Millennials have faced numerous challenges. Growing up, those born between 1981 and 1996 witnessed events like the September 11 attacks, ongoing wars, the worst recession since the Great Depression, a student loan crisis, and a pandemic. It’s no surprise that saving and investing for retirement hasn’t always been a priority.

However, many millennials are now finished with their education and have been in the workforce for several years. At this stage, it’s crucial for them to consider investing as a means to achieve their long-term financial goals.

Let’s explore some investing fundamentals and why starting now is so important.

Why it’s important for millennials to invest

If you experienced the 2008 financial crisis or felt the effects of the market downturn in 2022, you might view investing as risky. However, not investing carries its own risks.

“The worst mistake you can make in your mid-20s to mid-30s is to avoid saving and investing,” says Mike Kerins, head of advisor products at Apex Fintech Solutions. Investing early allows your money to grow over time. Despite market fluctuations, it’s uncommon for the stock market to remain down for extended periods.

Historically, stock investments offer higher returns than cash and bonds in the long run. Money in savings accounts tends to stagnate and is vulnerable to inflation, whereas stock market investments can compound over the years. From 1926 to 2020, large-cap stocks yielded approximately 10% compounded annually, while long-term government bonds returned about 5.5% annually and T-bills around 3.3%.

“The most reliable way to build wealth over time is to invest in a diversified portfolio of common stocks,” says Robert Johnson, professor of finance at Creighton University and chairman and CEO of Economic Index Associates.

Another benefit of investing consistently is the snowball effect of compounding.

“Millennials should start compounding early and let it work its magic over the decades,” Johnson explains. Compounding means you earn interest on your investments, and then interest on that interest, leading to a larger balance over time without needing to contribute additional capital.

For instance, if you invest $6,000 annually starting at age 25 and earn $100 in interest that year, by age 26, you’d earn interest on $6,100, then $6,300, and so forth. Over the years, this approach yields significantly higher returns compared to simply depositing that money in a savings account or keeping it idle.

Learn the basics of managing your investments

  • Risk Tolerance: Before making your first investments, it’s crucial to understand your risk tolerance, which refers to your ability and willingness to endure investment losses, whether temporary or permanent. While the stock market generally trends upward over the long term, it can experience significant declines in the short term. Consider whether you can withstand these downturns or if you might prefer safer investment options.
  • Asset Allocation: As you build your investment portfolio, you’ll need to decide how much to allocate to stocks versus other assets like bonds or real estate. These assets can be further categorized by factors such as geography, investment style, or type of company. This mix is known as your asset allocation and will likely transition from riskier assets early in your investment journey to more conservative assets as you approach retirement.
  • Active vs. Passive Investing: Another important choice is whether to be an active or passive investor. Active investors try to outperform market indexes like the S&P 500 by selecting stocks they believe will excel. Conversely, passive investing, or index investing, aims to mirror the performance of broader indexes and typically comes with lower costs. Historically, this cost efficiency has allowed passive investors to outperform their active counterparts over longer periods.
  • Diversification: Diversification is the financial equivalent of the saying, “Don’t put all your eggs in one basket.” By spreading your investments across various assets, you acknowledge that while some will thrive, others may falter. Well-diversified portfolios have historically shown strong performance over time.
  • Time Horizon: Understanding your time horizon is a vital part of any financial strategy. Defining key objectives, such as saving for retirement or funding a child’s education, will significantly influence your investment approach. Long-term goals—at least five years away—are generally best served by long-term assets like stocks. In contrast, short-term goals, such as saving for a home down payment, are better achieved with safer assets like high-yield savings accounts.

Most common types of investment accounts

  • IRA: An individual retirement account (IRA) allows you to save for retirement while enjoying significant tax advantages. Contributions to an IRA grow tax-free, enabling you to compound your returns more effectively than if you were taxed on them annually. You contribute funds on a pretax basis, which can lower your tax bill for the current year. You can start making withdrawals at age 59½, at which point you’ll owe taxes on the amount withdrawn.
  • Roth IRA: A Roth IRA is similar to a traditional IRA but with key differences. Contributions to a Roth IRA are made after taxes, meaning there’s no immediate tax benefit. However, when you withdraw funds after age 59½, those withdrawals are tax-free. This makes the Roth IRA a powerful tool for retirement savings due to its favorable tax treatment. Be aware that early withdrawals from both Roth and traditional IRAs typically incur a 10% penalty.
  • 401(k): A 401(k) is a popular employer-sponsored retirement plan that allows both employees and employers to contribute a portion of earnings for retirement savings. Many employers offer matching contributions, which is essentially free money and should be maximized if possible. Contributions grow tax-free, but withdrawals—usually starting at age 62 or 63—are subject to taxation.
  • Brokerage Account: A brokerage account enables you to invest in a range of securities, including stocks, bonds, and ETFs. Unlike retirement accounts, brokerage accounts are taxable, meaning you’ll pay capital gains tax on realized profits. If you’ve maximized your contributions to retirement accounts like 401(k)s and IRAs, a brokerage account provides an additional avenue for wealth accumulation. Many online brokers offer commission-free trading, and you can access your funds at any time without penalties.

These are just a few of the most common account types; there are other options worth exploring as well.

Best investments for millennials

  • Stocks: For millennials, investing for long-term goals like retirement is best achieved through assets such as stocks. A stock represents a partial ownership stake in a company, and its value typically reflects the performance of that business over time. You can invest in stocks directly or through exchange-traded funds (ETFs) and mutual funds.
  • Index Funds: Index funds are mutual funds or ETFs designed to replicate the performance of a specific index, such as the S&P 500 or the Dow Jones Industrial Average. These funds can invest in stocks, bonds, or even real estate. Because they are passively managed, index funds usually have low fees, allowing more of the returns to go to investors. They provide an excellent way to build a broadly diversified portfolio with minimal costs.
  • ETFs: Exchange-traded funds (ETFs) are funds that hold a collection of securities and trade throughout the day like stocks. You can find ETFs for stocks, bonds, commodities, and more. Many ETFs passively track indexes such as the S&P 500 or Russell 2000. They offer a convenient way to diversify your investments without requiring a large initial investment, as they typically do not have minimum investment requirements.
  • Mutual Funds: A mutual fund pools money from multiple investors to invest in a variety of securities, such as stocks or bonds. Your investment in a mutual fund is allocated according to the fund’s overall strategy; for instance, if the fund has 5% in Microsoft, your investment will also reflect that allocation. Unlike ETFs, mutual funds are traded once a day at the closing net asset value (NAV). They can be purchased through brokers or directly from the fund company and often require a minimum investment of several thousand dollars. Remember, the performance of mutual funds depends on the underlying assets they hold, such as stocks or bonds.

In Conclusion

It’s easy to see why investing for retirement may not have been a priority for millennials. However, now is the time to focus on investing and harnessing the power of compounding. Despite market ups and downs, a diversified portfolio of stocks has consistently been one of the best strategies for building long-term wealth. Don’t overlook the potential for a snowball effect that can significantly enhance your financial future over the years.