Getting your financial footing can be a challenge when you’re young, especially if you have student loan payments or a new mortgage make you feel penniless. However, it’s never too early to start financial planning. By creating a budget, improving your financial literacy and understanding investments, you can set yourself up for success while you’re in your 20s. Here’s what to know.
For more help planning your finances, no matter your age, consider working with a financial advisor.
Tip One: Get Financially Literacy
Financial literacy means understanding how to make profitable decisions with your money. In other words, getting a handle on the basics provides a solid foundation for your financial habits and goals.
For example, if you want to get out of debt, it’s essential to understand the best way to do so. Specifically, you would need a working knowledge of interest rates, budgeting and how to compare the growth of your debts versus your investments. This way, you will know how much your debt costs per month, how much extra money you have to tackle your debt with and whether diverting money from your investment contributions is worth it.
Tip Two: Minimize Debt
On that note, managing your debt is vital to your finances. For instance, student loans and credit cards can spiral out of control, putting you further behind your financial goals. Instead of letting interest payments eat up more cash, it’s best to create a debt repayment plan. There are two popular approaches to debt repayment: snowball or avalanche.
The snowball strategy means paying off your smallest debts first. Once you repay your smallest debt balance, you can apply this payment to your next smallest debt. This way, you gain momentum with each payment. On the other hand, the avalanche approach means attacking the debt with the highest interest rate, the logic being that interest makes debt more expensive over time. This way, you get rid of the costliest debt first, allowing you to apply an increasing amount of money to your debt’s principal.
Remember, debt is the inverse of an investment. An investment grows based on a rate of return, and debt grows because of interest. Therefore, it’s key to get your debt under control before you start investing significant amounts of money.
Tip Three: Start Saving and Investing
You might wonder what the point of rushing to save money is; after all, you’ve got thirty or forty years until retirement. However, that’s exactly why it’s best to start contributing to an investment account now: you’ll compound your returns over several decades and grow your savings exponentially.
For instance, say you start investing $150 per paycheck at age 25. Your investments have an average annualized return of 8%. After forty years, you’ll have about $1.1 million in your account. On the other hand, if you start at 35 and invest for thirty years, you’ll end up with about $490,000 in your account. As a result, it pays (literally!) to invest now instead of later. You can estimate the returns of your investments with SmartAsset’s free calculator.
If investing seems intimidating, you can start simple. If your employer offers a 401(k), contributing to it is an excellent choice. You can also receive matching contributions from your employer. On the other hand, if you don’t have access to a 401(k), an individual retirement account (IRA) is a straightforward way to begin. You can open an account and fill your portfolio with passive management investments, such as index funds and exchange-traded funds.
Tip Four: Learn How to Budget
A budget is one of the most helpful tools to strengthen your finances. Although the word can seem scary, knowing where your money goes throughout the month is one of the most empowering facets of financial literacy. For example, reviewing your expenses can reveal an unused streaming subscription, weekly restaurant trips and an old gym membership. Addressing these expenses can net you a quick $100 a month in your budget, allowing for more saving and investing.
Dozens of budgeting apps and tools make this financial habit easier than ever. You can start with your mobile banking app, which likely offers a free budgeting tool. However, you can also branch out to online budget calculators.
Tip Five: Keep Track of Your Spending Habits
A budget gives you a foundation for tracking your spending. In addition, a habit of spending less than you make will help unusually high spending become apparent. So, it’s best to give your finances a quick review every two or three months. Specifically, you can review your bank and credit card statements to see if you can reduce any expenditures in the future.
Tip Six: Start an Emergency Fund
Surprise expenses can derail the best-laid spending plan. For example, your budget might be chugging along for several months before you need a $700 car repair. Then, suddenly, your investment contributions are out the window, and it can be hard to get back on track once the emergency is over.
To combat this situation, start an emergency fund along with your investment fund. You can build it up over time in your savings account. A good rule of thumb is to have three to six months of expenses in an emergency fund. This way, a broken furnace or surprise medical bill will be a minor bump in the road instead of a crisis.
Tip Seven: Protect Your Wealth
While a conventional picture of success includes a paid-off home, a well-funded retirement and a high salary, this scenario lacks a critical element: protection. Generally, guarding your assets means purchasing insurance or sheltering your wealth from taxes (more on that later). For example, an uninsured home could be a major liability instead of an asset if it suffers fire damage. Instead, a homeowners insurance policy can cover these disasters and preserve your wealth.
Tip Eight: Focus on Your Health
Healthcare is one of the fastest-growing expenses in the United States. As a result, keeping this cost low will boost your financial wellness. To that end, the best way to reduce healthcare expenses is to maintain good health. For instance, a consistent diet, exercise habits and annual routine checkups can improve your health. Implementing these practices will enhance your quality of life and reduce the likelihood of spending time in the hospital.
Tip Nine: Understand Your Taxes
Amidst your financial successes and hardships, one constant will remain in the background: taxes. You’ll be paying Uncle Sam for your entire career and retirement, so it’s best to get well-acquainted to minimize your tax burden. Specifically, your salary and other forms of income place you in a tax bracket, which tells you what percentage of federal taxes you’ll pay.
In addition, your retirement accounts have unique tax implications. For example, a traditional 401(k) uses pre-tax dollars, lowering your tax burden while you work. However, you’ll pay income taxes when you withdraw money from your account during retirement. On the other hand, a Roth IRA uses money the government has already taxed, and you’ll pay zero taxes on income from this account when you’re retired. Therefore, tax planning while you’re young can help you optimize your finances.
Tip 10: Partner With a Financial Planner
Taking control of your finances is a serious endeavor. Luckily, financial professionals can help you develop a financial plan tailored to your unique circumstances. In addition, their knowledge and expertise can fill the gaps in your understanding.
It’s best to understand how your financial planner makes a living before committing to one. Financial advisors can charge in multiple ways. For example, some advisors charge per hour, while others charge a percentage of the assets they manage. Therefore, it’s recommended to find an advisor whose fees make sense with your situation. In addition, working with a fiduciary ensures the advisor puts your interests first instead of signing you up for investments with high commissions and management fees.
The Bottom Line
Creating a financial plan requires effort, but it’s well worth it. Your financial habits will drive your lifestyle now and during retirement, so it’s best to get your finances under control. A healthy budget, tax plan and retirement account will make all the difference when you’re starting off. And, fortunately, you don’t have to go it alone. You can hire a financial professional to establish your goals and put you on the right path.
Tips on Financial Planning for Young Adults
- Financial wellness can seem like juggling – after all, you need to prioritize a budget, retirement plan, debt management, insurance and more. Fortunately, a financial advisor can nail down each aspect of your circumstances and create a sound financial plan. Finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Investing strategies change as you age. Generally, it’s best to be aggressive while you’re young and more risk-averse as you age. For more, here’s how to manage your portfolio’s allocation at any age.
Photo credit: ©iStock.com/RyanJLane, ©iStock.com/fizkes, ©iStock.com/andresr