Solid financial foundation
Before you start investing, there are a few things you should do to prepare. First, make sure you have a solid financial foundation. This means paying off any high-interest debt, such as credit card balances or personal loans, and building up an emergency fund to cover unexpected expenses. You should also have a budget in place to manage your monthly expenses and ensure you have enough money to cover your bills and save for the future.
The reason you’re encouraged to pay off your high-interest credit cards and loans is because of compound interest. Simply put, your debts will grow faster than your investments so it’s better to tackle debt first rather than investments.
There’s also student debt to think about. If you started your university course after September 2012, you’ll only start paying back your loan when you earn more than £27,295. The amount you pay back is 9% of any amount above the threshold.
There is a time limit of 30 years to pay back your student loans. The clock starts ticking in month of April after you graduate. If you have not paid off your debt after 30 years, it’s written off. Most people will never pay off the full amount. In contrast, the money you invest in your 20s will benefit from decades of compounding.
Spend wisely, save wisely
When you’re young you might have more time and freedom than you have cash so it’s all too easy to spend all your earnings and not think about tomorrow. But you also have the freedom to be flexible. If you have fewer responsibilities or calls on your time, it’s also the best time to spend wisely on the things you really want, rather than fritter more of your earnings away.
There are good reasons why you might want to do that. You may have medium-term family-orientated or housing goals, for example. And, if you put your mind to it, you have longer-term goals too. After a long career, you don’t want to end up in a position where you can’t afford to stop working or continue enjoying a comfortable life.
Start right now
Saving is the best way to invest in your future and when you’re still in your 20s, you have time on your side.
The benefits of saving and investing are remarkable. Let’s suppose that you opt to invest in a diversified portfolio of global shares, which can be easily achieved by investing in a fund that tracks a global stock market index, such as the FTSE All-World Index.
According to our economists, the FTSE All-World index has delivered an average calendar-year return of 9.9% in British-pound terms since 31 December 1993. Nonetheless, let’s be more conservative and go for a more modest annual investment of 6% over the next few decades. Based on this assumption, an investor who starts saving just £262 per month at the age of 25 can accumulate more than £500,000 by the age of 65.
That doesn’t include any tax relief that you may attract by investing through a pension or an ISA for example.
On a 6% return, an investor putting away just £262 each month from the age of 25 will be able to accumulate more than £500,000 by the time they’re 65. The key fact is that total contributions make up just a quarter or so of the final £500,000 sum. The rest – almost £375,000 – is made up of capital growth. That’s the power of compounding – the multiplier effect as your investment returns combine with your capital contributions to help your wealth grow. And the longer you give it, the more dramatic the potential effects.
If our saver started later and only had 30 years, he would have to squirrel away £514 a month to reach £500k– £185,000 of invested capital and £315,000 of capital growth. And it would require £1,103 a month — almost £265,000 of invested capital and £235,000 of capital growth — to do it in 20 years.
Start with your workplace pension
When you’re in your 20s or 30s, your pension will probably not be your main concern. This is when you want to go out, have fun, travel, form a relationship and get on the housing ladder. Your pension is the least of your concerns but it’s also a great place to start.
By contributing to your pension, you are building up savings for your retirement, and your contributions will benefit from tax relief. Many employers will also match your contributions, which can be a significant boost to your retirement savings.
You might not want to lock all your hard-earned cash in your pension and that’s ok. You’ll have short and/or medium-term savings needs too such as saving for house deposit or for travelling around the world. For funds you might need in fewer than five years, it’s best to stick to cash. You can use savings accounts or Cash ISAs. Whichever way you do, it pays to save early and save often!
Consider a stocks and shares ISA
A stocks and shares ISA is a tax-efficient way to invest in the stock market. You can invest up to £20,000 per year in an ISA, and any gains you make on your investments will be free from capital gains tax and income tax. This makes ISAs a great way to build long-term wealth without having to worry about tax implications.
Diversify your investments
Diversification is key to successful investing. By spreading your money across a range of different investments, you can reduce your risk and increase your chances of long-term growth. Consider investing in a mix of equities, bonds, and other asset classes to create a diversified portfolio.
Keep your fees low
Fees can eat into your investment returns, so it’s important to keep them as low as possible. Look for low-cost investment options, such as index funds or Exchange-Traded Funds (ETFs), which offer exposure to a range of assets at a low cost.
Investing is a long-term game, and it’s important to be patient. The stock market can be volatile in the short term, but over the long term, it has historically delivered strong returns. By staying invested and resisting the urge to make frequent changes to your portfolio, you can benefit from the power of compound interest and long-term growth.