Investing in Your 20s (Rewind) (EP.127)

0:28We all need to make smart decisions with our money. but maybe you haven't heard before. So I'd love for you to check it out. And don't forget, if you're enjoying the podcast, the best way to say thank you is to leave a quick review or forward an episode to a friend. Now, let's get into this popular episode from my Investing by Age series.

0:50Welcome to the Long-Term Investor. This is the first in a series of episodes called Investing by Age. Obviously, people reach different financial stages at different ages, so you're likely going to find useful information in episodes outside of your age bracket. If you're in your late 20s, you might find the episode on investing in your 30s to be just as important. If you're in your 50s, you might find that aspects of episodes on investing in your 40s and investing in your 60s are relevant. With that in mind, let's dive into the essential aspects for investing in your 20s. The financial decisions you make in your 20s are arguably more impactful than any other time in your life because of the time your decisions have to compound.

1:36While I have five specific financial actions to take in your 20s, there is no more important decision you can make than choosing to start now. There's an example I use in my book that I'll drop into the show notes on thelongterminvestor.com of two college graduates with access to tax-deferred investment accounts earning 8 % a year. The first investor saves$250 a month for 10 years for a total of$30 ,000 and then doesn't make another investment for the next 30 years. And at the end of 40 years, her portfolio amounts to$509 ,605. The second investor doesn't invest for the first 10 years of the same 40-year period.

2:20Instead, he contributes$250 a month for the next 30 years for a total contribution of $90 ,000. But despite saving more money over a longer period of time, the second investor ends up with only$375 ,074. This goes to show you that the most potent combination for wealth creation is time and the power of compounding. Whether you're saving early and often, systematically adding to your investment portfolio, or staying the course through periods of uncertainty and market losses, time has the power to turn small decisions into incredible results. With that in mind, here are the five most important things you should do in your 20s.

3:08One, set goals. Before investing, it's important to understand what you want to do with the wealth you create. Creating a reverse budget is the best framework for setting these goals and establishing a plan to meet them. I have a reverse budgeting worksheet on my website, and I'll be sure to link that in the show notes. If you're not familiar with the concept of reverse budgeting, it's the opposite of traditional budgeting where you just track your expenses to figure out how much you have left to save. Reverse budgeting flips that idea on its head, instead focusing on how much you need to save to meet your goals, and then you spend the rest of your cash flow as you see fit.

3:48Not only is this a far more intentional and practical method for planning your savings, it's also far easier to maintain on a regular basis. To determine how much you need to save, all you really have to do is list out your short-term goals of five years or less. Then you total up the expected cost of those various goals and divide by 60 because there are 60 months and five years. And what you're left with is how much you need to save every month. If you have capacity to save more, then you can start applying the extra cash flow to your intermediate term goals that are 5 to 15 years away, or your long term goals that are 15 or more years out.

4:26One call out though is that your annual retirement savings goals, like contributing to a 401k or an IRA, should be listed among your short term goals since you need to be contributing to your retirement savings every year. Now, investing your retirement savings in a mix of stocks and bonds is going to be essential to growing your wealth. Because if your portfolio lacks sufficient exposure to risk your assets like stocks, then you may not generate enough returns to meet your long-term goals. A portfolio that doesn't take enough risk is also going to require an unrealistic savings rate relative to your cash flow.

5:02But while your retirement savings should be invested, savings for your other short-term goals of less than five years should be kept in cash rather than invested in the stock market. Market volatility is inevitable. It's the cost of higher expected returns in stocks versus bonds or cash. So it's unwise to accept the risk of market losses for your short-term goals because they have less time and sometimes no time to recover. Number two, max out your retirement accounts. I just referenced that you need to be contributing to your retirement savings every single year. There are a variety of retirement accounts that offer tax-free compounding of earnings, income, and capital gains, but the best place to start is investing enough in your employer-sponsored retirement plan to earn a match.

5:52The most common employer-sponsored plan types are a 401k, 403b, and 457. so you want to at least get your employer match in these kind of accounts. For example, if your employer has a 3 % match and your salary is$100 ,000, you'll need to contribute at least $3 ,000 to your retirement plan to be entitled to your employer's full matching contribution. Failing to make this contribution is basically leaving free money on the table. Now, once you've invested enough in your employer plan to receive the match, then you work towards maximizing your contributions to other tax-advantaged accounts. I have a quick blog post explaining the right order to use these accounts, and I'll share that in the show notes at thelongterminvestor.com.

6:40But the quick answer here is you'd go to a Roth IRA or deductible traditional IRA, then go back to maxing out your employer retirement plan, then the traditional non-deductible IRA, and then a taxable account. Lastly, although it's not always thought of as a retirement account, and it isn't right for everyone, utilizing a health savings account can also provide a unique way to boost your retirement savings. And if it's a good fit for you, then it's probably at the top of that list I just rattled off. You can also go check out episode 11 for more on this particular aspect of retirement savings.

7:18And of course, I have a blog post on something is important this, so I will also include a link to that in the show notes as well. Number three, build up a cash reserve. Having money available for unexpected expenses, regardless of your financial position, is extremely important. In fact, allocating some portion of your excess savings to what most people will refer to as an emergency fund takes priority over extra debt repayments or additional investing. In general, an emergency fund should contain somewhere between 3 to 12 months of expenses. If your emergency fund is starting from zero, then allocate at least 10 % of your excess savings each month to this account.

8:02If you have a high degree of job security and income predictability, then you can probably build this account up more slowly. You should also consider keeping your emergency fund in an online bank account to earn a higher rate of interest than you would earn in a primary checking account. And as an added bonus, keeping your emergency savings separate from your primary checking reduces the temptation to access those funds for non-emergency purposes. Now, even if you don't have an emergency or a cash shortfall at some point in your 20s, this emergency fund might transform into more of a cash reserve that you can use opportunistically as you get older.

8:41Number four, automate your finances. Finances, they just have a way of getting increasingly complicated as you age. So putting your savings, bills, and investments on autopilot can really simplify things. For your investments, automating a dollar cost averaging plan also removes the need for determining when is the best time to invest because you're regularly contributing a set amount to your portfolio. For example, you could contribute$1 ,000 to an investment account on the 15th of the month for a very long period of time. And what this does is not just allow you to diversify across asset classes, but to also diversify across time.

9:23Plus, making equal dollar purchases over time can potentially lower your average purchase prices because you buy fewer shares when prices are high and more shares when prices are low. While a lower average purchase price isn't always guaranteed, dollar cost averaging is still behaviorally advantageous because investing at regular intervals reduces the risk of buying at the worst times and experiencing an immediate loss in value. It's also the simplest way to invest paycheck to paycheck. You don't have to do anything beyond setting up the automated monthly contributions to your accounts. Now, everything thus far that I've been sharing are things that you should do, but this last item is something that you should not do.

10:06Number five, don't try to beat the market. Look, investing is a complex activity, but successful investing is surprisingly simple. The problem for most investors, though, particularly those in their 20s, is that they get in their own way by unnecessarily meddling in their portfolios. Sometimes people wouldn't characterize what they're doing as, quote, trying to beat the market. So let me give you a few examples of things you shouldn't do. Things that come to mind are trading individual stocks or options, buying sector or thematic ETFs, investing in actively managed funds. this type of behavior is a recipe for poor long-term performance.

10:51If you're doing some of these things and feel like you're experiencing some success, don't be fooled. Most people, for starters, aren't benchmarking their returns appropriately, which basically means that they aren't doing any better or perhaps even worse than a simple index portfolio. But even for people who are actually doing well, a handful of good years of return does not mean you should expect to do well over the course of a lifetime. There's an overwhelming amount of empirical evidence that professional investors can't consistently beat the market for an extended period of time. And if professionals can't earn returns above the market, why would you expect to do so?

11:31While it's natural to want investments that beat the market, most investors taking this route underestimate the competition they face and the opportunity for success. Even though there's an overwhelming amount of research showing that both individuals and professional investors routinely underperform the market, that doesn't mean you shouldn't invest. Instead, it simply suggests a low-cost strategy that doesn't rely on predicting market movements will improve your chances for success. To recap the most important elements of investing in your 20s, the single most important thing you can do right now is to start.

12:08But once you get started, you should one, set goals, two, max out retirement accounts, three, build up a cash reserve, four, automate your finances, and five, avoid trying to beat the market. Start making these changes now because the good decisions you make early in life will have more time to compound in your favor and set you on a path for financial success. In our next episode, we'll look at investing in your 30s, but until then, to long-term investing.

12:45Thanks for listening to the Long-Term Investor Podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com. Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.