As a millennial, your priority list might seem like it’s constantly growing. On top of that, you might hear people talk about saving and investing for the future. But with all your financial responsibilities, investing might seem daunting, or even an impossible task. Although it might not seem urgent now, investing now means you might see more money down the road. And it doesn’t have to be time-consuming or complicated. Below is a simple guide to the best investments for millennials.
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Why It’s Important for Millennials to Invest
Investing opens your finances to compound interest. Unlike a student loan or a mortgage, the compound interest that comes with investing is the good type of interest. Over time, the money you invest collects interest, and that interest compounds to earn you even more interest. That’s why it’s best to start investing early. While growth isn’t always guaranteed, being intentional and considering interest rates can help you build wealth.
Currently, the national average savings account interest rate is 0.06 percent. If, for example, you hold $5,000 in your savings account, by the end of the year you’ll have earned about $3. Then there’s the stock market, which has produced a return rate of about 10 percent each year for the past 100 years. If you decided to put that $5,000 into an investment account, you could earn about $500 by the year’s end.
The Basics of Investing
If getting started with investing seems like an overwhelming task, well, it doesn’t have to be. Below are some basics that can help you understand what to consider before making your first investments.
No one can predict the future, and each time you invest, you put money into markets that can fluctuate. For this reason, you should determine how much risk you’re willing to take so you can determine how much money you want to invest. This assessment is your risk tolerance.
Are you comfortable investing a large amount of money with the potential of maximizing your gains? Or do you feel better sticking to smaller increments that wouldn’t hurt you too badly amid an economic downturn? Your risk tolerance – the amount of risk you’re willing to take to invest – will inform your answer.
There are several types of assets, ranging from real estate to stocks and bonds. Each asset has its own levels of risk and returns potential. For this reason, you should try to balance your portfolio among different types of assets. You can do so through asset allocation.
When you allocate assets, you determine how to divide your investment portfolio among the many available types of investments. For example, let’s say the stock market has been down recently. In that case, your portfolio still might be in a good position if you’ve also invested in real estate during a boom in that sector. But if you’d invested solely in stocks, your investments might be looking pretty sparse.
Active vs. Passive
Another important part of determining your investment strategy is deciding how often you want to invest and how closely you’ll watch your investments. There are generally two types of approaches to investing: active and passive.
The goal of active investing is to make a number of smaller decisions to outperform larger markets. Active investing involves studying market trends, making short-term trades, and staying informed on current events that could sway market values. Passive investments, on the other hand, don’t rely on constant market analysis, nor does it involve hopping in and out of stocks. Instead, they make investments that reflect a market’s overall growth and just watch them grow over time.
Like asset allocation, portfolio diversification helps you vary the types of assets in which you’re investing. For example, you might hold a combination of real estate investments and stocks. But portfolio diversification means getting more granular and splitting your stocks among sectors – technology, energy, healthcare, you name it. The more you diversify your portfolio, the less volatility or risk you might face amid market changes.
Your time horizon is the length of time for which you plan to hold your investments and allow them to collect interest. A short-term horizon is typically less than five years, while a long-term horizon can span 10 years or more.
Investors on long-term horizons tend to be more aggressive and risky in determining their investments, since there’s more time involved. Determining your horizon can help you decide how aggressively you should invest and whether you should take a more active or passive approach.
Account Types for Millennials
Now that you understand some of the different approaches to investing, you can determine which account types you’ll use to make your investments. Each of these accounts can help you achieve your investment goals in different ways. Below are some options to consider.
An individual retirement account (IRA) gives you tax advantages as you contribute funds to the account from your income. You can invest pre-tax income into the account. In many cases, the money you contribute to your IRA account is also tax-deductible. However, this type of account does have some restrictions.
For 2021 and 2022, you can’t contribute more than $6,000 to your IRA per year. You can’t withdraw funds until you’re 59½ years old, which is when you’ll pay taxes on your withdrawals. You’re also required to start making withdrawals from your account once you turn 72.
A Roth IRA is basically the inverse of a traditional IRA. Your contributions and earnings will still become available when you’re 59½ and you’ve had your account for at least five years. However, the contributions you make to a Roth IRA come from post-tax income and aren’t tax-deductible. Down the line, though, this tax structure may be advantageous. Namely, you won’t have to pay taxes on your withdrawals once you reach retirement age.
A 401(k) is an investment plan many employers offer. This plan gives employees a tax break on their contributions. By signing up for this plan, an employee agrees to have a designated amount of money withdrawn from each of their paychecks. For 2021 and 2022, there is a maximum annual contribution limit of $19,500 and $20,500, respectively. As a bonus, some employers may match your contributions fully or up to a certain percentage of your income.
A brokerage account allows you to buy and sell securities such as stocks and mutual funds. You can use this account, in addition to your IRA or 401(k) plan, to make short-term or long-term investments. However, any profits you withdraw from a brokerage account are subject to capital gains taxes. This tax’s rate varies substantially based on a few factors. These factors include the length of time you’ve held the asset, your income tax bracket, and your marital status.
Best Investments for Millennials
Once you’ve determined which investment account or combination of accounts you want to use, you’re almost ready to start investing. You should also determine the types of assets in which you’d like to invest. Below are some of the most common investment types.
A stock represents ownership within a company. By buying individual stocks, you obtain fractions of a company’s value. Many investors buy stocks from companies whose products they use everyday. Typically, the value of a stock moves with the company’s performance.
Before you buy a stock, you should look at the company’s history of success and its potential for growth. Purchasing and holding stocks for a long period can help you take advantage of the long-term growth many companies see over years or decades.
Index funds are stock collections that follow a market index such as the S&P 500 or the Dow Jones Industrial Average. Some index funds comprise all the stocks included in an index while others consist of just a handful of stocks. Investing in index funds generally suits a passive approach since you don’t have to buy and sell stocks frequently to maximize your profits.
Index funds are often a less risky investment option than stocks. With index funds, your portfolio’s growth is based on the collective success of several companies. Profits from stocks, on the other hand, come from the success of individual companies.
An exchange-traded fund (ETF) holds several types of securities that typically belong to a certain asset category. For example, there are stock ETFs, bond ETFs, and currency ETFs. These funds can track an index or industry. Whereas index funds are valued at the end of the day, you can buy and sell ETFs throughout the day as their prices fluctuate. Investors using an active approach often trade ETFs during market hours to try to maximize their profits.
With a mutual fund, investors contribute money to a pool of funds shared with other investors. The money from that fund is invested in stocks, bonds, and other securities.
By purchasing shares of a mutual fund, an investor owns part of the fund and the respective amount of profits it generates. The price per share is called the fund’s net asset value, or NAV. The NAV is set at the end of each trading day.
Since they’re set up across entire categories, mutual funds can be safer than investing in individual stocks. Many brokers offer mutual funds but often require you to invest at least a few thousand dollars before you can participate. But you don’t need that much money to start investing in other securities and return to mutual funds later.
Your Financial Future Starts Now
Any investments you make now can significantly impact your financial state once you reach retirement age – and, if you’re lucky, far before then. Your investment account, asset allocation, and portfolio diversification choices today can lead to a better financial future tomorrow. For more information on how you can start investing right this moment, check out MoneyMash’s list of investment apps.