Thursday, July 7, 2011

Investing in your 20s: Rich in time but short on cash - USA Today

Q: What unique challenges do investors in their 20s face?

Twentysomethings can have a difficult time finding the money to invest as many rack up a large amount of debt to obtain an education. By Gregory Bull, AP

Twentysomethings can have a difficult time finding the money to invest as many rack up a large amount of debt to obtain an education.

By Gregory Bull, AP

Twentysomethings can have a difficult time finding the money to invest as many rack up a large amount of debt to obtain an education.

A: When it comes to investing, time is literally money. And if you're in your 20s, you're often relatively rich, when it comes to time.

But if you're living on an entry-level salary, you might not feel so rich if you're short on cash. It's ironic. Being young gives you the freedom to take a very long-term perspective on your investments. But that long time frame isn't going to help you much if you don't have anything to invest.

It's this paradox of young investors, being rich in time but poor on cash, which challenges many investors just starting out.

It's a harsh reality. Consider the power of time. A person who can save $12,000 a year for 40 years will have $1.5 million in today's dollars, assuming just a 5% annual return. However, a person who can only save half that long, just 20 years, will only have just $397,000. In other words, a person who saves half as long will have 75% less at the end of the period.

But to take advantage of your youth, you need to recognize the challenges and understand how to deal with them:

Entry-level salary. Perhaps the biggest challenge you face is the fact that you're probably pretty new on the job. You may have a junior level role at a company where the pay isn't all that great. After paying your rent and car payments, there may not be a whole lot left to invest.

The answer: Control your overhead. Just as successful entrepreneurs say keeping their costs down is a crucial to success, those just entering the workforce must do the same. Get your rent down. If you're rent is more than a third of your take home pay, that's too much. Find a way to reduce that monthly nut, or you'll have a tough time saving money to invest.

Your goal is to be able to at least save enough in your company's 401(k) plan to get the company match. If you can manage to save another 10% of your take home pay to invest, that's even better.

Debt load. An increasing percentage of students are leaving college with a huge pile of debt. This debt needs to be paid off using the already tapped resources from the entry-level salary.

The answer: If you can refinance the debt to a lower interest rate, do so. That's probably not an option, though. Instead, the same rule of limiting your overhead expenses applies.

Inexperience. Young investors often get sucked into all sorts of investment strategies. Some chase after penny stocks, which is almost always a bad idea long term. Others try to make lots of money chasing stocks that are going up, only to ride them way down when the correction comes.

The answer: Start with a basic diversified portfolio. An excellent way for beginning investors to get started is by investing in an exchange-traded fund that invests in the Standard & Poor's 500 index, such as ETFs that trade by the symbol SPY or VOO. By owning an investment like this, you'll see how to trade, monitor the value of a stock and collect dividends. Also, many brokers allow free trades in broad ETFs like this, so you can start investing without getting your money siphoned off by fees.

Being young is a huge edge when it comes to investing. Not only can you afford to keep your money invested for a long time, but you can take on more risk, and shoot for higher returns, because you can sit through a correction or two without panic selling.

The key to success, though, is dealing with the challenges and finding a way to save money and invest it. If you're able to find a way to squirrel away some cash, you'll be far ahead as a result.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz

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