Early-stage investors between the ages of 20 and 40 typically don’t have much financial capital (unless they’re tech experts or high-end models, of course). Not only are their incomes often lower than what they’ll earn in the future, but recent college graduates may also be digesting the debt they incurred during their studies.
But early-stage investors have other advantages that their elders may envy. With a lifetime of earning power ahead of them, they have an abundance of what investment researchers call human capital: their ability to earn a living is by far their greatest asset.
Investors in their twenties and thirties also have a valuable investment advantage: With plenty of time before they start needing to withdraw their money (for retirement, at least), early-stage investors can better harness the considerable power of compound interest. They can also tolerate more volatile investments that, over long periods, are likely to generate higher returns than safer investments.
If you’re just getting started with investing, it’s hard to go wrong when your strategy is to invest as much money as possible at regular intervals and stick to well-diversified core investments. But it’s also helpful to think of your “investments” broadly, allocating your hard-earned money to opportunities that promise the best return during the time you have available. For most people, this means multitasking a bit: rather than waiting until all your student loans are paid off to start investing in the market or saving for a down payment on a house, for example, you can earmark a portion of your paycheck for all three of these “investments” at once.
Here are eight tips for investing and multitasking in your 20s and 30s.
1. Give your debts their rightful place.
2. Invest in human capital.
3. Put in place a safety net.
4. Boost your retirement accounts.
5. Favor tax-free vehicles.
6. Invest according to your risk capacity.
7. Use simple and well-diversified basic elements.
Give your debts the place they deserve
One of the first pitfalls early investors face as soon as they start drawing a paycheck is whether to dedicate a portion of that paycheck to debt servicing or to investing in the market. If it’s a high-interest credit card or a particularly expensive student loan, the majority of your extra cash should be allocated to these “investments.”
Indeed, it is impossible today to obtain a guaranteed high return from an investment portfolio, while repaying debt guarantees a payment equal to your interest rate, less the tax benefits you receive from your debt.
As a general rule, investors holding debt with an interest rate of 5% or higher would be wise to focus on paying off those loans (or possibly refinancing them on more favorable terms) before diving headfirst into stock market investments. One exception: building an emergency fund (see below).
Invest in human capital.
Since we’re talking about “investments” in the broadest sense, your twenties and thirties are also ideal times to invest in your human capital—that is, to acquire additional education or training to improve your earning power throughout your life. Of course, not all such investments are profitable, and ideally, your employer should cover at least some of the funding. But if you’ve been considering getting a college degree or pursuing any additional training, the earlier you start, the more your investment will pay off over your lifetime.
Put in place a safety net.
Because financial capital is limited, young investors need to protect what they have and be prepared for financial emergencies should they arise. A good rule of thumb is to insure against risks that would cause extreme financial hardship and not to insure against items that wouldn’t. Homeowner’s (or renter’s) insurance, health insurance, disability insurance, and car insurance are essential, as is life insurance if you have minor children; however, you can skip extending the warranty on your laptop or washing machine.
An emergency fund is also essential, as having a cash cushion can prevent you from resorting to unattractive forms of financing, such as credit cards, or dipping into your RRSP if you lose your job or face an unexpected expense. While the rule of thumb of setting aside three to six months of living expenses in cash may seem daunting, remember that this is three to six months of essential living expenses, not income. Workers in the informal economy and entrepreneurs should consider setting a higher savings goal, as cash flow from their jobs can be very erratic.
Give your retirement accounts a boost.
Early investors put off saving for retirement for many reasons. For starters, many people in their twenties and thirties are saddled with significant student loan debt. Additionally, those in their twenties and thirties often have one or more short-term goals that compete with saving for their hard-earned money: a down payment on their first home, a car, a wedding, and children, for example. Psychology plays a role as well: With retirement still three or four decades away, people just starting their careers may find it difficult to feel the urgency to save for this goal.
Yet it’s younger investors who have the longest time to benefit from compounding, even if they can only save relatively modest amounts and the market gods serve up so-so returns during the time they have. A 22-year-old who starts saving $200 a month and earns 6% a year will have more than $362,000 by age 65.
In contrast, the investor who waits until age 35 to start investing but sets aside $300 a month and earns a 6% return will have just over $300,000 by age 65. Those first ten years of missed compounding wipe out the higher returns and larger contributions later, underscoring the need to start saving for retirement as early as possible, even if that means starting small.
Favor tax-sheltered vehicles.
For savers of all ages, investment vehicles that allow for tax-sheltered growth, such as company pension plans and group RRSPs, should be favored.
A company pension plan, if one exists, is invariably the easiest way to start saving for retirement. Not only do many company pension plans offer a match for employees’ investments, but the fact that contributions are deducted directly from paychecks helps reduce the pain of investing (if you never get your hands on the money, you won’t regret it). Automatic contributions also allow you to enforce savings discipline, even when the market is down or your cash flow is at its lowest.
Of course, you can reduce your RRSP contributions once you’ve set your initial contribution rate, but in reality, few participants do. And for early investors whose company-offered options are mediocre, it’s still worth contributing enough to get the match.
Invest according to your risk capacity
Investors are often advised to consider their risk tolerance: How would they feel if their portfolio lost 5% or 10% in a given week or month? This is important, especially if a nervous investor is tempted to upset their well-laid plan at an inopportune moment. But the more important concept is risk capacity—the amount you can lose without having to change your lifestyle or investment plan. It’s important to understand the difference between risk tolerance and risk capacity and to ensure that these two measures work together.
When it comes to retirement savings, people who accumulate money early in their careers have a high risk-taking capacity, as they likely won’t need their money for many years. This is why retirement portfolios typically include a significant portion of equity investments: Although aAlthoughthey experience more dramatic ups and downs than safer securities such as bonds and cash, stocks have historically rewarded their long-term investors with better returns than other asset classes.
On the other hand, if you’re investing for short-term goals like a down payment on a house, it’s probably not worth investing much, if anything, in stocks. While bond and cash returns are likely to be much lower, there’s also much less risk of them experiencing sharp downward swings. Portfolios for short-term goals can include a small amount of stocks for their growth potential, but the bulk of the money allocated to these goals should be in safer, lower-yielding assets.
Use simple and well-diversified basic elements.
S, you’ve decided to take advantage of tax-sheltered retirement savings and put the majority of your long-term portfolio into stocks. But now you have to decide how to invest that money. With thousands of individual stocks, mutual funds, and exchange-traded funds, this task can seem daunting, but resist the urge to overcomplicate things or venture into too narrow investment types.
Instead, focus on low-cost investments that offer broad diversification. For beginning investors, target-date mutual funds can make the investing process less mysterious: These funds take aggressive, stock-heavy positions when investors are in their 20s and 50s, then become increasingly conservative as they approach retirement. In addition, the best target-date funds invest heavily in low-cost, well-diversified investments.
