What is the best investment vehicle for a 20 year old?
I'm 20 years old and wondering what the best possible investment would be for me: a 401(k), mutual fund, or a Roth IRA?
Great that you are thinking about this at your age! With some discipline and good habits, you will be light years ahead of most of your peers.
First, I'll assume you have some savings or an emergency fund. This wouldn't be money that is invested but rather just parked in a bank account for example to handle an unexpected expense. Most agree that 3 to 6 months of expenses is a good amount and I agree with that.
If you have a 401(k) at work and the company offers a matching contribution, I suggest starting there. If they don't offer a match and your income doesn't put you in a high tax bracket, then a Roth IRA can make sense as your money grows tax free. In the 401(k), your money grows tax deferred and contributions that you make will lower your taxable income today.
The Roth does not lower your taxable income today but allows for tax free withdrawals at retirement.
It's always inspiring to see a 20-year-old thinking and seeking out information regarding important financial decisions like investing!
At age 20, you've got a lot of options and a lot of time (usually) before you need to retire so you have the luxury of choice between investment options which is always a good thing. One issue that I've seen, though, with younger investors is that they sometimes focus on retirement savings instead of prioritizing financial decisions that need to be made and addressed before making the distant future savings decisions like retirement and investing.
Now, the above statement doesn't apply to everyone. I personally know several 20-something people that definitely are correct to ask the question you're asking above, here's how to tell if it's the right question for you to ask yourself...
1. What does your debt situation look like? Debt can be a killer of future returns and financial plans because it leaches out financial resources today that could compound into a lot of savings later on. I always recommend my clients be debt-free or at least with a plan and on the road to being debt free before they start investing for the long-term.
2. How much money do you have saved for emergencies? I recommend at least 3-6 months (sometimes more for those with unstable incomes) worth of your expenses saved in a LIQUID vehicle like a checking or savings account and I wouldn't even start to save for the future unless you can get a serious handle on saving for the short-term. Otherwise, when an emergency comes up, a lot of people go straight to credit cards to pad those expenses instead of cash that they should have in the bank. This can be a major setback for the long term because it's tough to get traction or make headway when debt comes in and out of your financial picture.
3. What are your options now? If you have a 401(k) at work that comes with a match, this may be the best route to take. I like a 401(k) because it has higher contribution limits than an IRA. If you have no such option as a 401(k), I would look into a Roth IRA. You can stash up to $5500 a year into an IRA, but I like the Roth IRA because once you fund it with after-tax money, the Roth will grow tax-free and distributions can be taken out tax-free as well.
All of these retirement vehicles are long-term savings instruments though and can cost you unexpected taxes and sometimes penalties if you take your money out too soon, which is why I always ask question #2 to people who are thinking about saving for the future in one of them.
Best of Luck!
President of Brein Wealth Management, LLC
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It's great that you're thinking about this at a relatively young age. In an ideal world, the best way for you to begin investing would be in all of the above. If your company offers a match on any contributions to the 40(k), then it's best to try to contribute up to the maximum they'll match. Take advantage of the "free money." However, it's important that you understand that this money should be off limits to you until you pull the trigger on retirement (or at least until after age 59.5), which points to why it's good to have various "buckets" you're saving to.
Roth IRA's are particularly attractive for your age group because we will likely only see tax rates rise during your lifetime. It makes sense for you to pay taxes on your earnings now, at what may potentially be the lowest tax bracket you'll ever see again, and use your Roth IRA dollars tax free in retirement. There is no tax benefit to you, today, for making a contribution to a Roth account, but there will be huge benefits to you down the road. Again, this is money you should expect to not touch until retirement.
I would also encourage you to put some money away outside of qualified retirement accounts so that if/when you decide to make a major purchase like a home, you have some money that you can access without any penalties or excessive taxes. The other savings vehicles mentioned have restrictions on them that sometimes make it prohibitive to take withdrawals from.
As for mutual funds, this may be an investment vehicle you would use inside of a 401(k) or Roth IRA. I would suggest working with a financial advisor to determine what investment vehicles are best to suit your needs. We typically advise our clients that having some combination of Mutual Funds, ETF's and in some case, owning individual stocks, is the best route to go. ETF's offer a less expensive way to get exposure to some of the same investments mutual funds may expose you to. I'm over simplifying, but I emphasize again the importance of working with someone you trust to help you navigate the investment landscape.
Best of luck to you!
First, it is important to clear up the language you are using to help you better understand what you are truly asking. A 401(k) and a Roth IRA are not investments. They are types of accounts that have a preferential tax treatment. A mutual fund is an investment.
Second, whether it makes sense to contribute to a Roth IRA or a 401(k) will depend on a few factors, but of primary importance is your current tax bracket.
That being said, it is important to consider your risk tolerance and if you have an expertise that gives you an advantage over other investors. For example, do you have a background in real estate, software, or consumer goods? You should consider investing in what you know, rather than just putting your money into investments randomly. Investing in what you know can improve your odds of success and performance.
If however, you have not developed an expertise in any one area ( since you are 20 years old, this is a strong possibility), then you should consider investing in an index via a mutual fund or ETF.
If you have no interest in being involved with your investments, then you should consider finding a fee-only financial advisor to assist you in your investment needs.
I hope you found that helpful
If you have the option of a 401(k), I highly encourage you to participate. There is usually a company match which is free money. Within the 401(k) (or Roth or any investment vehicle), mutual funds are the best way to get diversification by broadening your investment exposure and lowering your risk/volatility.
Many mutual fund companies provide asset allocation funds, which include both equity/stock and fixed income/bond positions. These are great funds that re-balance automatically. I would encourage you to do your research on mutual funds before purchasing. Specifically take a look at the objective of the fund, the cost of the fund, the portfolio manager running the fund, and third party reviews of the fund.
I'd be happy to have a quick chat on the topic if you want to learn more.