Putting it bluntly, investing in your 20s is confusing as sh*t.
I know this because at the time of this writing, I’m 23 years old... and I’ve spent the last 3 years trying to figure this mess out.
It’s been a long journey, but I’m proud to say that I’m finally happy with the setup and plan that I’ve determined for myself...
... and I’d like to hand you what I’ve learned after countless hours of research, moving my accounts around, and spending hours on annoying phone calls.
In this article, you will learn...
... and much more.
“Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
- Albert Einstein
At some point in your life, you’ve probably had some old person shake a finger in your face and tell you how important it is to invest early.
While gramps may not know how to use his iPhone, he’s right this time.
The most important thing you need to know is this:
Compound interest is one of the most powerful forces that will help you in your investing journey.
In its simplest form, it means that your money can make money.
Here’s how it works:
Let’s say you invest $1,000 today and earn 10% interest. At the end of a year, that $1,000 will have grown to $1,100.
Then if you re-invest that $1,100 and get 10% interest on that, next year you’ll end up with $1,210... and on and on.
Eventually, investing that $1,000 over 50 years without any additions and compounding annually, you’ll end up with $117,391.
You’ll quickly see that the more you invest now, the more time you’ll allow your money to compound.
There are only 3 factors that impact the amount of money you have:
We’ll address interest rates and taxes in a bit. For now, know that while investing in your 20s, the best thing you can do is start to invest... NOW.
Now, what gramps most likely didn’t tell you when he said to invest early is that there are ways that you can rapidly accelerate your ability to retire.
Now one of my core values is that I only believe in retiring 50%.
To me, “retirement” means being financially stable enough to no longer have to work.
But retirement DOES NOT mean that you get to stop providing value to the world. It does not mean you get to stop growing.
So how can you set yourself up to retire early?
There is an entire movement called “FIRE” which stands for Financial Independence Retire Early that teaches exactly how you can do it.
It works like this:
You already know about the power of compound interest.
FIRE operates off of the idea that there will be a point where you have enough money invested where you can withdraw roughly 3-4% of your investments indefinitely without eroding your retirement fund.
To get to that point, the FIRE community works to invest 50-70% of their entire income by following minimalist principles.
Yes, that’s difficult and requires an insane amount of discipline... but when you invest 50-70% of your entire income, you’ll reach financial independence much quicker.
So how much money do you need to reach that point?
Approximately 25x the amount you want to live off of.
So say for example you want to live off of $50,000 for the rest of your life.
That means that if you have $1,250,000 ($50,000 x 25) invested properly, you can withdraw $50,000 from your investments each year, and still allow your money to compound enough to sustain you.
Now obviously this changes depending on how much you want to live off of.
Maybe you only need $25,000/yr to live off of. Then you’d only need $625,000 to reach financial independence.
Or on the other hand, maybe you want to live off of $200,000/yr. Then you’d need $5,000,000 invested.
No matter how you think about it, it’s important that you start mapping out a plan.
Your action item from this section is to play around with this compound interest calculator. Put in some numbers to see how long it would take you to get to your FIRE number if you kept up with your current career trajectory.
With all of this in mind, here are my exact suggestions for investing in your 20s:
Alright. So as a 23 year-old having done 3+ years of research on my financial strategy, here’s an exact outline of my current plan.
Now please note that I am in no way a financial advisor, and you should talk with a professional before implementing anything that I’m currently doing.
With that in mind, let’s dive in!
I like to think of my finances in 3 buckets:
Within each of those buckets, I have different investment vehicles to help me get to where I want to go.
The further out I’ll need the money, the less accessible it needs to be.
To understand what I mean, let’s break down each of the goals.
Short Term Goals
My short term goals include:
For some people, those goals may be mid term goals. But at the time of this writing, all of these goals are things I’d like to have done within the next year or so.
Because I need this money to be accessible and do not want to risk losing any of it, I do not want to have any of this money invested in the stock market.
So where does the money for each of those accounts go?
Into a high yield savings account.
I currently use multiple accounts at Ally Bank to do this. They offer a 1.6% interest rate on their savings accounts and you can make automatic contributions to each of them.
This means that all you have to do is set it and forget it. Each month, Ally will automatically contribute to the amount I allocated to each of those goals. Simple.
Now, your short term goals might be much different than mine.
Other good short term goals to have could include:
If you’re looking for some short term financial goals and still have a car payment or other debt with high interest rates, make paying off those a priority.
Mid Term Goals
I currently don’t have any “mid term goals”.
When you start investing in your 20s, some common mid term goals could include saving for a wedding, a down payment on a house, paying off your car, etc.
Long Term Goals
One of my long term goals is obviously to retire.
For me, I like to think of that goal as the long term “5+ years out” bucket.
Because I won’t be touching this money for such a long time, that money is invested in vehicles that makes the money harder to access, but has the potential for a much greater return on investment.
Within my long term bucket, I have 4 accounts:
Each of those accounts have different advantages and disadvantages, and I’ll quickly break them down here:
A 401(k) is a type of retirement account often offered by your employer that comes with special tax benefits. Because it’s considered “long term”, you’re penalized if you make withdrawals from the account before age 59 ½.
But here’s the good part:
If you have a job that offers a 401(k) with “matching”, that basically means your company is giving you free money... and you should take it.
An employer match means that the company will match up to a certain percentage of your salary to add into your 401(k). Let me explain what this means:
Let’s say your company offers a one to one match up to 5%. This means that if you make $50,000 a year, you can contribute $2,500 per year to the account... and your employer will match the $2,500 meaning you’ll actually be investing $5,000/yr into this account.
The best part is that the money will come out before you get your paycheck (meaning you don’t ever even see it), and that money will grow tax deferred.
Tax deferred means that you don’t pay taxes when you invest the money, allowing it to compound at an accelerated rate. You’ll pay money when you withdraw it later, but compound interest will have done its work, which makes a huge difference.
*** Something I learned the hard way about 401(k)s ***
Because I’m an independent contractor and entrepreneur, I don’t have a 401(k) offered through an employer. For a few years I thought this meant that I couldn’t have a 401(k) at all....
But that’s not the case!
If you own your own company, you can set up an individual (or “solo”) 401(k) to make contributions for yourself.
To find out why you might want to do this, check out the section on solo 401(k)s.
The Roth IRA is also a retirement account with special tax benefits. Just like a 401(k), you are penalized if you withdraw your money before you’re 59 ½ years old.
But here, the tax benefits are even greater because you put in after tax dollars to invest.... And then when you withdraw, you don’t have to pay any taxes.
For an extreme example, let’s say you invest your Roth IRA money into some hotshot stock (not recommended) that ends up skyrocketing to a $10,000,000 value.
When you withdraw it, you won’t have to pay taxes on any of that money.
Now obviously that’s kind of ridiculous, but you get my point — your money gets to grow and compound for YEARS and you aren’t taxed when you withdraw the money.
For 2020, you can contribute up to $5,000 to your Roth IRA without penalty.
Solo 401(k) and Solo Roth 401(k)
You can skip this section if you aren’t self-employed.
For the self-employed people out there reading this, you’re going to want to pay attention!
First, it’s important to note that you must meet certain eligibility requirements to have this plan, which you can read about on the IRS website.
The bare bones basics of the solo 401(k) are as follows:
Again, you should check with your financial professional about solo 401(k)s, but it’s another tax advantaged account you can use to put away a LOT of money into!
Now, with all of the boring account talk out of the way, it’s time to answer the question you’ve probably been asking:
Where should I be investing my money?
After reading up on the subject for a few months, ALL of the resources I read agreed on several things:
Heck, even Warren Buffet is a huge advocate for buying Vanguard low cost index funds!
Once I came to this conclusion, it was just a matter of which index funds I should buy.
I’m kind of a control freak when it comes to my investments, so I chose to do the slightly more complicated thing and choose my asset allocation (aka how you’re dividing your investment portfolio between stocks, bonds, and cash) myself.
Choosing your asset allocation is probably one of the most important financial decisions you’ll make. If this sounds scary to you as you just start investing in your 20s, don’t worry.
There are things called target date funds that can do this for you automatically that will get you 85% of the way there. All you have to do is choose the year you are going to retire, and invest in a single fund. Then Vanguard will adjust the allocation as you get older.
For more information on Vanguard’s target date funds, just click here.
The reason I didn’t choose a target date fund is that since I was born in 1996, the target date fund I’d most likely choose would be the 2065 fund... which is still 10% bonds right now.
Bonds tend to behave opposite of stocks — going down when stocks are up, and going up when stocks are down. So when you have bonds, you’re reducing some of your risk.
Being 23 with a lot of time on my side, I wanted to allocate my own funds to be 100% stocks for the time being. I'll most likely adjust in my 30s to buying a few more bonds.
When I was researching my allocation, I considered a few different strategies including:
At the end of the day, I ended up talking to two separate financial professionals that I trust about my situation, and ended up taking a different approach altogether:
Again, I am not an investment advisor and you need to do your own research, but I wanted to be completely transparent and show my current allocation!
Too many people just ignore their finances thinking they’ll “deal with it later”.
But “dealing with it later” can literally cost you tens of thousands, if not millions, of dollars over your lifetime.
Don’t you think that’s somewhat important?
While it may sound intimidating, my mentor Jonathan Levi has a great quote that may help your thinking on this:
“The difference between anxiety and excitement is knowledge.”
If you are feeling scared about all of this stuff (as I was just a few months ago), chances are you probably just haven’t studied it enough.
You’re well on your way just by having invested time reading this post — if you want to further your research, check out some of the resources I listed below to get started!
Go kick ass!
I highly recommend checking out the resources I have listed below for you to get started.