As recent graduates begin to enter the workforce, one of the best things they can do is start putting financial plans and goals in place. Part of these plans should be how to approach investing, as well as best practices to follow.
If you don't know where to begin, here are three smart investing moves for recent graduates.
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1. Contribute to a Roth IRA
One of the best things about a Roth IRA is that it essentially works like a regular brokerage account with major tax advantages. Unlike a 401(k) plan, where you're given a choice of limited investment options, you can invest in any single company or exchange-traded fund (ETF) you want to in your Roth IRA account. And since you contribute after-tax money into a Roth IRA, you can take tax-free withdrawals in retirement.
Having your money grow and compound tax-free can easily save you thousands in taxes when you potentially sell the investments in retirement. If you have $100,000 in a fund in both a Roth IRA and brokerage account and want to sell them, the difference could be up to $15,000 in taxes if your capital gains rate is 15% (the rate for single people making between $40,401 to $445,850).
Roth IRAs also have an income limit for eligibility. So if you're early in your career, it's best to take advantage of the tax benefits of a Roth IRA because there may come a time when you're over the income limit.
2. Begin acquiring dividend-paying stocks
An underrated source of income -- especially in retirement -- is dividend payouts. To set yourself up to receive worthwhile payouts in retirement, you need to begin accumulating dividend-paying stocks. The earlier you begin, the better, because compound interest and time will work wonders.
As you begin to invest in companies or funds that pay dividends, you should also enroll in the dividend reinvestment program (DRIP) offered, which takes the dividends you receive and automatically uses them to buy more shares of the company or fund that paid them out.
If you contribute $500 monthly to an investment that returns 10% annually, the difference in the total amount you'd have between that and an investment that adds a 2.5% dividend yield on top would be over $600,000 in 30 years. With a 2.5% dividend yield, here are the various annual dividend payments you'd receive with different account totals.
| Account Total | Annual Dividend Payouts |
|---|---|
| $1 million | $25,000 |
| $1.5 million | $37,500 |
| $2 million | $50,000 |
Data source: Calculations by author.
With those payouts, you could be receiving over $2,000, $3,100, and $4,100, respectively, monthly in retirement.
3. Use dollar-cost averaging
Unfortunately, it's easy to let your emotions control some of your investing decisions; it happens to the best of us. One of the ways you can try to avoid this is by using dollar-cost averaging. With dollar-cost averaging, you make regular investments at consistent intervals, no matter the stock's price at the time. It's essentially how 401(k) plans work. Each paycheck, you make contributions into the account, and it's invested regardless if the assets are "expensive" or "cheap" at the time.
You can choose to break down your investment schedule however you see fit. It could be weekly, biweekly, monthly, quarterly, or whatever other time interval works for you. What's most important is that you get into the groove of making regular investments and have it become a natural part of your financial plans. The $1 million, $1.5 million, and $2 million totals from above may seem like a lot, but with dollar-cost averaging, time, and compound interest, it's fairly easy to attain for many people.
