How to Invest at Age 21

The fact that you're even thinking about beginning to invest at age 21 puts you at a massive advantage to many people in a similar situation to you. The number one benefit you have, when it comes to investing at a young age, is you have a much longer timeframe than if you leave investing until later in your life. This is really important, because the longer the investment time frame you have, the more risk you can afford to take with your investments, and therefore the higher returns you can likely expect over the long term. 

One of the key issues with investing at such a young age is that you won't be exactly sure how the rest of your life is going to plan out. So it's really important to make sure that you've got lots of different pots of money for lots of different potential future plans. 

In today's article, I'm going to explain the importance of investing at an early age and investment options for short term, medium term and long term investments. But before we get into the nitty gritty of the types of accounts that you should consider, it's really important to understand what it is you're investing for. Because regardless of whether you're investing at age 21 or 51, before you can know what are the right types of investments for you, you need to understand what your end objective actually is. 

What Are Your Plans for the Future?

So when you're 21, or in your late teens or early 20s, it can be a bit hard to understand or know what your long term plans are for the future. You may be at university now, you may be working full time, you may be about to finish university, or you may be travelling and not really sure what you want to do with the rest of your life. To start with, it's important to realise that you're definitely not alone. 

Very few people in this world really understand what their life is going to look like when they're 21. The important thing is to start giving a little bit of thought as to what you might want to do. These plans are not set in stone, but starting to get a rough outline of the type of life you want to live, the types of things you want to do with your time, and the type of career you want to have will give you some insight as to the type of investments you should have, and how much you should have in each of your plots. 

Should You Invest for the Long Term in Your 20’s?

And this is the first point to understand, when you're looking at your investments. There's no one size fits all approach to investing your money at any age. It's important that you've got different pots of money that are allocated to different things you want to do in your life. Broadly speaking, we bundle these into three different pots, your short term investments, which are anything between zero to three years. Your medium term investments, which tend to be from, say, three to seven years. Your long term investments, which is anything that you don't plan to access for more than seven years.

When you're trying to decide how to invest at age 21, you're going to be placing more emphasis on your short and medium term investment options. Because you don't know exactly what your life is going to look like, making plans for the long term is difficult. It's not that we should ignore that completely, but the main difference to your life is going to be felt through maximising your short term and medium term investment options. So with that said, let's look at what some of these might be. 

Short Term Investment Options at age 21

When you're age 21, or somewhere in your early 20s, your short term investment options are some of the most important. Who knows when you may get an opportunity that requires access to cash at short notice. That might be a job offer on the other side of the country that’s going to cost you a couple thousand pounds to move. It may be the trip of a lifetime with some friends. It may be the need to purchase a new car. 

There are many different things that can come up when you're at a young age that you haven't necessarily planned for. This is why having a cash reserve or emergency fund is really, really important. This is a lump sum of money that you can have quick access to at a moment's notice should you need it. And whilst I'm talking about this as an investment option, realistically, you shouldn't look to invest this money, as these are funds that you could potentially need, in a short space of time. 

How Much Should You Have in an Emergency Fund

There's lots of debate as to what amount you should have in a cash buffer. As a young person, you can tend to get away with a smaller amount, as you're likely to have few responsibilities. A good rule of thumb could be six months worth of living costs. Now, if you're living at home, not paying for your own bills, this could be quite low. So I generally recommend at least a minimum of £5,000, if you can get that much together. This provides you with a safety net, and a level of security that you can fall back on if something comes up, or if your circumstances change unexpectedly. 

As to what account to use for this money, it's best to just keep it in a basic current or savings account. You're not going to get much in the way of interest on these, but you know you're going to be able to access that money at very short notice, should you need it. The aim here is not to grow your wealth with this pot, but more just to provide that flexibility and security. 

Are Premium Bonds Good for an Emergency Fund?

Some recommendations you read online suggest using NS&I Premium Bonds for your emergency fund, but I'm not a big fan of this. The main reason is that it can take a couple of weeks, or even longer, to access your money from this account. Whilst it does give you the opportunity to potentially win a million pounds in a type of lottery, that's not what this money is for. You want to make sure that if you are stuck on the side of the road with a blown car engine, or you need to get access to some money within a few hours or days, you can rely on those funds being available. 

For use as a cash buffer for short term savings, Premium Bonds can be a good option, but for an actual emergency fund, you should stick to a basic current os savings account.

Medium Term Investment Options at age 21

For most people who are looking at how to invest at age 21, the bulk of your money should likely go towards medium term investment options. These are funds that you are prepared to invest into the stock market, though it's important to keep in mind that if you're doing that, you need to have an investment timeframe of at least 3 years, and preferably 5 years. This is because investments like the stock market can go down as well as up, so giving yourself  sufficient time to have the funds invested means you have time to ride out those ups and downs.

Investing your money in a medium term pot gives you lots of options for the future. So regardless of whether your plans are to emigrate to a different country, to buy your first house, to go back to University or to start a family, investing in a pot that has a timeframe of around 3 to 7 years will cover a lot of the potential plans that you might have.

Are ISAs a Good Way to Invest for the Medium Term?

So there are some specific features that medium term investments should have. Firstly you need to be able to access them without penalty within the next 10 years. You need to have the money invested into a diversified portfolio so that you can aim to have this investment grow in line with, or ideally above, the rate of inflation. This is particularly relevant at the moment with inflation at all time highs.

It's also important to try and manage the tax on these investments, because over this period it is probable that you will experience some form of capital growth and income if you invest In the right way. If you're not careful, this could attract capital gains tax and income tax, which you want to avoid if at all possible. It's for this reason that utilising an ISA wrapper is one of the most efficient ways to hold your medium term investments. You can contribute up to  £20,000 into this account, and once it’s in there it grows tax free, and you can withdraw it at any time tax free as well. Importantly, the ISA is just a wrapper. 

Is Money in an ISA Invested?

Within the actual account you're able to hold lots of different forms of investments, or just keep it in cash if you're not comfortable with investing. If you are looking to invest the money, you don't have to go 100% into the stock market. Most investment platforms will give you the option to invest at various different risk levels, with various different percentages. Investing into the most aggressive form of investment would have 100% in the stock market, the most cautious would have likely somewhere between 20 to 30% and there are plenty of balance options offering between 50 to 75% in the stock market. It's important to remember that the higher the better percentage, investing in shares, the higher your likely long term returns, but also the higher the levels of volatility.

The Benefit of Lifetime ISAs for Young Investors

Another good option to consider for medium term investments is what's known as a Lifetime ISA. A Lifetime ISA is an account designed mainly for people saving for their first home, but it can also be used for retirement planning as well. You can attribute up to £4,000 pounds per year into a Lifetime ISA, and the UK Government tops this up with a 25% bonus of up to £1,000. That 25% Bonus makes this a very attractive option for people looking to save for a first home.

Now importantly, you can get access to this money for purposes other than buying first home, but you will pay a penalty of 25%. This means you lose all of your bonus, plus a little bit of your own initial investment as well.  So it should only be considered as something you need to access other than for a first home if it's in the event of an emergency. The other thing to keep in mind is that the £4,000 You can contribute into a Lifetime ISA also counts towards your overall ISA cap of £20,000. So if you were to maximise your Lifetime ISA contribution of £4,000 per year, that means you could put up to £16,000 into your other ISAs such as a Stocks & Shares ISA or a Cash ISA .

For most people the combination of ISA’s are going to be one of, if not the, best ways to hold your medium term Investments. Most people at the age of 21 are unlikely to have more than £20,000 pounds per to invest, but if you do you can also consider a General Investment Account. These do attract tax but again, depending on your earnings this may not be an issue for you as there are plenty of allowances such as the Dividend Allowance, Capital Gains Tax allowance and your regular Personal Allowance to utilise before you pay any tax.  

It's also important to keep in mind that you can move this money from your General Investment Account into an ISA over time, so if you have a lump sum you can move £20,000 each year into different forms of ISA, making your portfolio very tax efficient over time.

Long Term Investment Options at age 21

As I said before, when you're aged 21 and looking at how to invest you probably shouldn't focus too much on your long term investment options. You can invest into a pension and if you're working, your employer will pay into one for you, but it's really important to keep in mind that the money you put into it pension will be locked away and till you're at least age 55.

Given how far away that is for you, there's also the potential for this age to increase, just as the State Pension age is increasing all the time as well. So whilst you shouldn't likely contribute too much into a personal pension from your own money, you should take some care and pay attention to your existing pension contributions. 

Due to auto-enrolment if you're working part time or full time, you'll likely be having pension contributions made on your behalf. These will be going into a default investment option which may not be in line with your own attitude to risk and your own thoughts around investments. When you’re reviewing these pension options, keep in mind that you can't access that money for a significant length of time. If the investment option is too conservative, you run the risk of missing out on tens or even hundreds of thousands of additional capital once you reach retirement.

If you do want to start making some minor pension contributions these can be beneficial as there is tax relief available. This means your contributions are grossed up by the Basic Rate Tax, and this provides a boost to the account and allows compounding to take effect over many many years.

What is the Best Way to Invest for a Young Person

If you're thinking about how to invest at age 21, the most important thing is just to do something. When you are starting at such a young age, you have a long time for compound interest to take effect. The details of which specific fund or wrapper you pick aren't as important as maintaining a long term, consistent investment approach. Making ongoing, regular contributions to investments over a long period of time is likely to end up was significantly better results than making ad hoc lump sum contributions at a later stage in life.

Finally, don't forget you're only 21 once! It's great to be considering making some investing options and thinking about your financial future, but don't give up your life now for potential freedom at some point in the future. As time goes on you will gain more responsibility, more costs and less freedom in your life, which means that crazy opportunities that you can take advantage of now aren’t necessarily going to be available to you in 15 years time when you've got a mortgage and a couple of kids. It's always important to maintain that balance over enjoying your life now, whilst also being responsible for your future.