Investing for Millennials

Investing for the first time can stir up myriad of emotions. First time investors often feel overwhelmed, anxious, and confused. If this is you, you’re more than likely experiencing at least one of two things. Either you don’t have the know-how to get started, or you don’t believe you have the means to begin investing. Worry not. This article is for you, as well as anyone else wanting a high-level introduction to the world of opportunity that investing opens.

The Value of Now

For most, investing is the critical way to build wealth, reach financial goals, and enable generosity. What may feel like major financial sacrifices now will be dwarfed by big yields over time. Core to the power of investing is the concept of compounding interest. As you invest, you gain a return if the value of your investment increases. This means that your investment is now worth more than it was when you initially invested it.  In most cases, the increase in value gets reinvested. This means you now have the potential to earn a positive return on both the money you initially put in as well as the increase. Effectively, you will earn larger returns and faster, so long as the investment continues to appreciate!

The power of compound interest, then, puts a significant value on time.  The chart below illustrates this whereas a 25-year-old who invests $10,000 per year for 10 years is compared to a 35-year-old who invests the same amount per year for 30 years. Both instances assume an annual return of 8%*:

The 25-year-old’s investment is worth sizably more than the 35-year-old, and they invested 3 times less and for one third as long! This is simply because they started 10 years earlier; giving the investment that much longer to grow and mature.

Investing early can help you be significantly more financially prepared for retirement. Another reason to invest for retirement early is that it gives you more time to ride out any significant downturns in the stock market. Those that wait until later in their career to save and invest for retirement typically can’t afford to invest as heavily in stocks because of the risk of a poorly timed downswing in the market causing a major blow to their portfolio before retirement.

To that end, investors will always want to balance their tolerance for risk with their intended purpose for the investment. Let’s say, for example, you are saving for a down-payment on a home in 5 years. You could invest through a brokerage account and hope for nice returns, but you would also risk losing a significant percentage of your investments in the process. Without much of a time horizon to make up the losses, one may elect the safer and more guaranteed return (albeit smaller) of a savings account or a Certificate of Deposit (CD).

Like the rest of our finances, our faith should inform our decisions around investing. Ultimately, our money is not ours at all -- but God’s. Investing can also increase our better ability to give our money to things with eternal importance.

What are my options when investing?

Perhaps you are urged to get started after seeing the potential benefits of investing now. If so, there are three questions to ask yourself next:

“What type of account should I open?”

“What type of investments should I make?” and

“What company should I use to open an account?”

I’ll address each of these next.

Types of Accounts

Tax Advantaged Accounts**

Traditional Individual Retirement Account (Traditional IRA): intended to help people save and grow wealth for retirement. The money contributed to this account (a max of $5,500 per year) is tax-deductible at the time contributed and grows tax-free, meaning you don’t need to pay taxes if/when your investments increase in value (capital gains tax). When you take withdrawals out, however, you will pay income taxes based on your tax bracket at the time of withdrawal. Be aware, because withdrawals are recognized as income, they can also force you into a higher tax bracket later in life.

Roth IRA: similar to the traditional IRA, except the timing of the tax is reversed. The contributions to a Roth IRA (at a max of $5,500 per year) are not tax deductible, meaning you must contribute after-tax dollars. When you withdraw from your Roth IRA account, however, you don’t pay taxes on the withdrawals (withdrawals don’t count toward your taxable income).

Employer Retirement Plans: these are investment accounts that employers put in place for their employees. They commonly include Regular 401(k)s, Roth 401(k)s, 403(b)s, SEP IRAs, and SIMPLE IRAs. A 401(k) is an account that both you and your employer can contribute to as a way to save and grow wealth for retirement. The contributions to a regular 401(k) are tax-deductible, grow tax free, and will be taxed only when you take withdrawals, while a Roth 401(k) is taxed like a Roth IRA. 403(b)s are very similar to 401(k)s, but are designed for nonprofits and government organizations. SEP IRAs and Simple IRAs are also like 401(k)s, but are most commonly used by smaller compnies. These have become far less common in recent years.

Health Savings Accounts (HSA): intended to help people save and pay for out-of-pocket health expenses. To qualify for an HSA, you must have a high deductible health insurance plan (HDHP). What is unique about HSAs is that contributions are tax deductible, the account grows tax free, and withdrawals are tax free if used for qualified medical expenses. See my previous post on HSAs for a deeper dive on these accounts.

Other Types of Accounts

Taxable Investing Accounts (Brokerage Accounts): these accounts have no unique tax benefits, so any dollars invested in these are subject to capital gains tax.

Annuities: a financial product that allows you to contribute funds for a finite period, and then gives you a steady payout for a predetermined length of time. This type of investment is typically not recommended for young investors because of high costs and inflexibility.

Whole Life Insurance: life insurance that includes an investment component along with life insurance policy itself. Essentially, it will give out a sum of money to a beneficiary upon death while providing a modest rate of return on the amount invested, often called the Cash Value. The Cash Value can be withdrawn or borrowed against, but typically does not grow materially for several years. This type of investment is also not typically recommended for young investors because of the high costs and inflexibility.

Kinds of Investments

After you’ve decided what type of account to invest in, it’s now time to determine which types of investments to put your money into. These options can range from very conservative to very aggressive, making this is an important decision.

Mutual Funds, ETFs, and Target Date funds: these are all portfolios often made up of different stocks, bonds, or a combination of both. Purchasing shares of a mutual fund or an ETF (Exchange Traded Fund) allows you to you diversify easily and are great options for investing. These funds can be actively or passively managed. This describes how much the fund is changing over time. An active fund is changing frequently as the managers of the portfolio are trying to beat the market. A passive fund, or index fund, doesn’t change much over time and tries to match the market. A target date fund is a specific type of mutual fund that can specifically help you invest for retirement. The managers of the fund rebalance the mix of stocks and bonds every year according to a selected time frame. For example, if you are 30 and hoping to retire by 65 (2052), you would buy a target date 2050 fund (closest to your target retirement year). Initially the fund would be comprised almost entirely of stocks. As you get closer to retirement it will gradually be changed to reduce the percentage of stocks and increase the percentage of bonds. Target date funds are a great way to both diversify and take the pressure off yourself to choose the right investments. One thing to be aware with these funds is that initially they are rather risky. Most start out by comprising 90% stocks and 10% bonds. This could result in some drastic losses if the stock market were to decline suddenly, but young investors fortunately have more time to ride out these significant downturns in the stock market. Therefore, some of this risk can be mitigated so long as you can stay disciplined and stick to a long-term plan.

Individual Stocks and Bonds: purchasing shares of a company (stocks) or lending your money to an organization, such as the government or a company for a set period of time in order to receive a fixed percentage of returns (bonds). Generally, investing in individual stocks and bonds is not recommended for new investors (or even experienced investors) because of the lack of diversification, resulting in a lot of risk.

Companies to Consider

There are an endless number of companies that offer IRAs and taxable accounts, but they are not all the same. They differ in fees and minimum investment amounts, among other factors. Three reputable companies that I recommend considering for an IRA (Traditional or Roth) are Vanguard, Betterment, and Wealthfront***.  They are all relatively easy to use and have low fees.

Here are a few pros and cons for each of these companies:

Vanguard:

Pros: No transaction costs. No fee ETFs. Free for basic service (do it on your own).

Cons: $1,000 investment minimum for IRAs. $7 transaction cost for non-Vanguard funds. Must create and rebalance portfolio manually if investing in multiple investments.

Betterment:

Pros: Low fee. Fully automated portfolio creation and rebalancing. No minimum investment. Incredibly user friendly. Great for beginning investors. Offers partial shares of ETF’s.

Cons: 0.25% management fee (still very low by industry standards).

Wealthfront:

Pros: Fully automated portfolio creation and rebalancing. Easy to use. Great for beginning investors. Low fee -- First $10,000 managed for free.

Cons: $500 minimum. Does not offer partial shares of ETF’s.  0.25% management fee on everything above $10,000 (still very low by industry standards).

Bringing it all Together

No doubt there is a lot to learn and a huge amount of often conflicting messages being directed at Millennials. Amidst it all, I recommend the following as a general rule for most millennials who are just getting started with investments and are in one of the lower tax brackets****.

1. Employer Sponsored Retirement Plan: If your employer offers a match to a percentage of your contribution into your 401(k) or 403(b), then the best thing you can do to start investing is to contribute at least enough from each paycheck to receive the full company match. Consider investing your contributions into the target date fund that most closely corresponds with your anticipated retirement year.

2. Individual Retirement Account (IRA): After contributing enough to your 401(k) to get the full match from your employer, consider maxing out a Roth IRA. If you are in a higher tax bracket and the amount you can deduct in not limited you could consider a Traditional IRA instead. The companies listed above are all great options for where to open your Roth IRA. For Betterment and Wealthfront, you will be asked to fill out a questionnaire about your goals and risk profile in order to determine how your account should be invested. With Vanguard, you must make the portfolio yourself. Again, a great place to start is a target date fund that most closely corresponds to your target retirement year.

3. HSA: After maxing out your IRA, look to an HSA, if eligible, and try to max out contributions to it. HSA’s allow you to hold the asset in cash, or invest it in a variety of funds. Consider keeping your maximum out-of-pocket amount in cash and investing the remainder in a diversified mix of mutual funds and/or ETFs.

4. Go Back to the Employer Plan: Now it’s time to exceed just the minimum for the company match. Consider increasing your regular contribution to your Employer Sponsored Plan until you’ve reached the annual contribution limit (typically $18,000).

5. If you still have leftover savings that you want to invest, start investing in taxable accounts with mutual funds and ETFs. The three companies mentioned earlier are all great options for this as well.       

 

A summary of the account types covered in this article is displayed in the table below (for 2017):

Even though this post covered a lot of ground, we have barely scratched the surface on this topic. It’s rare for someone to try to tackle investments on their own. Reach out to me if you are looking for someone to walk alongside you and help you invest wisely. I would love to meet you and see how Wacek Financial Planning can help.

 

*Investment returns are not guaranteed and past performance does not predict future results. An average 8% rate of return may be a reasonable outcome over long periods of time when investing in stocks, but it will almost certainly include years of significant negative returns.

**This is not an exhaustive list of all potential tax advantaged retirement accounts but the most common. The details and numbers used are representative of the facts when this blog was written in 2017.

***These companies are the ones that I’d recommend at the writing of this blog post in 2017. Over time the figures and companies that I’d recommend are subject to change.

****Please note that this is the general order that I’d recommend for most investors who are just getting started; however, each situation is different and I may recommend a different order depending on your goals, tax bracket, or unique situation.  

About Wacek Financial Planning

Founder, Ben Wacek, is a fee-only, Certified Financial PlannerTM who has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective, using Biblical principles.  If you’d like to learn more about Wacek Financial Planning, please visit www.wacekfp.com.

 

Photo courtesy of Startup Stock Photos of StockSnap.io

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