If you are in your 20s and have started planning for retirement, then you probably feel pretty lonely: A survey conducted two years ago by Scottrade suggests that four out of five young people have not yet begun actively planning for retirement.
If you're one of the smarty-pants 20-somethings that have already started to save for retirement, you're already winning. For every dollar you save in your 20s, you can reasonably expect a minimum tenfold return -- and you could definitely see more.
Achieving a return that high, however, requires a lot of patience and perspective.
If you are in your 20s now, it will be 30 to 40 years before you touch any of the money you've diligently stored away. That means you can afford to put all of your retirement nest egg -- that's right, 100% -- in the most risky and lucrative investment medium there is: the stock market.
Consider this: Large-cap stocks yielded an approximate 10.4% average annual return from the mid-1920s through the mid-2000s. In rolling 30-year periods, even during the Great Depression, stocks beat bonds every time.
Investors in their 20s can establish a large portion of their nest eggs by getting totally invested in stocks at this early stage of the game. Time is your friend; it minimizes the risk involved with total stock asset-allocation because you have time to ride out the lows of the market.
This isn't the Wild West. There are a few rules you should follow if you want to maximize your returns and minimize your exposure to risk.
Rule No. 1: Don't put all your eggs in one basket
By investing 100% in stocks, you are already (sort of) putting your eggs in one basket, so spread the love around. Index funds are a great way to gain exposure to a variety of stocks for a lower cost than a managed fund. The Vanguard Large-Cap ETF (NYSEMKT:VV) is a good place to start for new investors. This fund offers a sampler of some of the largest U.S. stocks and will save you a fortune in fees in the long run. ETFs offer a lot of flexibility: You can buy and sell them like stocks, and you don't need to have a lot saved up before you can purchase a few shares.
Alternatively, if you want to get broader stock-market exposure and you have a little more to spend, consider the Vanguard Total Market Index Fund (NASDAQMUTFUND:VTSMX). This fund offers about 30% of mid-cap and small-cap exposure in addition to its large-cap holdings. This fund has a $3,000 minimum initial purchase, but many brokerages offer monthly periodic investing in mutual funds after you make your initial purchase, which will help automate saving.
Rule No. 2: Avoid target-date funds
The idea of avoiding any actual retirement planning by tossing your money into a target-date fund is alluring. These funds allow investors to pick their target retirement year, and they supposedly provide an asset allocation that is risk-proportionate to the investor's time horizon. These funds, however, are often too conservative for young investors who have time on their side.
For example, the T. Rowe Price 2055 Retirement Fund (NASDAQMUTFUND:TRRNX) is invested 10.53% in cash and bonds. Investors in this fund are more than 40 years from retirement, and there's no reason they should have any portion of their portfolios in bonds or cash. This reduces the fund's potential return, and on top of that, investors will lose even more to management fees, which are significantly lower among passively managed index funds.
The long haul
Riding out the highs and lows of the market is the hardest part about being fully invested in the stock market. Once you get past the psychological barriers, however, you will find that the rewards are great down the line. Putting away a little now will give you more freedom in your career, more confidence in your future, and more options in your life. Your future self will marvel at how smart you were.