If you’re the type of 20-something who wants to take a deep dive into personal finance, pat yourself on the back. There are plenty of great websites and books to immerse yourself in. But if that is so not you, no worries. You can build a fantastic foundation for financial success by focusing on just three key goals.
∙ Pay your bills on time. Sounds obvious, but perhaps you’re familiar with the saying that the road to hell is paved with good intentions? If you intend to pay bills at the end of the month, you can run into the “Whoops, I’m a little short” scenario: You spent a tad more during the month than you anticipated. So you let a bill or two slide.
The trick is to put bill paying ahead of spending. Set up automated bill pay. It’s super easy and free. Just link your checking account with any monthly bill — student loan payment, credit card, etc. That ensures bills get paid. Then, if you haven’t already, set up banking alerts to send you updates on your balance. If you see it’s getting low, you know to scale back spending.
A bonus: Your track record for on-time bill payments is the single biggest factor in computing your FICO credit score. You definitely want to sweat your credit score. Any time in the coming years when you want a loan, it will play a big role in approval, amount and rate.
The FICO scoring algorithm only cares that you pay the minimum balance due each month with credit card bills. That’s a costly trap. Given the high interest rate charged on credit card debt — the average is more than 16% recently — paying the minimum basically means you will be paying that high interest for years.
∙ Shovel 20% of after-tax pay into savings. The focus here should be on two types of savings: building an emergency fund and saving for retirement.
Emergency fund is cash you can tap at a moment’s notice to cover an unexpected expense: car repair, health insurance deductible, staying afloat when a pandemic causes massive unemployment.
Your emergency fund needs to be a separate savings account. That’s how you nudge yourself to only use the money in an emergency. Use an online bank that has a high-yield savings account (a quick online search will land you at great candidates) and have a monthly automatic deposit sent from your checking account to the online savings account. This is free. Regular banks tend to pay lousy interest rates on savings accounts.
Three months of living costs is your first goal. Stretching it to six months can be some valuable peace of mind. The key is to just get started, whether it’s $100 a month or $200 a month. Every month you’re making progress.
Retirement: As ridiculous as it sounds to be saving for something four or five decades off, this is the perfect time to start. The earlier you start, the less of your own money you will need to set aside.
If there is one concept you want to wrap your head around it is compound growth, which is all about time. The more time your money has to grow, the better. Save $1,000 at age 25, earn a 5% annualized return and it will be worth more than $11,000 at age 75. Save $1,000 at age 35 and it will be worth just $7,000 at age 75. You saved the same amount, earned the same return. The only difference was the time your money had to compound.
Wonks who study “retirement security” have found saving at least 10% of your salary if you start in your 20s should be a base goal for landing in retirement in good shape. Make it 15% and your odds of hitting retirement with plenty of income to maintain your lifestyle are going to be even stronger.
If you have a workplace retirement plan that offers a matching contribution you can use that for your retirement savings. Without a workplace plan? Check out Roth IRAs. You can save up to $6,000 this year. If you’re self-employed you are eligible for a SEP-IRA, which can enable you to save even more than in a Roth IRA.
Big discount brokerages such as Fidelity, Vanguard and Schwab all offer IRAs.
∙ Drive smart. A car may be a necessity, but it is a financial sinkhole. Your goal should be to spend the least possible and keep a car as long as possible. Develop this habit now, and you can plump up retirement savings by more than $500,000.
The auto industry is hell-bent on wooing you with examples of how much you can borrow. That’s a trap. Do they know or care how you’re doing with the student loan? The emergency fund? Retirement account? Of course not! That’s on you.
First, focus on used, not new. Much cheaper. A three-year-old car is still going to be in good shape and drivable for many more years.
Never lease. Never. Look, this is where 20-somethings get hoodwinked. The monthly payment on a lease will always be lower than the monthly payment if you buy with a loan. But here’s the thing: When you lease, you end up on a payment hamster wheel that you never get off.
Paying off a car gives you a wonderful chunk of change each month to put toward other goals.
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