as possible. It's literally free money! Your employer is just handing you extra money for growing your original money. This is something that too many people in our age group don't take advantage of, and it's going to hurt them when they hit 60 and are trying to retire. Here's how:
Let's expand on our example from earlier. Instead of a one-time $100 contribution, let's say you contribute $100 per paycheck and your employer matches you, so $200 every two weeks. Here's how much money you'll have after 40 years at a 10% growth rate:
I'm not kidding when I say compound interest is magical.
3. Put a Little Away for Emergencies
Here's another trap that our generation falls into: not having enough cash in case you have an emergency. It could be anything: your car breaks down or your Labradoodle needs surgery. Anything that comes out of nowhere and serves as a shock to your checking account could be an emergency. This DOES NOT include: emergency beach trips with the girls or your buddy Zach's bachelor party in Denver. The emergency fund is absolutely critical in providing a solid base to launch the rest of your financial life.
So how much should you have saved for emergencies? Most finance experts recommend between 3-12 months of typical expenses saved in cash that's easily accessible through a savings account. Personally, I think that "3-12 months in cash" is a huge number. Start small! Give yourself that mental win that you've accomplished the establishment of a savings account. Save $100, then $250, then $500, then maybe $1,000. Every milestone you hit will help you sleep a little bit more soundly at night. I've also found that it'll help you say "yes" to more things. Dinner with your friends? Sure! Want to go see that movie? Hell yeah I do! Why? Because I can afford it, that's why. You have that financial cushion now, leading to a happier financial life.
So where are you supposed to keep all this cash? Your checking account? Mattress? Banana stand? None of the above. You'll want to open a separate savings account, but be picky. If you have a checking account with a traditional bank (Chase, Bank of America, Wells Fargo, etc), you'll probably want to skip their savings accounts. Because these companies don't make much money on these types of accounts, as well as have extensive physical bank branches to pay for, the best interest rate they can typically offer is around 0.05%. That makes me physically ill to even type. You'll want to check out online banks that deal in "high interest savings accounts." These include Marcus, Ally, Yotta Bank, SoFi and others. They can typically offer you around 0.40-0.75% on your cash. Still not great, but better.
3. Understand Taxes (and how to beat them)
There will come a time where you look at your pay stub (that's what our parents still call them), you'll see a lot of deductions: Social Security, insurance, FSA/HSA, 401(k), then you'll see state and local taxes. I know, I know; taxes are brutal. All of a sudden, 10-37% (depending on how much you make) of your money is just gone, never to be seen again. There is some good news, though: you can take steps to beat the tax man at his own game.
The first is one we've already talked about, and it's your 401(k)! Contributing to a 401(k) is pre-tax, which we discussed earlier. The benefit of this is that your money goes into the account before taxes can be applied, lowering your taxable income. This results in a lower total amount the government can take from you in each paycheck. The catch with a 401(k) though is that you are taxed when that money comes out in retirement, meaning you'll unfortunately have to make up some taxes on the back end.
The second method is so good that it should be illegal. Back in 1998, Congress created a new type of retirement account, called a Roth IRA. A Roth IRA is an account that you can open yourself with pretty much any brokerage account (not Robinhood, as they don't offer this yet). The way it works is you contribute money that is "post-tax," meaning the money that has hit your bank account from your paycheck. You can contribute up to $6,000 per year to this account and invest it in pretty much any way you want: index funds, individual stocks, whatever! Many brokerages also offer actively-managed Roth IRA solutions if you just want to hand the keys to a professional and not have to worry about it. The best part? Once you turn 60 years old, you have access to this account tax-free. That's right. You pay $0 in taxes on any of the gains you've made in this account. Open one of these as soon as you can.
If you're interested in a managed Roth IRA strategy with a winning team that has beaten the market each of the last three years, our partners at Titan Invest are offering an exclusive discount to my readers. Just use this link to sign up and fund your Roth IRA with $500. They take it from there!
4. Give Yourself a Head Start on Credit
Credit is aggressively misunderstood with young people. When I say "credit," what's the first thing that comes to mind? Is it a metal credit card clanging onto the table to pay for $14 tacos? Is it a number you get sometimes from your bank and there's an arrow pointing to a red, yellow or green scale? Those are both sort of correct. Let me explain.
Credit is basically how much financial institutions like banks and credit card companies trust you. It takes into account a lot of factors, rolls them together and then spits out a number between 300-850. The higher the number, the better your life will be, basically. A higher number means that the financial world trusts you more, so you'll get lower interest rates and access to bigger loans for things like cars and mortgages. So how do they come up with this number?
There are quite a few factors that go into calculating a credit score, but the biggest ones are:
Length of credit history - how long have you had an open line of credit, like a credit card or a car loan?
Payment history - do you make your payments on-time? Have you missed any payments or applied for bankruptcy protection?
Credit usage - do all of your credit cards have balances on them? Do you have a mortgage and a car loan at the same time?
Types of accounts - this can also be called the "credit mix" and is the different types of credit you have, broken into installment loans (mortgage, car loan) and revolving loan (credit cards)
Recent activity - did you recently open a new credit card, or apply for a new installment loan that required a company to check your credit?
All of these factors directly affect your credit score, so here is what all of the above means: get started on your credit early, and pay attention to it! Open a credit card early and pay for everything on it, but make sure you pay it on-time every month. Missing payments will ding you, so ensure that you're staying on-top of payments and usage. Do this, and you are setting your future self up for incredible success.
5. Take Risks!
Too many are following the old ways of investing: 60% stocks, 40% bonds. That style of thinking doesn't really work anymore. Young people like us have access to more and more options now. We have index funds, managed ETF's, passive ETF's, high profile investment funds like Arkk, stocks, bonds and cryptocurrency. It's all enough to make your head spin! And while I cannot recommend one specific investment strategy because I'm not an RIA, I can suggest that you take a look at index funds.
Index funds track the market. That's it. When you hear your dad or that guy at the office say "market was up three points this week," you can smile knowing that you are also up three percentage points this week. So why would I suggest looking into these? Because 90% of investors, amateur or professional, do not beat the market over a 15-year period. That means if you try to pick stocks yourself, chances are that you're going to lose. So my personal strategy has been to build a base of index funds to serve as my rock-solid foundation. On top of that, I'm taking some risks.
First up, I do like to pick individual stocks. You can see the stocks I've heavily researched here. I like to pick disruptive growth stocks in high-growth industries like telemedicine, app-based language learning and new-age banking, in order to grow my wealth over time as these industries become more common. It's a risk, but one I believe will pay off in the long term.
My second strategy is way more risky, and that's cryptocurrency. I am invested in both Bitcoin and Ethereum, dedicating about 10% of my overall portfolio to them. Why? Because they have been the top performing assets over the last decade, destroying the market in the process, and I think they have way more room to run. Even if I'm wrong, however, I have plenty of time to recover. And that's the beauty of investing in your 20's! Even if you're wrong on an investment, or something goes south, you have the most amount of time to fix it and recover prior to retirement. It won't hurt you too badly.
6. Enjoy Yourself
Now here's one you won't find on another list like this: I want you to actually spend money and have a great time. Enjoy it! Your 20's are a time where you likely won't be earning a ton of money, but you also won't have a ton of responsibilities like a mortgage or a child. Enjoy this time, because if there's one thing you learn from this piece, it's that time isn't to be wasted. You can use it to compound your money and have a blast at the same time. And if you're able to do that, then you really can't lose.
Did you find this article helpful? Are you in your 20's and have another tip you want to drop? Let me know in the comments below! And don't forget to sign up for my email list so you can get these in your inbox as soon as they post. Thanks for reading!