The Best Investments for Young Adults

Young investors 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, putting your money to work is not as hard as it may seem.

Saving for Retirement

If you are young, your greatest financial asset is time⁠—and compound interest. 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.

This means that you should consider putting as much of your savings as possible in some form of equities, such as common stocks and stock mutual funds⁠. You might also consider real estate, either in the form of a personal residence or a mutual fund that invests in real estate holdings, called a REIT. It is important to be able to increase the purchasing power of your retirement savings over the course of your life because you will need every penny you can muster after you stop working.

401(k)s and IRAs

IRAs and employer-sponsored retirement plans are great ways to start 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 while you don't get a tax benefit from your contributions, both they 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 72 (as of 2020), 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.

Saving for College

If you are still trying to get through school or have not yet started, then there are several other vehicles for you to consider socking money into:

529 Plans

Every state has this type of college savings plan that allows you to put money away for higher education. (It now covers K-12 private education as well, but that likely won't be your problem.) The funds can be allocated among various investment choices and will grow tax-free until they are withdrawn to pay for qualified higher education expenses. The contribution limits for these plans are quite high, and they can also provide gift and estate tax savings for wealthy donors looking to reduce their taxable estates.

Coverdell Educational Savings Accounts

This type of college savings account is another option for those who want to take a more self-directed approach to their investments. The annual contribution limit is currently $2,000 per year, but it may still be a viable alternative if you want to purchase a specific investment that is not offered inside a 529 Plan.

U.S. Savings Bonds

These are yet another alternative to consider for conservative investors who don't want to risk their principal. The interest that they earn on U.S. Savings Bonds is also tax-free as long as it is used for higher education expenses.

Short-Term Investments

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 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.

Young investors should understand that over a long period of time such as their working years, investing in ETFs that track the market and letting dividends and interest build almost always beat a short-term stock trading strategy. Although returns can be high, most day-traders bust within a year. In the worst-case scenario, they lose their entire principal and can even end up owing their brokerage interest on margin trades.

The Bottom Line

The most important decision 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.