You have big goals. One day you'll own your own place, have a family, retire early — or at the very least you won't be living paycheck to paycheck. Most young people know they need to be savers, after all, with 59% of millennials socking away for retirement before age 25, according to a recent study.
That's great! The only problem? If you're just saving your money in a plain bank account earning 1% a year, and you're not investing it, you probably won't reach those goals. To see savings grow and protect money from inflation, you've got to hold other types of assets beyond cash, or else that $500 in your checking account will be nominally the same and buy you even less stuff 25 years later. On the flip side, if you invest that same $500 — even with modest returns of about 5% per year — it would be worth almost three times that.
Now, this does not mean you should rush out and put all your savings into Apple stock in a brokerage account. First, make sure you have basic savings accounts (like 6 months of expenses for emergencies) set up and fully funded.
Then take a breath, and get ready to learn a little — and make a plan: "Investing is sexy, but you have to earn your right to get there," said Douglas Boneparth, a certified financial planner at Bone Fide Wealth in New York. "You need to handle your short term goals before the long ones. Those things need to be done first before taking money and putting risk on it."
That key word, "risk" — usually taken on by buying stocks — is your source of power as an investor, but to paraphrase the Spiderman saying, you'll need to manage that power responsibly. If you succeed, you'll be rewarded richly, thanks to capital appreciation (e.g., stocks getting more valuable) and compounding. In fact, investing for retirement as soon as possible can put you nearly a million dollars ahead of those who start a decade after you.
So how do you get started investing, whether for retirement or — if you're already maxing out tax-advantaged accounts like your 401(k) or Roth IRA — in a brokerage account, for shorter-term savings goals?
The guide below, of course, is no replacement for seeking out the help of a professional. No two people have the same incomes, goals, and priorities, and these factors are all crucial for creating an actual plan. But here's some advice to help you get started — and know what questions to ask.
How much money should you invest in stocks versus bonds?
A big part of figuring out where to park your cash boils down to two things: "Two main components are time horizon and tolerance for risk," Boneparth said. "Those are the two biggest factors that go into creating an asset allocation for you."
Asset allocation means what percentage of your money you put into stocks versus bonds versus other types of asset classes. Time horizon is fancy-speak for how long you can go without touching your money. And risk, in this context, represents how much money you could lose and still be okay.
A rule of thumb popularized by Vanguard founder Jack Bogle is to subtract your age from 100 and put that percentage of your money into the stock market, the "birthday rule" — aka, own your age in (relatively-less-risky) bonds.
So if you're 25, you might want roughly 75% of your investments in stocks, and 25% in boring old bonds. The logic here is that the longer you can wait, the more likely it is your investments will catch more good markets than bad ones. That said, some financial experts disagree with the birthday rule and think young people should hold even more in stocks — or less. Another factor?
Risk tolerance: a separate but equally important issue to think about, because investing has as much to do with personal discipline as it does with choosing the right stock or fund. Every time you move your investments around, you're likely incurring fees (transaction costs); plus, people also tend to get the timing wrong when they try their own hand at "buying low and selling high."
That's why most robo-advisors or financial advisors will try to figure out your risk tolerance by asking you what you're likely to do in a downturn. If a stock market crash will make you liquidate your 401(k), you might be better off holding less stock — at least if it will prevent you from pulling your cash. After all, of the best ways to grow your money is to invest in equities when the market corrects and stocks are cheap.
"The average duration of the drawdown is typically around 12-18 months, and typical recovery is 2-3 years," said Don Riley, chief investment officer at the Wiley Group. "Some investors not only can sit through that, they're actually adding to their portfolios while stocks are down.
The short version? Decide how much risk you can take — and if you're young, know you can probably take a lot — then set it and forget it.
What funds or ETFs should you buy?
To grow your money, hit that sweet spot between catching as much of the stock market's gains as possible without freaking out and liquidating your 401(k) during a market crash. Diversification helps: According to an analysis from Fidelity, a diversified portfolio lost an average of 35% during the most recent market bottom, while an all-stocks portfolio lost half. What you want is a healthy mix of stocks and bonds, of big and small company shares, and of international and domestic equities — not just U.S. companies.
"What we've seen in terms of asset allocation is a lot of clients are too home-biased," Riley said. "They don't have a large international exposure... If you're young you can go to 80-90% equities."
Translation: If you're in your 20s and 30s and investing for retirement, you want mostly stocks, with a mix that includes shares of companies domiciled outside the United States.
The easiest way to check all these boxes is to hold a low-cost, three-fund portfolio, like the "lazy"combination of Vanguard Total Stock Market Index Fund, Vanguard Total International Stock Index Fund and Vanguard Total Bond Market Index Fund — or similar ETFs in each category (read up here, here and here). Financial analyst Rick Ferri suggests about 40% in bonds, 40% in U.S. stocks, and 20% in international equities; though, again, young folks might want to hold less in bonds and more in equities.
Want more detail before you decide? Here are some other rough rules of thumb to help you.
U.S. stocks: If you're in your mid-twenties and setting up a retirement account, the largest portion of your portfolio will probably be in a mix of U.S. stocks, which come in three main flavors: Large-cap, mid-cap, and small-cap. Cap is short for "capitalization," and it's a fancy way of describing large, medium and small-sized companies. Larger ones are generally better-tested and maybe safer, but it's also harder for them to grow.
Ballpark allocation: 40-60%
International stocks, including some emerging markets stocks: The other largest component of your portfolio is going to be international stocks, or shares in companies headquartered in other countries. Stocks in emerging markets generally are riskier than those in developed nations, so you might want no more than about 5% of your portfolio in so-called EM stocks. And, overall, though international stocks come with currency risk, they provide vital diversification in years when U.S. markets are weaker.
Ballpark allocation: 20-40%
Bonds: Bonds or fixed income assets are different from stocks. The basic idea is that one party pays interest to borrow money for a fixed period of time. A common misconception is that bonds are necessarily "safer" than stocks, which is sometimes but not always true. Certain bonds, called "junk" bonds or "high yield bonds," carry more risk than others and you can gauge risk through ratings from AAA to C or D. Some advisors tell young investors to avoid investing in bonds, unless you're saving for a major short-term purchase, like a house. That said, bonds do help cushion the pain in a stock market crash.
Ballpark allocation: 10-20%
Eager for even more precision? Planners recommend checking out "target-date funds" to see how those portfolios are allocated, since they are designed to suit different people at different ages.
Blackrock, a large investment manager, has several such funds: If you're planning on retiring in 2060, they'll put half your money in the Russell 1000, an index of the 1000 largest U.S. companies; 30% would go into international stocks, and 16% in a real estate fund. Only 1% is invested in bonds at all.
Vanguard, another of the largest investment managers, avoids real estate and has a higher allocation to bonds, but is still really similar. These are good rubrics for figuring out how typical people your own age are investing.
How to set up an investment account
The rules above can be helpful if you're making tweaks to your 401(k). But what if you want to invest freestyle through a brokerage account or IRA? A final tradeoff to consider is how much money you're willing to pay for good advice.
If you want to be totally DIY, you could avoid fees entirely by studying a few target-date funds, and then copying them by buying corresponding exchange-traded funds through a free brokerage like RobinHood, or using the promotional period on a more established brokerage.
Exchange traded funds come in all shapes and sizes. You can buy ETFs that are super targeted on robots or environmental sustainability, or you can buy broad ones that reflect the 500 biggest companies in the United States, for example.
Now, the DIY way takes work, and is susceptible to human error. That's why many investors pay for help managing money, whether to a fee-only financial planner, or a robo-advisor through companies like WealthFront, Betterment, WiseBanyan, or WealthSimple. If you're uncomfortable investing with a startup, the big banks have robo-advisors now too, including Charles Schwab, Bank of America, UBS, and even Goldman Sachs. (Still, reading independent reviews of ETFs never hurts, even if an advisor suggests them to you.)
You can grow your money by investing — not speculating
A final fundamental concept to understand about investing is how to distinguish it from speculation, which is confusing, because there's actually not an agreed-upon definition for either term.
Roughly speaking, speculation is when you're trying to make a quick buck through an investment. It's not a great strategy to grow wealth long term. The person scanning stock news for a company with "explosive growth potential" is probably speculating. Buying a plot of land because you think there's oil underneath it? Speculating.
It's even possible to speculate on proverbial "safe" investments like mutual funds if you're not careful and end up with fund overlap: That's when you accidentally have too many shares of one stock, for example, if you own two or three ETFs that all hold that company. That's a good reason to learn about any fund or ETF you buy — and exactly what assets are under the hood.
At the end of the day, smart investors care just as much, if not more, about not losing money as growing it: "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return," wrote the grandfather of securities analysis, Benjamin Graham.
You'll note that "safety of principal" — i.e., not losing your cash — comes first. Billionaire Warren Buffett had an even pithier way of stating the same idea when asked to sum up the two main rules of investing: "Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1." All the more reason to do your homework before committing to an investment.
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