Because they're just starting out, early career accumulators--loosely defined as people in their 20s and 30s--don't typically have much in the way of financial capital.
But early career accumulators have other assets that their older counterparts can look upon with envy. With a whole lifetime of earnings stretching before them, early career people are long on what investment researchers call human capital: Their ability to earn a living is their greatest asset by a mile.
Investors in their 20s and 30s have a valuable asset when it comes to investing, too: With a very long time horizon until they'll need to begin withdrawing their money (for retirement, at least), early career investors can better harness the power of compound interest. They can also tolerate higher volatility investments that, over long periods of time, are apt to generate higher returns than safer investments.
If you're just embarking on your investment journey, it's hard to go too far wrong with the mantra of investing as much as you can on a regular basis and sticking with very basic, well-diversified investments. But it also pays to think of your "investments" in a broad sense, steering your hard-earned money to those opportunities that promise the highest return on your investment over your time horizon.
Here are some tips for investing well and yes, multitasking, in your 20s and 30s.
Put debt in its place
One of the earliest forks in the road that many early accumulators face once they begin earning a paycheck is whether to steer a portion of that paycheck to service debt or to invest in the market. If it's high interest-rate credit card or student loan debt, it's worthwhile to earmark the bulk of one's extra cash for those "investments."
The reason is that it's impossible to earn a high guaranteed return from any portfolio investment today, whereas retiring debt delivers a guaranteed payoff that's equal to your interest rate. Focus on paying down your loans before moving full steam into investing in the market.
Make the investment in Human Capital
While we're on the topic of "investments" in the broadest sense, the 20s and 30s are also the ideal life stage to make investments in your own human capital--obtaining additional education or training to improve your earnings power over your lifetime. Of course, not every such investment pays off, and it's ideal if you can get your employer to shoulder at least some of the financing. But if you have considered an advanced degree or extra training of any kind, the earlier you get started, the higher your lifetime return on your outlay is apt to be.
Build a safety net
With limited financial capital, it's essential that young accumulators protect what they have and be able to cover financial emergencies should they arise. A good rule of thumb is to insure against risks that would cause extreme financial hardship and to skip insurance for items that would not. Homeowner's (or renter's), health, disability, and auto insurance are musts, as is life insurance if you have minor children; on the flip side, you can do without the extended warranty for your laptop or washing machine.
An emergency fund is also essential, as having a cash cushion on hand can keep you from having to resort to unattractive forms of financing like credit cards or raiding your investments if you lose your job or encounter a surprise expense. While the rule of thumb of stashing 3 to 6 months’ worth of living expenses in cash might seem daunting, remember it's essential living expenses, not income.
Kick-start your retirement savings
Early accumulators tend to put off saving for retirement. They often have one or more shorter term goals competing for their hard-earned money alongside retirement savings: down payments for first homes, cars, weddings, and children, for example.
Psychology is also in the mix: With retirement three or four decades into the future, people who are just embarking on their working careers in their 20s and 30s may be hard-pressed to feel a sense of urgency in saving for it.
Yet the youngest investors have the longest time to benefit from compounding, and that benefit accrues even if they're only able to save fairly small sums and the market gods serve up "meh" returns over their time horizons.
The 22-year-old who starts saving $200 a month and earns a 5% return per year will have more than $362,000 at age 65. Meanwhile, an investor who waits until 35 to start investing yet socks away $300 a month and earns a 6% return will have a little more than $300,000 at age 65. Those first 10 years of missed compounding swamp both higher returns and higher contributions later on, underscoring the virtue of getting started on retirement saving as soon as you can, even if it means starting small.
Invest in line with your risk capacity
Investors are often advised to consider their risk tolerance: How they'd feel if their portfolios lost 5% or 10% in a given week or month. That's not unimportant, especially if a nervous investor is inclined to upend her well-laid plan at an inopportune time. But the really important concept is risk capacity--how much you could lose without having to change your lifestyle or your plan for the money.
When it comes to retirement savings, early career accumulators have high risk capacities because they won't likely need their money for many years to come. That's why retirement portfolios usually feature ample weightings in stock investments: Even though they feature sharper ups and downs than safer securities like bonds and cash, stocks have historically rewarded their long-term investors with better returns than other asset classes.
On the other hand, if you're investing for shorter-term goals--such as a home down payment, you probably don't want to have much, if anything, in stocks. Yes, the returns from bonds and cash are lower, but they're also much less likely to encounter big swings to the downside.
A more detailed version initially appeared on Morningstar.com
