How should a person in their early 20s invest their money?
The phrase is one of several lessons learned by a West Point grad, and this saying relates directly to investing in your early 20s. Acknowledge that investing successfully is hard, because it takes self-discipline and delayed gratification.
Those two concepts don’t sound any fun.
But, as the writer says, we should embrace times that are difficult, because we always learn something- and we’ll be better prepared for the next time things suck.
I’ll answer this question by pointed out two advantages that you have as an investor in your early 20s, then provide some concrete steps for investing.
The power of compounding earnings
It was 1999, and I was talking to a co-worker, Ron, who was about 50 years old. A large insurance company we both worked for was merging with another firm, and we were both leaving the company. (I left to start my current business).
Get free sample chapters for my book: Not Another Personal Finance Book.
I had suspected that Ron well below his means, because I had a good idea of how much money he made. Both Ron and his wife worked, yet they lived in a blue collar-type neighborhood with small homes.
Ron wasn’t retiring early, but he had enough money to take some time off. He told me that he and his wife had planned financially, so neither of them would need to start working immediately after leaving a job.
They planned, they saved aggressively, and invested wisely.
How did he do it?
He compounded earnings on his investments.
Here’s how: Consider a $1,000 investment at a 5% interest rate, with total annual interest of $50.
Compounding interest is defined as earning “interest on interest”, and when you compound interest, your total earnings can be much higher.
In year one, you earn $50 in interest. Here’s the key point: in year two, the investor keeps the original $1,000 invested, plus the year one earnings of $50. The total amount invested in year two is $1,050.
$1,050 invested at 5% = $52.50 in interest, or $2.50 more than in year one.
The returns get bigger over time.
Think about a bucket. You can envision more money going into the bucket each year, since you leave your earnings in the bucket. If you took each year’s interest out, you’d only invest the original $1,000 each year- and you’d end up with far less money over time.
You have a longer time to compound earnings on investments in your 20s vs. your 50s.
If you’re recovering from a financial setback, this article may help.
You can make up for investment losses over time
Another advantage of investing in your 20s is that you can make up for investment losses, because you’re investing for a longer period of time.
So, what’s a “normal return” on stock investments, if such a number exists? Seeking Alpha (a site I highly recommend) has some great stats on historical returns for the S&P 500 from 1928 to 2015:
- Over 88 years, the S&P 500 went up 64 years and went down 24 years.
- The worst return was -43.84% in 1931 (ouch) .The best return was 52.56% in 1954.
- The mean return (think average) was 11.4122%
So, what’s normal? Seeking Alpha says 11%, and other stats suggest 8-10% over a 70-80 year period.
If you stay invested for the long term, those losses will balance out with the gains over time- and you’ll probably earn that average 8-10% rate.
Here are some practical steps:
Create a budget, and move funds into a savings account
- Create a budget, even if that budget is simply on notebook paper.
- Separate your expenses between fixed and variable, and take a hard look at your variable spending.
- Take steps to cut your variable expenses each month and put the amount you save into a separate savings account.
Monitor your spending and your budget
- Consider using a budgeting app to monitor your spending
- Set up a separate bank account to discipline yourself to save
- Save 5% of your monthly gross income
Use a retirement account to invest- through an employer, or on your own
- Carefully review each retirement plan offering from your employer.
- Ask about the tax-deferred investing component of your firm’s retirement plan. Do your investments grow tax-deferred?
- If you’re self-employed, ask financial advisor about your investment options.
One last thing: Read The Richest Man In Babylon. It’s a simple- yet powerful- book on savings and investing.
As always, check with a financial advisor and a CPA for more specific advice.
Good luck!
Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
Co-Founder: accountinged.com
(email) ken@stltest.net
(website and blog) https://www.accountingaccidentally.com/
(you tube channel) kenboydstl
This post was originally posted on my Quora page. This post is for educational purposes only.
Image: Bullseye, Jeff Turner CC by 2.0