Investing can get a bad rap thanks to the two market downturns most Millennials have lived through. Combine that with the crash of the housing market, which caused many of us to watch our families lose their homes or file for bankruptcy. It’s no wonder that Generation Y isn’t crazy about investing.
In reality, investing should be boring. You sign up for your 401(k) and choose an asset allocation. Or you open and fund a brokerage account, indicate what you’d like to buy, and set up an automatic contribution each month.
Plus, it’s not necessarily safer to stuff your cash savings under your mattress. While it’s important to keep some of your assets in an easy-to-access savings account, the interest you’ll earn on that is small compared to your potential earnings over time if you invest some of your money instead. You want the value of your assets to exceed inflation and continue increasing in value. Your mattress money, on the other hand, will be worth less when you fish it out 30 years from now than it was when you put it there.
Investing wisely can grow your potential nest egg beyond the rate it will grow if you rely on savings accounts only. But you need to be in the right place, financially speaking, before you’re ready to start.
Beginning Before You’re Ready
Before you open a brokerage account, there are other financial things to get in order first. Your high-interest credit card debt needs to be paid off, and you should be able to cover your monthly bills without accumulating debt again. If you have student loans, make on-time payments. Pay more than the monthly minimum if you can.
Next, work toward building up savings. Set aside a few months’ worth of your income in an emergency fund.
Finally, save for retirement. Contribute enough to your employer-sponsored 401(k) to get a company match. On top of that, fully fund a Roth IRA each year if your income falls within Roth limits.
After you pay off debt, save for retirement, save for emergencies, and pay your typical monthly expenses, look at the money that you have left. Is there anything you’re saving up for that you’d like to buy in the next five years, like a house? That cash should stay cash, ideally stashed in the highest-interest savings account you can find. (This is another reason why I hate most of the studies that say Millennials are “risk adverse” because of how much cash they have. Often there are very good reasons to have a lot of cash on hand, like emergency savings or saving for a down payment or travel.)
Once you’ve taken care of all those other things, you can start creating a plan for investments.
When you start investing, think about how much money you are comfortable not touching for at least five years. It’s important to invest for the long term because your investment dollars need time to grow. Some people treat the stock market as a get rich quick scheme, but you’re more likely to be successful if you hold onto your shares for years. Your portfolio will experience years with positive returns and years with negative ones, so stretching out your investing time horizon will allow the good years to outweigh the bad. (And bear in mind that your retirement accounts are investment accounts, too. See? You’re already an investor!)
Waiting Too Long to Start
Since we reached adulthood, Millennials have been bombarded by dire news reports about the economy. Here’s why this shouldn’t scare you: if you’re in your 20s or 30s, you have time on your side.
And thanks to the beauty of compound interest, time is exactly what you need for your investments to grow. The longer you wait, the more money you need to invest each month to make up for lost time. If you start earlier, you can set aside less money and still come out on top in 25 years.
Putting All Your Eggs in One Basket
You’ve heard the advice to “diversify.” This means spreading your investments across a range of assets and securities.
Here’s an example of what that would look like: if you buy stock in only one company and the share price drops, you’re out a lot of cash. But if you own shares in a variety of companies, one stock performing poorly will affect a small percentage of your overall portfolio. This is why I’m a fan of index mutual funds and ETFs: You own a basket of stocks in a “sector” as opposed to one individual stock.
Whenever you buy shares of a stock or index fund, you pay fees on the trade. It’s unavoidable. But what you can do is minimize how much you pay in fees.
For mutual funds, the adjective you want is “no-load.” This means you buy shares directly from the investing company, not through a third-party advisor who gets paid a commission on your purchase. For index funds and ETFs, look at the expense ratio, which is the percentage of a fund’s assets that go toward the cost of managing a fund. The lower the better.
Another thing you want to check are the trade fees, which is how much is costs to buy or sell a fund. It’s usually more expensive to buy a mutual fund and less expensive to buy an ETF. There are even a few ETFs with no trade fees. While fees shouldn’t be the only factor you consider when picking funds, there are a variety of low-fee options available.
Whenever you sell shares of stocks or funds, you pay taxes on your earnings if the money is held in a taxable account. These are called capital gains taxes. How much you pay depends on a few factors.
If you sell shares you’ve held for less than a year, that’s known as short-term capital gain, and they are taxed at your ordinary income tax rate. If you hold shares for a year or longer, those are long-term capital gains and they’re taxed at a lower rate. For most people, the rate is 15%.
But remember, any gains in retirement accounts like Roth IRAs or 401(k)s aren’t taxable in the year that you receive it. You invest in your Roth IRA after you’ve paid taxes, so the returns you’ll withdraw later are tax-free. You don’t pay taxes on the 401(k)s until you withdraw the money in retirement.
The most important way to be a successful investor is to stay calm, even when the market is volatile. The more diversified your investment portfolio is and the longer you hold onto your investments before selling shares, the less likely you’ll be affected by downward drops in the market. You can even continue to buy investments systematically throughout the period of market volatility. This is called “dollar cost averaging,” and it can help lessen the risk of buying a single investment at a specific time.
If you prepare yourself financially by paying down debt and building up savings, investing for the first time shouldn’t be scary. Pick your brokerage account with fees in mind, set up an automatic transfer each month from your checking or savings account, and do some research or talk to your financial advisor about what investments you’d like to make. Keep a level head in good times and bad times and let compound interest do the work for you.