Choosing Retirement Investments in Your 20s and 30s is Simple

Disclaimer: I am not a retirement or financial professional, and I take no accountability for the performance of your retirement portfolio. You take full responsibility for following the suggestions of some guy on the internet.

If you’re in your 20s and 30s, choosing the right investments in your retirement fund is incredibly straightforward. This is because there are only two guaranteed ways to make money in the markets long-term:

  1. Insider trading
  2. Investing in a broad-base portfolio (of mostly stocks) that mirrors the overall state of the economy and waiting 40 years

Anyone who says differently is lying to you because they want you to pay unnecessarily high fees for them to actively manage your money.

Let’s dig into the above statement a little more.



Why is it that you shouldn’t pay active money managers?

Because unless they’re participating in insider trading (point 1), they can’t consistently beat the market. And in exchange for that underperformance, they charge more than you need to pay.

Instead of using active money managers, I strongly recommend you use low-cost index funds. An index fund is an asset that divides up your investment money across multiple companies, weighting proportionally by each company’s market capitalization (market cap = stock price * number of shares, basically the company’s total value in the market), therefore reflecting the price movements of every company within that fund. It’s bought and sold like a stock.

How do we know that it’s impossible to consistently beat the market?

There’s a concept called the Efficient Market Hypothesis which essentially states that because all public information is already baked into the price of a stock, it’s impossible to “beat the market” in the long term. This means that it’s impossible to consistently receive a higher percentage gain than you would have received had you invested into every company proportionally by market cap. This doesn’t mean that an individual can never beat the market, but it does mean that it’s practically impossible to beat the market regularly or to make any guarantee ahead of time that you will be the one who will beat the market. Of course, due to random chance, a few fund managers will end up beating the market many years in a row… but just like being on a hot streak in the casino, past success is no guarantee of future performance.

Even Warren Buffett agrees. At the end of 2017 he cashed out on a 10-year bet where his investment in an S&P 500 index fund (which tracks the performance of the top 500 US companies) outperformed a portfolio of actively-managed hedge funds — by 90%. And this bet started in 2007, right before the market tanked during the 2008 recession!

My advice here is simple: because nobody can beat the market by actively picking individual stocks to buy or sell, don’t bother playing that game. Choose to passively invest your money in index funds instead and ignore any advice to the contrary. Doing so will not only maximize your gains, but will also minimize your stress.

But index funds are composed of stocks, aren’t stocks risky?

Stocks are riskier than any other normal investment… but only in the short term. And remember, this is saving for retirement, so we’re acting with the long-term in mind.

Within your retirement account you must choose to allocate your money between stocks and bonds. However, because your timeline is 30–40 years to retirement, you should be as close as possible to 100% stocks.

To see why, we need to look at something called the Equity Premium Puzzle. Given that over the last 100+ years stocks globally perform 6% better than bonds on average, the Equity Premium Puzzle asks why anybody holds bonds at all.

Nobel prize-winning behavioral economist Daniel Kahneman says the reason is because humans are more scared of losing something they already have than they are of leaving potential new money on the table. Because people are terrified of market crashes and recessions, they have a tendency to put money in “less risky” bonds, even though over our 30–40 year horizon they’ll miss out on earning hundreds of thousands of dollars! What’s really “more risky”?

Let’s compare two portfolios, one that is 100% bonds with an average 3.5–4% return, and one that is 100% US stocks with an average 8–9% return. Over a 40-year horizon, that portfolio might look like this:

Sure, the stocks line looks much more shaky, and as you can see there are a few major recessions and market crashes over our hypothetical 40 year period… but at the end of our time horizon, stocks significantly outperform bonds. And after enough time has passed, even a massive market correction is not enough to wipe out the outsized gains of stocks vs. bonds. In fact, even if you invested in the S&P 500 at the absolute worst time in the past 20 years (October 2007, the peak before the recession began), you’d still have 77% returns (as of June 2018) — better than the 54% returns you would have from a bond yielding 4% over the same time period!

Of course, the possibility of a recession significantly reducing our retirement savings is scary… but remember, our time horizon is 30–40 years. A recession lasting three years is nothing compared to how long we’re waiting! Those big dips are stressful, yes, but if you want to maximize your retirement savings in the long run, I implore you to invest mostly in stock index funds and then forget about those funds until you’re 5–10 years from retirement, at which point you should start diversifying into fixed-income securities like bonds. By not caring about the movements of the market until it actually matters to you, you’ll be able to beat human nature and get the best results possible.

Even if you do retire during a market downturn, it’s not like you’re not going to be taking all your money out at once. You’ll only take whatever you need each year out of your retirement fund, and the rest will be left in there to rebound along with the market recovery.

Choosing index funds with a long time horizon is investing. Picking specific stocks or having a short time horizon is gambling.

So how do I actually start investing my retirement money in index funds?

Now that we’ve established that you should invest in stock index funds, the next thing to prioritize is minimizing load, the amount (usually a percentage) that you pay any service to manage your money.

First, let’s discuss the primary exception to the above rule: if your employer offers a 401k with company matching, then you probably should be using that. The reason is obvious — free money. If your employer matches dollar-for-dollar on contributions to your retirement account, there’s almost no fee amount that will outweigh that free matching money. It’s also likely that your 401k provider offers a stock index fund as an investment option — look for something like a Vanguard fund that is made up of 100% large-cap US stocks. I can’t give you any more specific advice in this post because every 401k has a different set of funds to choose from. Careful with the pre-set “aggressive” allocations offered; my last 401k provider’s “aggressive” option was 25% US treasuries, which have the lowest return of any bond.

If you’re investing on your own or just left your company, then you’re going to want to put your funds in an IRA (individual retirement account) ASAP — those 1–3% per year 401k fees are steep if they’re not compensated by employer matching. Most IRAs, especially those that are run by a robo-investment service such as Betterment (more below), charge way less than your 401k provider does.

In order to minimize your load and maximize your returns, you pretty much have the following options:

  • Put your money in a Vanguard account and rebalance it periodically across their index funds. This will cost you 0.1% per year in fees, which is basically the lowest load possible.
  • Use a robo-investment service such as Betterment to automatically and optimally manage your money across different Vanguard index funds, which will cost you around 0.35% per year in fees. (Full disclosure — the links above contain my Betterment referral code.)

Sure, the additional 0.25% that Betterment charges will eat into your returns, but my question to you is this: do you want to think about your investments a little bit, or do you want to never think about your investments at all?

If you’re like me, having to think about how much money you should be allocating in US vs. European vs. developing country stocks sounds less fun than burning your hand on the stove. I highly recommend you take the lazy route and choose Betterment (or Wealthfront, same idea). They’ll do all the remaining hard work for you, and it’s even possible that due to some fancy tax magic they perform on your behalf, you’d do better with Betterment than you can do on your own.


To sum it all up:

  1. Never pay anybody who claims they can beat the market.
  2. Invest in mostly stocks via low-cost index funds.
  3. Don’t worry about how your investments are doing until you’re getting close to retirement.
  4. Consider a low-cost automatic robo-investment service such as Betterment or Wealthfront to even further reduce your cognitive load.

And what should you do when you hit 55 or 60, when you’re no longer acting on a 30–40 year horizon, and you have to start thinking about using your retirement funds for income?

Consider hiring a financial planner. But one without percentage-based fees.


Frequently Asked Questions

How much should I have invested at this point in my life?

Rule of thumb is you should have 1x your salary invested by age 30, 3x your salary by age 40, and 10x by age 50. This scales your retirement contributions with your (hopefully) increasing salary as you get older, matching your available retirement funds with your lifestyle expectations post-retirement.

And don’t worry, most people don’t hit the mark by age 30. Do your best.

How can I start saving for retirement when my salary is low?

Every year you don’t save for retirement is a year of compound interest lost. If you start saving at 25, you will end up having nearly double the retirement money than you would if you started saving at 35.

My recommendation is to just do it, even if it’s a small amount. Start by setting aside 4% of your salary and increase it by 1% every 3 months until your take-home salary just about matches your monthly expenses. Then make sure you bump up the percentage you’re saving every time you receive a raise.

So I shouldn’t pick individual stocks at all? Doing so is fun!

There’s nothing inherently wrong with picking individual stocks, as long as you realize that doing so is gambling, not investing.

And sure, gambling can be fun! But you can also lose a lot of money gambling.

I’m not saying that you shouldn’t play the markets — but recognize you’re taking on a significant amount of risk by doing so. High risk, high reward. If you’re gonna gamble, the thrill better be worth the stress. Just don’t put in more than you can afford to lose, and do this with money other than your retirement funds.

What’s the difference between a Traditional IRA/401k and a Roth IRA/401k?

The difference is in the timing of tax. See the following table for when tax is incurred:

Taxable accounts (if you just put money from your bank account into a regular brokerage account): you pay income tax (~35%) when you get paid by your employer, and you pay capital gains tax (~15%) on any stock appreciation when you sell your investments. You can withdraw your principal (the money you originally used to buy the stock) tax-free.

Traditional IRA/401k: You pay NO income tax when you get paid by your employer (the money skips your checking account and goes directly into your retirement account), but when you sell your investments you pay income tax on the FULL amount that you withdraw — both principal and gains.

Roth IRA/401k: You pay income tax when you get paid by your employer, but you pay NO tax on anything when you sell investments.

If your income tax rate will be the same now as when you retire, then Traditional and Roth accounts have the same exact expected value when you withdraw your retirement savings (the timing of paying taxes is different, but the net payout to you is the same). However, if your tax rates will be different when you retire than they are now, then it gets interesting:

  • If you think your taxes will be higher when you retire, you should consider using a Roth IRA/401k. This might be because you’re early in your career and your income is lower now than you think it will be later, meaning that you pay a lower income tax rate now than you will later. Maybe you live in a state with no income tax, but at retirement you may move to a state that does have income tax. Or maybe you think the government will jack up tax rates between now and when you retire.
  • If you think your taxes will be lower when you retire, you should consider using a Traditional IRA/401k. This might be because you plan to move from a high tax state such as New York or California to a state with no income tax such as Texas or Florida. Or maybe you think the government will drastically lower tax rates between now and when you retire.

You can also do some real interesting (shady, yet legal) stuff with a Roth IRA, such as stuffing it with near-valueless shares of a company you just founded, later reaping the tax-free rewards when the company is worth millions. This is how Mitt Romney ended up with a Roth IRA worth more than $100 million, despite a Roth IRA contribution limit of $5,500 annually.

How much money should I keep in my checking account?

Only as much as you need to pay your regular bills.

Inflation in the US is somewhere around 2% per year, meaning that $100 in goods today will cost $102 at this point next year. Most checking accounts currently pay 0.1% interest per year, or even lower. That means you are actually losing money by keeping it in your checking account!

If you have a Betterment account, you can set up a non-retirement account that invests in whatever you want (a mix of stocks and bonds may be a good idea here, as your time horizon is shorter than retirement). You can then use their Smart Deposit feature to automatically transfer money from your checking account to Betterment whenever your bank balance exceeds some threshold you set.