Millions of recent college graduates are starting careers, qualifying for 401(k) plans and trying to balance student debt with long-term saving needs and grown-up expenses. The new financial dilemmas can be mystifying.
Some rules of the game are pretty well known even among beginners, like the value of saving as much as possible, qualifying for the maximum employer match on the 401(k), building an emergency fund and emphasizing the growth potential of stocks over the safety of bank savings.
But experts offer a variety of tips that aren't quite so obvious, like the value of taking more risk than a beginning investor might be comfortable with at first. Investors in their 20s, for example, are typically urged to put most of their long-term investments into stocks. Simple index funds tracking the returned an annual average of about 14 percent over the past five years. Bonds typically pay a fraction of that, and cash savings like bank accounts earn almost nothing.
"Beginning investors should make sure that they aren't always following the herd mentality," says Todd Burkhalter, CEO of Drive Planning, a financial consulting firm based in Georgia. Aside from the standard lineup of stock and bond funds, young investors, he says, should consider holdings like private placement investments in real estate and energy industries – things that aren't so common.
That kind of advice relies on the fact that young investors can afford more risk than older ones since they have more time to recover from downturns.
Young investors who grew up doing things online may be wise to consider equity crowdfunding sites such as Realtyshares.com that allow users to invest in out-of-the-mainstream private ventures like house flipping projects, and start-ups, some experts say.
Thanks to new rules that took effect in May 2016, anyone (not just high income investors) can invest in non-public companies in exchange for equity.
"Portfolio diversification is important, especially investing into asset classes beyond publicly-traded equities," says Chris Rawley, CEO of Harvest Returns, an online platform for investing in agriculture. "Multiple streams of income produced by assets that are not correlated with the stock market are important to reduce risk in a portfolio.
"Crowdfunding platforms make it possible for new investors with smaller investment balances — as low as $100, or even $10 — to diversify into real estate, farmland, and other tangible assets that produce a steady yield."
Investors young and old have been told over and over of the value of passive, index-style investing with funds that track broad market gauges like the Standard & Poor's 500. Many studies have shown that index funds beat actively managed funds over time, largely because of their lower fees.
But some advisors say young investors should start gaining experience with individual stocks as well, though the ins and outs of stock picking can be daunting for a beginner. Sharon Marchisello, author of the financial guide "Live Cheaply, Be Happy, Grow Wealthy," recommends that a beginner join an investment club where like-minded investors evaluate and pool their contributions to purchase individual stocks or other financial products.
Clubs can be found online, through sites like Meetup.com, or even at the local library. Some clubs pool member contributions, which can be quite small, and invest by majority vote, while others are discussion groups for exchanging ideas, tips and war stories.
"A good club will also assign a monitor to each holding and develop 'when-to-sell' guidelines," Marchisello said. That helps members learn discipline.
She says that as the portfolio grows the young investor can add strategies that are less likely to come to mind at the start, like selling covered calls, an income-generating technique using stock options that give the buyer the right to buy your shares at a set price for a given period.
Many young investors are in low tax brackets and unfamiliar with tax strategies, but pros say it's never too soon to start profiting from the tax statutes.
That starts with the tax deferral provided by the traditional 401(k), or the tax-free status of the Roth 401(k). The Roth, unlike the traditional 401(k), does not offer an up-front deduction on contributions, but many advisors say young investors should put at least half their 401(k) contributions into Roth accounts anyway. That's because tax-free withdrawals can be more valuable than tax-deductible contributions if an investor has decades for investments to grow.
Also, many young investors are likely to be in higher tax brackets in retirement than they are now. With a Roth, you pay tax now to avoid a higher tax bill later, while a traditional 401(k) can mean avoiding a low tax today only to pay at a higher rate in retirement.
Another smart tax strategy for beginners is to avoid a tax bill next April by making sure enough is withheld from each paycheck, says Gabriel Pincus president of GA Pincus Funds, an investment advisor based in Dallas and Chicago. This is done when filling out the W-4 form, part of the paperwork blizzard a new employee may deal with without much thought.
"When completing your W-4, select single [tax status] and zero dependents, Pincus says. "I believe it is better to withhold more during the year and get a refund at the end of the year rather than owing money [to Uncle Sam that] you may have already spent. Yes, you are giving the government a zero percent interest loan, but the peace of mind that you won't owe money in April should help you forget about [that]. Deposit half your refund check directly into savings and half into your taxable investment account."
Recent graduates often feel their top financial priority is to pay off student loans, but that can be a mistake, says Andy Smith, a financial planner at Financial Engines in Indianapolis, Indiana.
"I advise young investors to aggressively save for retirement rather than racing to pay off student loan debt when they graduate," Smith said. "The employer matches, tax breaks and compound interest that retirement contributions offer are worth far more than the interest saved by accelerated student loan repayment."
Generally, paying down debt makes the most sense if the loan's interest rate is higher than the investment return that cash could earn.
Investing is just one piece off a financial puzzle that includes needs like paying off those loans and building ordinary savings for an emergency fund, a car and home down payment. Dennis LaVoy, advisor with Telos Financial in Plymouth, Michigan, urges young people to consider what might knock them off the rails by doing things as mundane as studying up on employee benefits.
"Being in a sound financial state involves much more than saving for retirement," LaVoy said. "Are you properly insured to protect your spouse and children? Do you have disability insurance to protect you if you can't work? Many employers offer these benefits at very reasonable pricing. You need to determine the amount of coverage you need and take advantage of your employer programs."
Fixating on investing can be self-defeating if it means skimping on other financial needs common among young people, says Joshua Escalante Troesh owner of Purposeful Strategic Partners, a registered investment advisory firm in California.
"A young investor should not maximize their retirement investing. Contributing 10 percent to 12 percent of salary to retirement accounts is sufficient and allows for focus on other important life goals like saving for a home down payment or staying out of credit card debt. Once other life goals are funded, they can increase their retirement savings."