The years following college graduation aren’t always known for savvy financial moves. Living with parents, maybe. Student loan debt, yes.
Call it a pipe dream, but what those years should be known for is investing. It’s hard to overstate how valuable your 20s are, but on the long, long road to retirement, saving throughout that decade is kind of like putting an extra engine in your car.
Say you wait until age 30 and invest $100 a month for 35 years; you’d put away over $42,000, but end up with $181,000. Invest $100 a month during your 20s, and you’d save only $12,000, but wind up with over $200,000 at age 65. (Note: This assumes you earn a 7% average annual return.) For that growth, you can thank the magic of compound interest.
The problem is coming up with the money and figuring out how to invest it. On a starting salary, even $100 a month can feel like a tight squeeze, and a college education often doesn’t cover investing 101.
Here are five tips to help you invest in your 20s.
A 401(k) is a tax-advantaged retirement account, which means you can contribute directly from your paycheck pretax. Employers that offer this benefit often also match contributions up to a certain percentage of your salary. To be clear: Some employers give you money just for saving for retirement.
If your company offers a match, you should contribute enough to get the maximum, or work your way up to that.
If a 401(k) isn’t an option, or you’re already earning a match, see if you meet the income requirements for a Roth IRA. Unlike a traditional IRA or a 401(k), it won’t give you a tax break on contributions, but it offers something potentially better: You won’t pay federal taxes when you pull money out in retirement. That’s right, your contributions and investment earnings grow tax free.
One other note here: Some companies offer a Roth version of the 401(k). If yours is one of them, you should probably take advantage.
Want a million dollars? Let’s say you earn $35,000 a year and your employer matches half of your 401(k) contributions, up to 6% of your total salary.
If you contribute 6% beginning at age 22, you’ll have over $1.2 million by 65, assuming a 7% return and annual salary increases of 3%. Without that employer match, you’d have just $800,000. And without contributions to a 401(k), you’d have — $0, of course.
Many millennial investors make the mistake of avoiding risk. That investment example above, where $12,000 grows into $200,000? It would require a reasonable allocation toward stocks; while investing in stocks can be riskier than say, putting your money in a savings account, over the long run stocks have shown to be a much more rewarding investment.
Of course, when you invest in stock, you’ll probably see drops in the short term. That’s why the market is generally a no-go if you need the money within five to 10 years. But history shows us that, in the end, you’ll come out ahead for long-term investments like retirement. One reason why investing in your 20s is so important is that you’re looking at a very long term, which allows you to capitalize on all that growth.
According to a Vanguard analysis, a portfolio of 70% stocks and 30% bonds — a reasonable stock-to-bond allocation for growth — had an average annual return of 9.1% between 1926 and 2015 (even with some rocky years, including 1931 and 2008). Bonds are a safer, lower-return investment that can counter the risk of stocks. But those who played it safe and stuck strictly to bonds saw a return of only 5.4% on average within that same period.
Let’s use the same 401(k) scenario in the last example. The difference between a 9.1% return and a 5.4% return is close to $1.3 million. It’s not reasonable to count on a 9% return, but you can take appropriate risk and hope for the best.
» MORE: How to invest your 401(k)
The best way to invest in stocks or bonds is through index funds or exchange-traded funds. These funds hold pieces of many investments, and they’re designed to mimic the performance of an index. An index tracks the performance of a portion of the stock market; for example, the S&P 500 tracks 500 of the largest companies in the U.S.
Instead of buying the stocks of all of those companies — or even buying individual stocks, period, which takes more time and research than most of us want to commit — you can buy into an S&P 500 index fund that holds shares of those stocks.
The idea is to invest in several of these funds within your 401(k) or IRA to build a diversified portfolio that includes U.S. stocks, international stocks and a small allocation of bonds. For each fund, you’ll pay an expense ratio, which covers the cost of running the fund.
A 401(k) will have a small, curated list of fund choices. In general, you can decide between two funds in a category — an example of a category would be U.S. large-cap, or large company, stocks — by going with the one with the lowest expenses.
A tough roadblock for new IRA investors are fund minimums, where funds require minimum investments of $1,000 or more. A 401(k) allows you to avoid that. An IRA workaround: ETFs don’t have minimum investment requirements. These funds trade like a stock throughout the day and are purchased for a share price, which for some funds can be as low as $50. That can get you in the door of several ETFs for very little money.
Not to question your stock-picking skills, but researching, selecting and managing individual stocks is challenging — even the pros can screw this up. Going with index funds could easily save you a few hours, or roughly six Pokemon Go sessions, a week.
» MORE: How to invest $500
An index fund makes investing easier, but if you still need help, you’re lucky to be living in an age when you can get it for cheap.
With a 401(k), that help is typically available through a target-date fund. This type of fund adjusts to take less risk as you age. You can pick one by using the date in its name, which is supposed to line up as closely as possible to when you plan to retire. So if you’re 25 now, for example, you’d add around 40 years and pick a fund tagged 2055 or 2060.
You’ll generally pay higher expenses in a target-date fund, but some investors find the simplicity is worth it. Keep in mind that you can always swap to a different fund later.
If you’re investing in an IRA, you could open that account with a robo-advisor, which is a computer-based investment management company. These companies charge a percentage of your account balance for their services. Many big players such as Wealthfront and Betterment cost less than 0.50%, and that includes investment expenses and management fees.
Target-date funds have an average expense ratio of 0.57%; stock index funds average just 0.11%. Robo-advisors, as noted, might cost a total of 0.50% of your investments. But a little oversight and a buffer against your own mistakes earns you peace of mind, which could be well worth it.
Starting where you are is just fine, and if that means contributing $100 or less, at least you’re putting away something. But over time, you need to save more, as $200,000 does not a retirement make.
To figure out how much you should shoot for, use a retirement calculator, preferably one that gives you a monthly savings goal. Then work your way there in little jumps. One of the easiest ways to do that: Up your savings rate every time you get a raise.
Carrying through that 401(k) example, if you also increase your savings rate by half of every 3% annual raise, your balance at age 65 would be closer to $3 million.