7 Investment Ideas for Young Adults
You’re always being told to invest your money. But exactly what should you invest it in while you’re young? Below are seven investments you should consider while you’re young. You certainly don’t have to invest in all seven. But by picking just two or three and steadily funding each, your wealth will begin to grow quickly.
1. A Retirement Plan — Any Retirement Plan
There are two primary reasons for doing this: getting an early jump on retirement savings and tax deferral.
Let’s look at the early jump on retirement savings first.
If you begin contributing $10,000 per year to a retirement plan beginning at age 25, with an annual return of 7% (blended between stocks and bonds), you’ll have $2,008,829 in your plan by age 65. Being on that kind of fast track may even enable you to retire a few years early.
But if you delay saving for retirement until age 35, the results are not as encouraging. Let’s say you begin saving $15,000 per year at age 35, also with an average annual rate of return of 7%. By the time you’re 65, your plan will have only $1,426,427.
That’s more than 25% less, even though your annual contributions will be 50% higher. That’s a compelling reason to begin saving for retirement as early as possible. You don’t need to contribute $10,000 either. Contribute as much as you can now and increase the amount as you move forward and your earnings increase.
The tax deferral angle is just as magical. In the above example, we showed how investing $10,000 per year beginning at age 25 will give you a retirement portfolio of over $2 million by age 65. A big part of the reason why that’s possible is because of tax deferral.
But let’s say you choose to make the same investment each year in a taxable investment account. You have a combined federal and state income tax marginal rate of 25%. That will lower the effective return on investment to just 5.25%.
What will the results look like after 40 years at the reduced after-tax investment return?
You’ll have just $1,290,747. That’s more than 35% less, due entirely to taxes.
Retirement Plan Options
If your employer offers a company-sponsored retirement plan, this should be your first choice. They’ll typically offer either a 401(k) or a 403(b) plan that will let you contribute up to $19,000 per year out of your income.
In addition to the tax deferral discussed above, retirement plan contributions are tax deductible from your current income. A contribution of that size would produce a major tax break.
If you don’t have a plan at work, consider either a traditional or a Roth IRA. Either will allow you to contribute up to $6,000 per year and provide tax deferral on your investment earnings.
The major difference between the two IRAs is that while contributions to a traditional IRA are tax deductible, contributions to a Roth IRA are not. However, the Roth IRA more than makes up for that lack of tax deductibility.
With a Roth IRA, withdrawals can be taken completely tax free once you reach age 59½ and have been in the plan for at least five years.
2. S&P 500 Index Funds
When you’re young, your investments should be concentrated in growth-oriented assets. That’s because in the decades ahead of you, you can take advantage of compounding of much higher rates of return on growth investments than you can get on safe, interest-bearing ones.
The S&P 500 index has provided an average annual rate of return of 10% going all the way back to 1926. That’s an incredibly powerful source of compound earnings.
As an example, if you were to invest $10,000 at age 25 in safe certificates of deposit (CDs) paying an average annual rate of return of 2%, you’d have $22,080 by age 65.
But if you invest the same $10,000 at age 25 in S&P 500 index funds producing an average annual rate of return of 10%, you’ll have $452,592 by age 65. That’s more than 20 times as much as you would have if you invest the same amount of money in CDs!
This isn’t an argument against cash. You should have a sufficient amount of cash sitting in an emergency fund to cover at least three months of living expenses. That gives you a cash cushion should you either lose your job or be hit by a bunch of unexpected expenses. The other advantage of an emergency fund is that having one will keep you from needing to liquidate your investment assets.
However, when investing in S&P 500 index funds, be aware that the figure of 10% per year is an average over more than 90 years. It has fluctuated dramatically. For example, you may lose 20% one year and gain 35% the next. But when you’re young, this is a risk you can easily afford to take. You’ll miss out on plenty if you don’t.
3. Real Estate Investment Trusts (REITs)
Real estate is another growth-type investment, and you absolutely can’t get enough of those when you’re young. Investing in a real estate investment trust, or REIT, is an opportunity to hold a portfolio of commercial real estate. This can be more valuable than owning a single investment property, because the portfolio is invested in different types of property in various geographic locations. That gives you greater diversification than you can get with a single property.
Another major advantage is that you can invest in a REIT with just a couple thousand dollars. Buying an investment property outright would require a much larger amount of capital just for the down payment. We can also add that you don’t need to actively manage a REIT the way you would with an investment property. Plus, REITs have the advantage of investing in commercial real estate, which often outperforms residential properties.
There’s even an argument that REITs have outperformed stocks in the past few decades. But even if the returns are no better than equal to those of the S&P 500 index, a REIT is still a valuable hold for a young person.
First, real estate has been a strong performer over at least the past half-century. Second and perhaps more important, real estate — and commercial real estate in particular — often moves independently of the stock market.
For example, it’s entirely possible that a real estate investment trust will continue to provide positive returns even when the stock market is falling. This is not only because REITs pay regular dividends, but also because commercial real estate may continue to rise in value when the stock market is falling.
Perhaps more than anything, REITs are a way of diversifying your growth assets beyond stocks.
4. A Home
This one’s kind of a mixed bag. On the positive side, owning a home lets you build substantial equity over many years. This is done by a combination of gradually paying down your mortgage and the value of the property increasing.
Owning a home also has the advantage of leverage. Since you can buy a home with as little as 3% down (or no down payment at all with a VA loan), you can get the benefit of appreciation on a $300,000 property with an out-of-pocket investment of just $9,000.
Even if you do nothing more than simply pay off the mortgage in 30 years, your $9,000 investment will grow to $300,000. That will increase your initial investment by a factor of 33. But price appreciation of the property can make that number a lot higher.
The downside to buying a home when you’re young is that you may not be at a point in your life when the relative permanence of homeownership will work to your advantage. For example, being early in your career, it’s entirely possible you’ll need to make a geographic move in the near future. If you do, owning your own home could make that move more difficult.
If you’re single, owning a home forces you to pay for more housing than you actually need. And of course, a future marriage could also hold the possibility of making a geographic move or needing to purchase a different home.
Owning your own home is definitely an excellent investment when you’re young. But you’ll have to do some serious analysis to determine if it’s the right choice at this point in your life.
5. Robo Advisors
We’ve already discussed investing in stocks through S&P 500 index funds, or commercial real estate through REITs. But if you’re not familiar or comfortable with investing on your own, you can always do so through a robo advisor.
That’s an online, automated investment platform that does all the investing for you. It includes creating your portfolio, then managing it going forward. They even reinvest dividends, periodically rebalance your portfolio and offer various tax strategies to minimize your taxable investment gains.
What’s more, you can use a robo advisor for either a taxable investment account or a retirement account, particularly IRAs. It’s hands-off investing at its best. All you need to do is fund your account and the robo advisor handles all the details for you. And they typically invest in a mix of stocks and bonds, and many also invest in REITs.
Here at Investor Junkie, we like Wealthfront and Sign Up, which are the two largest independent robo advisors. Both offer an incredible range of investment benefits and are on the cutting edge of the industry. We made a comprehensive comparison between Betterment and Wealthfront here.
But those are two of many robo advisors available, and you owe it to yourself to check out the many robo advisors available.
6. Paying Off Debt
One of the major investment complications for young people is debt. Student loan debt alone is a major issue, with the average loan amount at nearly $33,000 for 2019. But many young people also have car loans and more than a little bit of credit card debt.
The problem with debt is that it reduces your cash flow. If you earn $5,000 per month and $800 is going out for debt payments, you really have only $4,200 per month.
In a perfect world, you would have no debt at all. But this isn’t a perfect world, and you probably do.
If you do have debt and you also want to invest, you’re going to have to find a way to create a workable balance. It would be great to say that you’ll just make your minimum debt payments and throw everything else into investments. That will certainly allow you to take advantage of the compounding of income that investments provide.
But at the same time, there’s an imbalance. Investment returns are not guaranteed, but the interest you pay on loans is fixed. Put another way, even if you lose 10% on your investments, you’ll still be required to pay 4% on your car loan, 6% on your student loan debt and 20% or more on your credit cards.
One of the best investments you can make early in life then is to begin paying down your debts. Credit card debt is a good first target. They’re usually the smallest debts you have but carry the highest interest rates. If you’re paying 20% on a credit card, you won’t be able to get that kind of return consistently with your investments. Paying off those credit cards is the best debt reduction strategy you can make.
7. Improving Your Skills
Most people don’t think of improving their skills as an investment. But when you’re young, that can actually be one of the very best investments you can make. After all, the income you earn over your lifetime will be your single greatest asset. The more you can increase it, the more valuable it will be.
Plan to invest at least a small amount of money and time in acquiring any skills you need in your career. You may also think about skills you want to add to prepare you for either a higher paying job or even for changing careers later on.
You can take additional college courses, order online courses or enroll in various programs that will add to your skill set. Sure, it will cost you money in the short run. But if it will increase your income substantially in the future, it’ll be some of the best money you ever spent. And that’s an investment in the truest sense.
Because of income limits, it’s not likely you’ll be able to spread your money into all seven of these investments. But you should pick at least two or three and charge forward. Investing works best when it’s done early in life. That will let your money to grow, giving you more options in the future.