The benefits of investing at a young age are vast. For one, you can develop a habit of saving and investing as a youngster. Second, you can reap the rewards of one of the most magical concepts known to mankind: compound interest.
But before we dive into those ideas, let’s address the elephant in the room: risk. Many people are scared to start investing because they could lose money in the process.
It’s no secret that the stock market can be volatile — but it can also reap rewards for those who invest wisely and who continue to invest over the long-term. Yet despite the potential for growth in investment, fewer young adults are investing now than in the past.
According to one survey, just one-third of all millennials (ranging in age from 18 to 35) have invested in the stock market, either directly or indirectly. In comparison, slightly more than half of all adults just slightly older than millennials (commonly referred to as Generation X, and between ages 36 and 51) have money in the stock market.
There are many different ways for young people to invest their money. Even if their funds are relatively limited, they can still put their money into company-sponsored 401(k) accounts or an Individual Retirement Account (IRA).
They can also purchase stocks, mutual funds, or stock exchange-traded funds (ETFs). The critical aspect of investing is less about the vehicle chosen (although there are important differences, particularly for tax purposes), but that you get started as early as possible to maximize your investment.
How Compound Interest Works
Investing early is the key to earning as much as possible due to what is known as compound interest. This concept essentially allows your investment to grow significantly over the years, as interest is added to the principal sum of an investment.
Over time, interest is added to interest, and that interest is then reinvested. This means that your investment will continue to grow — and you will reap the benefits of an ever-growing investment in the vehicle of your choice.
In essence, compound interest creates a snowball effect when the markets do well, allowing you to build up a nest egg that is far greater than the amount of money that you initially invested.
Benefits of Investing at a Young Age
The primary benefit of investing at a young age is that you can take advantage of – you guessed it – compound interest.
Think of it this way: the earlier that you start saving, the sooner that the interest and/or dividend will be added to the principal amount of your investment. Then your investment can grow over time, with the benefit of each upswing in the market allowing you to maximize your investment.
Investing at a young age also allows you to better weather any marketplace ups and downs. When you invest over the long-term, you can keep your money in the stock market if it crashes, knowing that it will bounce back over time — and that you may even end up in a better financial position compared to the people who had to remove their money from the marketplace.
The benefits of investing early is easily shown in a number of charts around the internet that list how much you would need to save each year to save a certain amount by retirement age (65).
The following chart from Investopedia assumes a 7% rate of return on investments. Note that if you start investing at age 30, you will need to invest just $7,234 per year to save $1,000,000 by age 65. However, if you wait until you are 45 to start investing, you will need to save more than triple that amount — $24,393 per year. That is the benefit of compound interest — and why investing early is so critical.
Table Source: Investopedia
There are many different ways for millennials to get started investing, and different options to choose from when it comes to types of investments. Learning about these types of can help you decide how to move forward with your plans to invest early.
One of the most popular forms of investments for young adults is the 401(k), a retirement savings account that is typically offered by most employers, often with an employer match up to a certain percentage.
With a 401(k), the money that you contribute is deducted from your income, so that you pay less in income taxes as a young adult. After retirement, your deductions are tax, typically at a lower rate when you have a reduced income. Typically, 401(k)s are set up through your employer, and are funded by automatic deductions from your paycheck.
A ROTH Individual Retirement Account (IRA) is another type of retirement account. Unlike 401(k)s, ROTH IRAs are funded by post-tax income. However, deductions from these accounts are tax-free. They have certain income and other eligibility guidelines and can be established through a bank, brokerage company, or other approved institutions.
Many young adults choose to invest in the stock market. This can be done in a number of ways, such as by investing in a mutual fund that consists of small pieces of many different stocks or by purchasing exchange-traded funds (ETFs). Investors can also choose to purchase individual stocks for a specific company, such as a technology company that they believe has promise; this often requires a greater investment.
Purchasing stocks, mutual funds or ETFs requires setting up an account with a broker. Investors can choose to use an online broker, a traditional broker, or a robo-advisor that helps them choose the stocks that are best for them.
Another newer and more unique option for investors is the growing peer-to-peer lending industry. In short, consumers can invest in personal loans that are given to other consumers. They then will receive their money back with interest, assuming the borrower repays the loan. While some borrowers do not end up repaying their loan, the majority do, helping investors make money. These loans almost always have higher interest rates than typical personal loans, so you can make a decent chunk of change with this interesting strategy.
Ultimately, while the specific type of investment will vary for each person, the most important lesson for young adults is to invest early. By putting as much money as you can into the investment of your choice, you will set yourself up for a comfortable retirement later in life. The benefits of compound interest can help you achieve financial security — but only if you start investing sooner rather than later.
Tom – as his blog’s title suggests – is a FIREd Up Millennial working to achieve financial independence and retire early. You can see his recent posts and thoughts @FIREdUpMillenn.
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