When asked what mankind’s greatest invention was, Albert Einstein answered, “Compound interest.” And he was right.
If you’re investing at only 18 or 19 years old, retirement may feel like a lifetime away. But investing at a young age is the best way to give yourself a head start – and using the power of compounding can make you wealthy.
How Does Investing Young Give You the Advantage?
Mary Millionaire decided to start investing at 19 years old. Every month, she put $300 into an S&P 500 index fund with an average return of 8%. After 40 years, Mary had an investment balance of $1,047,302.
Darren Delay decided to start investing when he was 29 years old. Every month, he deposited $600 into an S&P 500 index fund with an average return of 8%. After 30 years, Darren had an investment balance of $894,215.
Mary’s total investment was only $144,000 over 40 years, while Darren invested $216,000 over 30 years. Even while investing more money, Darren lost out on over $220,000 by waiting to invest!
How to Start Investing Young
If you want to start investing young, you need to make sure you have your finances in order. Follow these steps to help you get started:
1. Determine How Much to Invest Each Month
Before you open an investment account, you need to know how much money you can invest each month. Determine your monthly expenses and put together a basic budget to see how much you have to invest – but don’t rush to open a Roth IRA just yet.
Save an Emergency Fund
If you don’t have an emergency fund in place, set aside at least 3 months’ expenses in a savings account. If you start investing but then lose your job (or another emergency comes up), you don’t want to have to sell off your investments to cover it.
Pay off High-Interest Debts
If you have any high-interest debts (i.e. bad debt), focus on paying those off first. There’s no sense in investing for an 8-10% potential return if you’re paying 15% interest on a credit card. Focus on taking care of high-interest debt before maxing out your investment accounts.
Don’t Miss the Match
The only exception to the rules above are your employer-sponsored retirement accounts. If a company match is available, invest enough to get the match – even while paying off your debt. This is typically a 50-100% immediate return on investment, so don’t miss out on this.
Once you have your finances in order and high-interest debt taken care of, you can take any extra funds you have and start investing.
2. Leave Your Investments Alone
Investing is a long-term process, so if you choose to invest, make sure you’re willing to leave your investments alone for at least 5 years. It’s best to aim for 10 years or more.
As tempting as it might be, “get-rich-quick” schemes (like buying and selling stocks to time the market) rarely ever work. Statistics show that the odds aren’t in your favor, even for professional investors.
Instead, focus on consistently investing every monthly paycheck for the long haul. Compound interest doesn’t really gain steam for at least 10 years, so make sure you’re willing to let the investments grow.
3. Understand Investment Basics
Once you’re ready to start investing, it’s a great idea to go over a few investment basics before buying anything.
When you buy a stock, you own part of the company you invested in. As the company grows, your stock goes up in value. Some stocks will also share profits in the form of dividends. Stocks typically grow more than other assets over the long-term but they also have a higher risk of losing value.
A bond is a loan to a company or government agency. Since the company or agency usually pays a fixed interest rate for the bond, bonds are considered a fixed-income asset. Bonds are considered less risky than stocks (and are seen as a way to reduce your portfolio risk) but they don’t grow in value as much as stocks do.
Investing in real estate means purchasing property to improve upon – or rent out – for income. It can be a high-risk activity but may help you build wealth quickly. If you want to invest in real estate without buying a house, an REIT allows you to put money into an investment company that purchases, improves, and rents real estate for you (and gives you a piece of the profits).
Asset allocation is how you split your investments across asset classes. In the investing world, this is typically measured by how much you have investing in stock, bonds, and other assets. Coming up with a proper asset allocation depends on your age, investing goals, and risk tolerance. Once you have an asset allocation that fits your investing style, you can use it as a compass for your investing strategies.
Where to Start Investing Young
When you're young, you generally want higher returns that stocks, stock-based mutual funds, or ETFs can provide – rather than slower-growing investments like bonds and CDs.
Yes, there is inherently more risk in these types of investments, but remember: You’re investing with a long-term mindset. Over a 10-year period, most stocks and mutual funds are going to beat bonds and CDs by a substantial margin.
So where should you start investing?
Mutual Funds Are Easy First Investments
Mutual funds are a group of securities that you can invest in easily. They’re a great way to dip your toes into investing and get immediate diversification across hundreds of companies.
Say you invest in the S&P 500 Index Fund from Vanguard (VFINX), you’re purchasing a piece of the 500 companies represented on the S&P 500 index. These companies include Microsoft, Amazon, Tesla, Apple and Netflix.
As these companies innovate and grow, you get a piece of the returns. If a few of the companies have a bad year, you’ll be protected because you’ll have hundreds of other companies to lean on for growth.
Mutual funds have annual fees, and actively-managed funds have higher fees than index funds. Before investing, learn how much your mutual funds charge.
Don’t Forget About ETFs
While mutual funds are a great starting point, many of them have minimum investments to buy them. In fact, VFINX requires a $3,000 minimum just to buy into the fund. ETFs are a great way to get started if you don’t have much available to invest.
Exchange traded funds (ETFs) allow investors to purchase mutual funds at a single share price, which is typically much lower than the fund’s minimum investment.
Example of Buying EFTs
The ETF purchase price of the Vanguard S&P 500 index fund (ticker symbol VOO) was closer to $350 in 2020 – well below the $3,000 minimum for the mutual fund.
Investors can also purchase ETF shares while the market is open, giving them a strike price that is real-time. A mutual fund purchase price, however, is locked at the end of the trading day.
Open Your Investing Account
Now that you know how ETFs and mutual funds work, you can open an account to house these investments. There are several types of investing accounts to choose from.
401(k) Account Retirement Account
One of the most popular investment accounts is a 401(k) or 403(b) retirement account through your job, allowing you to invest directly from your paycheck. Some even come with company matching funds. If you are a contractor or self-employed, you can have your own solo 401(k). These retirement accounts typically have access to a limited selection of investments but usually include mutual funds and bonds.
To open a retirement account at your job, simply contact your human resources department and ask them for assistance with opening it. For new hires, there may be a waiting period. Once available, however, you can simply open it and start contributing.
Individual Retirement Account (IRA)
Another great account for retirement investment is an IRA. These accounts can be opened through an investment firm or an online brokerage. IRAs are tax-advantaged accounts that allow you to defer taxes when you invest (or in the case of a Roth IRA account, when you withdraw funds from them).
The investments available in your IRA depend on the brokerage used to open your account. Most firms allow you to purchase low-cost mutual funds, no-cost mutual funds, and ETFs from them, as well as stocks, bonds and other investment securities.
Retirement accounts like 401(k)s and IRAs are great ways to save for retirement and provide tax incentives to do so – but there are strings attached: Access to your money is restricted until you reach a minimum age and withdrawals are taxable. But while you’re saving, the tax advantages can’t be beat.
Standard Brokerage Account
If you aren’t investing for retirement – or need access to your funds sooner – consider opening a standard brokerage account. Also known as “taxable” accounts, they don’t have preferential tax treatment like the retirement accounts mentioned above.
Similar to an IRA, you can open a standard brokerage account with an investment firm or online where you’ll have access to multiple investment options.
Avoid Risky Investing at a Young Age
Investing in individual stocks can be exciting, but this can also mean losing a ton of money that could otherwise grow in a mutual fund. In fact, picking the wrong companies could mean losing all the money you’ve invested. You’re better off picking a low-cost index fund and enjoying the growth of a diversified portfolio.
If you do choose to pick stocks yourself, use a small percentage of your available funds (i.e. 10%). Do your homework to understand how a company operates, how they’re doing financially, and how they are going to continue growing.
For further reading, check out our guide on 8 Key Facts to Know About a Company Before You Invest.
It's Never too Early (or Too Late) to Start Investing
Whether you’re 19 years old or nearing 60, it’s never the wrong time to start investing. If you’re still earning money, make it a habit to invest – no matter what the amount.
The true key is to invest regularly, every month, and let the magic of compounding do the work for you. You’ll thank yourself for getting started today!