This article has been written a thousand times. I am going to try and take a bit of a contrarian approach. This is a suggested approach during your 20s to set yourself up for financial independence – whatever that means for you. We shared some thoughts on financial freedom on the 100th episode of our podcast Investing Compass. 

I’ve made a lot of financial mistakes in my life. But I got my act together in my 20s and managed to save a good amount of money despite my low salary. And that has given me more options now that I am 44. Whether made unconsciously or not, our youthful decisions tend to lead to a narrower set of pathways for the future. Financial freedom is about expanding those pathways and creating optionality for the future.  

Get your retirement sorted

Conventional wisdom is that your 20s are a time for exploration and figuring out who you are and what kind of life you want to live. There is nothing wrong with that but whatever you decide to do in life financial flexibility will help. My financial focus during my 20s was retirement. That is one decision I made in my 20s that I don’t regret.  

Retirement is often the last thing on the mind of someone in their 20s. Afterall it is so far away and there are more pressing matters – financial and other wise. But the fact that retirement is so far away is the exact reason it should be the primary focus.

There is nothing more valuable than time when it comes to investing. There is no impediment that time can’t overcome. Can’t save a massive amount? Time will make up for it. Don’t know anything about investing? Buy an index fund and let the passage of time works its’ magic.

Want to save $100,000 for retirement at 65? At a 7% return you can count on $100,000 for every $9,500 that you can save by the time you are 30. That takes saving and investing $55 a month during your 20s. If you wait until your 50s to get serious about retirement it will take saving and investing $450 a month.

There is an extra advantage in focusing on retirement when you are young. The tax advantages associated with super also compound. The more contributions to super that can be made through concessionary and non-concessionary contributions as early as possible the more total wealth will be created at retirement.

A $5,000 pre-tax concessionary contribution into super at 25 at a marginal tax rate of 32.5% will be worth $63,641 with a 7% return at 65. Saving it outside of super would result in $50,538. And that doesn’t include the lower tax rate on dividends and capital gains over the life of the investment.

Setting yourself up for retirement in your 20s may seem counterintuitive. But retirement is something that all of us will face. It is an issue that needs to be addressed at some point and mathematically the best time to address it is when you are young.

Compulsory super means that retirement saving will be a lifetime endeavour. However, achieving financial independence takes more than simply saving at the compulsory level. It means higher savings rates. And creating optionality in the future to retire early, take a career break, cut back to part-time or pursue a lower paying line of work means at some point additional contributions need to be made.

It also means saving outside of super to bridge the gap prior to the preservation age when super can be accessed. But the case for taking care of retirement first is overwhelming.  

Minimising cash

An emergency fund is a key component for investing success. It protects your long-term investments in growth assets like shares from unexpected expenses. It is important to keep in mind that there is an opportunity cost from holding cash. Historically the return on cash has barely exceeded inflation. Over the long term the secret to building wealth is to earn a return that meaningfully exceeds inflation. Cash is not the answer.

The longer growth assets are held the greater the impact of compounding. That means more total wealth. The opportunity costs from holding cash are highest when potential investment horizons are long.

Cash provides psychological safety which is something we all seek. Many people intuitively attain this security before investing as portfolio values can fluctuate significantly. Younger investors are faced with the greatest impact from high cash levels.

When I was younger, I tried to keep my emergency fund at a bare minimum and concentrated on saving and investing as much as possible. Looking at return projections helped to keep me focused. Over time I’ve grown my emergency fund as the opportunity cost of cash dropped.  

An emergency fund is not a one-off endeavour. It can be built up overtime. And there is an argument that while you are younger there is less of need for a large emergency fund. A study in the US cited the duration of unemployment by age. The median duration of unemployment for 25- to 34-year-olds was 7.8 weeks. As people age it takes longer to find a job. The median duration for 55- to 64-year-olds was 12.7 weeks. Highly skilled workers suffer from age discrimination and are often perceived as being overqualified for many jobs.

The likelihood and costs of unexpected expenses tend to grow as people age and more possessions are acquired. A car and house are two examples of possessions that can lead to high unexpected expenses which are disproportionately owned by older adults. Medical expenses tend to be lower when you are younger. And being childless can reduce the chances of unplanned cash outlays.

This is not an argument for not having an emergency fund. It is simply a statement of fact that a universal rule of thumb for the size of an emergency fund should be adjusted by circumstances. Getting as much money invested – especially in super – should be the goal in your 20s.    

Avoid speculative investments

We are told that being young is the time to take risks. Maybe in life but investments are a different story. Conventional wisdom says that if a speculative punt pays off, you are set-up. If it doesn’t you have time to make up for the losses. That supposed wisdom just doesn’t hold up. The advantage to investing when you are young is time. The opportunity cost of not investing or losing a significant amount of money is significant.

I started investing in shares when I was in university. It was the dotcom bubble and I bought into the hype. In retrospect I didn’t really know what I was doing. But I read a couple articles and confidently bought individual shares in can’t miss internet related companies. Global crossing was one such example. I will spare the details. But it is safe to say a lot of my early investments were anything but can’t miss.

I had visions of being the next Warren Buffett. I ignored the fact that Buffett said most people should invest in index funds. What I should have done was follow his advice and built the core of my portfolio in relatively safe and steady investments. There was plenty of time to add other investments later in my life when I had learned a bit more about investing. One of the things I’ve learned is that there is power in buy and hold investing.

Losing money on investments matters a lot more when you are young. The stock market is going to have periods where it goes down. The problem was that my speculative bets didn’t just go down. They crashed. In the case of Global Crossing the company went bankrupt. I don’t remember how much I invested in Global Crossing. But I do know that investing in an index fund would have been worth significantly more 22 years later.

Being young is hard. There is a lot of pressure to “make-it” as fast as possible. But financial freedom takes time. And using your 20s to set yourself up for success is an opportunity that won’t present itself again. Focus on savings and getting money into the market where long-term returns provide the most benefit.

In the next article I will share thoughts on setting yourself up for financial success in your 30s. I would love to hear your thoughts at mark.lamonica1@morningstar.com