An investing road map for early career accumulators

Tips on getting the most bang for your investment dollars when you're just starting out.

Christine Benz 24 April, 2017 | 5:00PM

Because they're just starting out, early career accumulators--loosely defined as people in their 20s and 30s--don't typically have much in the way of financial capital (unless they're technology savants or supermodels, that is). Not only are their earnings often low relative to where they'll be in the future, but new university grads may also be digesting student debt.

But early career accumulators have other assets that their older counterparts can look upon with envy. With a whole lifetime of earnings stretching before them, early career people are long on what investment researchers call human capital: Their ability to earn a living is their greatest asset by a mile.

Investors in their 20s and 30s have a valuable asset when it comes to investing, too: With a very long time horizon until they'll need to begin withdrawing their money (for retirement, at least), early career investors can better harness the power of compound interest. They can also tolerate higher volatility investments that, over long periods, are apt to generate higher returns than safer investments.

If you're just embarking on your investment journey, it's hard to go too far wrong with the mantra of investing as much as you can on a regular basis and sticking with very basic, well-diversified investments. But it also pays to think of your "investments" in a broad sense, steering your hard-earned dollars to those opportunities that promise the highest return on your investment over your time horizon. For most people, that will require a bit of multitasking: Rather than wait until all of your student loans are paid off to begin investing in the market or saving for a down payment for a home, for example, you may want to earmark a portion of each paycheck for all three "investments."

Here are some tips for investing well and yes, multitasking, in your 20s and 30s.

Put debt in its place

One of the earliest forks in the road that many early accumulators face once they begin earning a paycheck is whether to steer a portion of that paycheck to service debt or to invest in the market. If it's high interest-rate credit card or student loan debt that features a particularly high rate, it's worthwhile to earmark the bulk of one's extra cash for those "investments." The reason is that it's impossible to earn a high guaranteed return from any portfolio investment today, whereas retiring debt delivers a guaranteed payoff that's equal to your interest rate. As a general rule of thumb, investors carrying debt with an interest rate of 5% or more would do well to focus on paying down those loans (or possibly refinancing into more favourable terms) before moving full steam into investing in the market. One exception: building an emergency fund (more on this below).

Invest in your human capital

While we're on the topic of "investments" in the broadest sense, the 20s and 30s are also the ideal life stage to make investments in your own human capital -- obtaining additional education or training to improve your earnings power over your lifetime. Of course, not every such investment pays off, and it's ideal if you can get your employer to shoulder at least some of the financing. But if you have considered an advanced degree or extra training of any kind, the earlier you get started, the higher your lifetime return on your outlay is apt to be.

Build a safety net

With limited financial capital, it's essential that young accumulators protect what they have and be able to cover financial emergencies should they arise. A good rule of thumb is to insure against risks that would cause extreme financial hardship and to skip insurance for items that would not. Homeowner's (or renter's) and auto insurance are musts, as is life insurance if you have minor children; on the flip side, you can do without the extended warranty for your laptop or washing machine.

An emergency fund is also essential, as having a cash cushion on hand can keep you from having to resort to unattractive forms of financing like credit cards or raiding your retirement savings accounts if you lose your job or encounter a surprise expense. While the rule of thumb of stashing three to six months worth of living expenses in cash might seem daunting, remember it's three to six months worth of essential living expenses, not income. This article includes tips for emergency funds.

Kick-start your retirement accounts

There are a lot of reasons that early accumulators put off saving for retirement. There's the not small fact that many people in their 20s and 30s are saddled with heavy student debt loads. Moreover, 20- and 30-somethings often have one or more shorter term goals competing for their hard-earned dollars alongside retirement savings: down payments for first homes, cars, weddings and children, for example. Psychology is also in the mix: With retirement three or four decades into the future, people who are just embarking on their working careers in their 20s and 30s may be hard-pressed to feel a sense of urgency in saving for it.

Yet the youngest investors have the longest time to benefit from compounding, and that benefit accrues even if they're only able to save fairly small sums and the market gods serve up "meh" returns over their time horizons. The 22-year-old who starts saving $200 a month and earns a 5% return per year will have more than $362,000 at age 65. Meanwhile, an investor who waits until 35 to start investing yet socks away $300 a month and earns a 6% return will have a little more than $300,000 at age 65. Those first 10 years of missed compounding swamp both higher returns and higher contributions later on, underscoring the virtue of getting started on retirement saving as soon as you can, even if it means starting small.

Focus on tax-sheltered vehicles

For retirement-savers of all ages, it's worthwhile to focus on investment vehicles that give you a tax break for doing so: RRSPs and registered company retirement plans.

A company retirement plan, if one is available, is invariably the simplest way to get started on retirement savings. Not only do many company retirement plans offer matching dollars on employees' own investments, but having contributions extracted directly from a paycheck helps reduce the pain of investing. (If you never put your mitts on the money, you won't miss it.) Making automatic contributions also helps enforce disciplined savings, even when the market is falling or your cash flows are at a low ebb.

For early accumulators whose employer pension contributions are poor, it's always worthwhile to contribute enough to earn the match; after that, turn to an RRSP for your additional investable assets. If you still have money left over to invest after meeting the match on your employer-provided plan and making an RRSP contribution, you can then go back to your company retirement plan and make the maximum allowable contribution. Only after you've taken full advantage of those tax-sheltered vehicles should you consider an investment in a non-retirement account (i.e., a taxable brokerage account).

Choose TFSAs if your taxable income is low or if you're multitasking

Retirement investors have another decision to make: Should they contribute to their RRSP or TFSA? The answer comes down to whether you'd rather pay tax today or later on. You make pre-tax contributions to RRSP accounts but have to pay ordinary income tax when you pull the money out in retirement. The tax treatment of TFSA contributions is exactly the opposite: You don't get a tax break on the contribution, but your withdrawals in retirement will all be tax-free.

Pre-tax (RRSP) contributions offer immediate gratification, in that all of your investment dollars can start working for you on day one, without paying taxes. But TFSA contributions can actually make more sense for young accumulators, whose tax rates at the time of contribution may well be lower than when they begin withdrawing money in retirement.

TFSA accounts offer an additional attractive feature that RRSP accounts do not: Contributions can be withdrawn at any time and for any reason without taxes or penalties. That makes a TFSA a perfect "multitasking" account for investors who need to build up both an emergency fund and retirement assets.

Of course, this need not be an either-or decision. This article outlines circumstances where an investor can make the best use of all different retirement accounts.

Invest in line with your risk capacity

Investors are often advised to consider their risk tolerance: How they'd feel if their portfolios lost 5% or 10% in a given week or month. That's not unimportant, especially if a nervous investor is inclined to upend her well-laid plan at an inopportune time. But the really important concept is risk capacity -- how much you could lose without having to change your lifestyle or your plan for the money. (This article discusses the difference between risk tolerance and risk capacity -- and how they can sometimes be at odds with one another.)

When it comes to retirement savings, early career accumulators have high risk capacities because they won't likely need their money for many years to come. That's why retirement portfolios usually feature ample weightings in stock investments: Even though they feature sharper ups and downs than safer securities like bonds and cash, stocks have historically rewarded their long-term investors with better returns than other asset classes.

On the other hand, if you're investing for shorter-term goals--such as a home down payment, you probably don't want to have much, if anything, in stocks. Yes, the returns from bonds and cash are lower, but they're also much less likely to encounter big swings to the downside.

Employ simple, well-diversified building blocks

So you've decided to take advantage of tax-sheltered wrappers for retirement savings, and to park the bulk of your long-term portfolio in stocks. But you still have to decide how, specifically, to invest that money. With thousands of individual stocks, mutual funds and exchange-traded funds, that task can seem daunting, but resist the urge to overcomplicate and/or to venture into overly narrow investment types.

Instead, focus on low-cost, broadly diversified investments. For investors just starting out, target-date mutual funds can take the mystery out of the investment process: These funds employ aggressive, stock-heavy postures when investors are in their 20s, 30s and 40s, then gradually become more conservative as retirement draws close.

If you don't want to delegate control of your portfolio's stock/bond/cash mix and investment selection, a simple way to put together a well-diversified portfolio is to employ index exchange-traded funds. Such funds track a segment of the market, such as the S&P/TSX Composite Index, rather than trying to beat it. That may sound uninspired -- and uninspiring. But broad-market index funds often have the virtue of very low costs, which can give them a leg up on actively managed funds over time. If you do opt for actively managed funds for all or a part of your portfolio, low fees should still be a key priority.

See also:

  • An investing road map for mid-career accumulators
  • An investing road map for pre-retirees
  • An investing road map for retirees

    About Author

    Christine Benz

    Christine Benz  Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.