Millennials have faced many challenges. Growing up, those born between 1981 and 1996 experienced the September 11 attacks, subsequent wars, a severe recession, a student loan crisis, and a pandemic. It’s understandable why saving and investing for retirement may not have been a priority.
Now, with most millennials having completed their education and worked for a few years, many are at an age where they can and should start thinking about investing to achieve long-term financial goals.
Let’s explore some investing basics and why it’s important to get started.
Why Millennials Should Invest
If you witnessed the 2008 financial crisis or were affected by the market downturn in 2022, you might view investing as risky. However, not investing carries risks too.
“The worst thing you can do in your mid-20s to mid-30s is not save money and invest. If you invest early, it gives your money a long time to grow,” says Mike Kerins, head of advisor products at Apex Fintech Solutions. Despite market fluctuations, it’s rare for the stock market to stay down for a long period.
Stock investments offer higher returns over cash and bonds in the long run. Money in savings accounts stagnates and loses value to inflation, while stock market investments can grow over the years. For instance, large-cap stocks returned roughly 10 percent annually from 1926-2020, whereas long-term government bonds returned about 5.5 percent, and T-bills returned around 3.3 percent annually.
“The surest way to build wealth over long periods is to invest in a diversified portfolio of common stocks,” says Robert Johnson, professor of finance at Creighton University and chairman and CEO of Economic Index Associates.
Another benefit of investing over time is the snowball effect. “Millennials need to begin compounding early and let that compounding work its patient magic over decades,” Johnson says. Compounding means earning interest on your investments and then earning interest on that interest, which helps your balance grow significantly over time.
For example, if you invested $6,000 per year starting at age 25 and earned $100 in interest that year, at age 26, you’d earn interest on $6,100, then on $6,300, and so on. Over the years, your returns would be much larger than if you just saved the money in a bank account.
Learn the Basics of Managing Your Investments
Risk Tolerance: Before making your first investments, understand your risk tolerance—your ability and willingness to handle investment losses, which could be temporary or permanent. While the stock market generally rises over the long term, it can experience severe declines in shorter periods. Decide if you can endure these declines or if you prefer safer investments.
Asset Allocation: As you build your investment portfolio, determine how much to allocate to stocks versus other assets like bonds or real estate. Assets can be further divided by geography, investment style, or company type. Your asset allocation will likely shift from riskier assets early in your investing life to safer ones as you near retirement.
Active vs. Passive Investing: Decide whether to be an active or passive investor. Active investors try to outperform market indexes like the S&P 500 by choosing specific companies. Passive investing, or index investing, aims to match the performance of broad indexes and typically costs less, often leading to better long-term results.
Diversification: Diversification means spreading your investments across various assets, recognizing that some will perform well while others may not. Broad diversified portfolios tend to perform well over time.
Time Horizon: Knowing your time horizon is crucial for any financial plan. Identifying key goals, like saving for retirement or a child’s education, will influence your investment choices. Long-term goals (at least five years away) often involve owning stocks, while short-term goals (like saving for a house down payment) are better served by safer assets like high-yield savings accounts.
Common Types of Investment Accounts
IRA: An Individual Retirement Account (IRA) lets you save for retirement with tax benefits. Contributions grow tax-free, allowing higher returns than taxable accounts. You contribute pre-tax funds, possibly lowering your current tax bill. Withdrawals start at age 59½, with taxes due on the withdrawn amount.
Roth IRA: Similar to a traditional IRA, but contributions are made after taxes. There’s no immediate tax benefit, but withdrawals at age 59½ are tax-free. Roth IRAs are excellent for retirement savings due to this tax advantage. Early withdrawals from both Roth and traditional IRAs usually incur a 10 percent penalty.
401(k): A popular workplace retirement plan, the 401(k) allows employees and employers to set aside earnings for retirement. Many employers match employee contributions up to a certain amount, which is essentially free money. Contributions grow tax-free, but withdrawals (typically starting at age 62 or 63) are taxed.
Brokerage Account: Allows investment in stocks, bonds, and ETFs. Brokerage accounts are taxable, meaning you pay capital gains tax on any realized gains. If you’re maximizing retirement savings through 401(k)s and IRAs, a brokerage account can help build additional wealth. Many online brokers offer free trading commissions and easy access to your money without penalties.
These are a few popular account types, but there are others to consider.
Best Investments for Millennials
Stocks: For long-term goals like retirement, stocks are ideal. Owning stocks means holding partial ownership in a business, and over time, stock performance reflects business performance. You can invest in stocks individually or through ETFs and mutual funds.
Index Funds: These mutual funds or ETFs aim to match the performance of an index like the S&P 500. Index funds can invest in stocks, bonds, or real estate. They’re passively managed and have low costs, making them a great way to build a diversified portfolio with minimal fees.
ETFs: Exchange-traded funds (ETFs) hold a basket of securities and trade like stocks. You can invest in stock ETFs, bond ETFs, commodity ETFs, and more. Many ETFs track indexes like the S&P 500 and offer a diversified portfolio even with a small investment. Unlike mutual funds, ETFs typically have no minimum investment.
Mutual Funds: A mutual fund pools money from investors to invest in a group of securities like stocks or bonds. Your investment mirrors the fund’s overall investment. Mutual funds trade once a day at the closing net asset value (NAV) price. They can be purchased through a broker or the fund company and usually have a minimum investment of a few thousand dollars. Mutual fund returns depend on the underlying assets they hold.
Bottom Line
It’s understandable why investing for retirement may not have been a top priority for millennials. But now is the time to start thinking about investing and taking advantage of the power of compounding. Despite market fluctuations, investing in a diversified portfolio of stocks has proven to be one of the best ways to build long-term wealth. Don’t miss out on the potential for a snowball effect over the years that could greatly benefit you financially in the long term.
