Young investors today who wish to begin a savings plan face a bewildering array of investment options. There are not only thousands of products and services to choose from, there are almost as many different firms and vendors that market them in various capacities. Fortunately, deciding which types of investments are best is not as hard as it may seem. Finding the right answer begins by examining what you want to get out of your money both now and in the future.
Saving for Retirement
If you are young, your greatest financial asset is time. At this point in your life, your primary investment objective for your long-term savings should be growth. Investors in their 20s will have at least 40 years over which to accumulate retirement savings. Historical data clearly shows that common stock and real estate are the only two asset classes that have grown faster than the rate of inflation over time. This means that most or all of your long-term savings should probably be placed in some form of equities, such as individual common stocks and stock mutual funds – and perhaps real estate, either in the form of a personal residence or a mutual fund that invests in real estate holdings. It is imperative to be able to increase your purchasing power in your retirement savings over the course of your life because you will need every penny you can muster after you stop working.
Of course, IRAs and employer-sponsored retirement plans are the best places to start when saving for retirement. Employer-sponsored plans often provide matching contributions, and this can give your retirement savings a tremendous boost; a 50% match on the first 5% of your contributions can result in tens of thousands of extra dollars in your pocket at retirement.
Most financial experts tell young people to use a Roth IRA instead of a traditional IRA because– although you don’t get a tax benefit from your contributions – both your contributions and everything they earn will grow tax-free until retirement and you won’t pay any tax on withdrawals. Roth features are also available in many qualified plans such as 401(k) plans. Money in traditional IRAs and 401(k)s is taxed at your personal income tax rate when you withdraw it at retirement – and you are required to withdraw a certain amount, starting after age 70½, whether you need it or not. Ultimately, the Roth combination of tax-free growth (and no required withdrawals) coupled with the superior returns posted by equities is virtually impossible to beat over time.
Buying a Home
Traditional financial wisdom has usually dictated that a house is one of the best investments you can buy, but whether or not this is true depends upon several variables. The duration of your residence and the current housing market will factor heavily into this issue, as will the current interest rate environment, rental prices and your personal financial situation. If you plan on living in one place for less than five years, it is probably cheaper to rent in most cases because, mathematically speaking, it usually takes at least five to seven years to accumulate enough equity in a home to justify buying one rather than renting.
The alternatives for your short-term cash, such as an emergency fund, are pretty much the same regardless of your age. Money market funds, savings accounts and short-term CDs can all provide safety and liquidity for your idle cash. The amount that you keep in these investments will depend on your personal financial situation, but most experts recommend keeping enough to cover at least three to six months of living expenses.
The Bottom Line
The most important decision that you can make as a young person is to get into the habit of saving regularly. What you invest in matters less than the fact that you have decided to invest. The right investments for you are going to depend largely upon your personal investment objectives, risk tolerance and time horizon.