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.
1. Become Financially Literate
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.
2. Don’t Pay With Credit
It is essential for young adults to avoid relying on credit for purchases because it can lead to financial habits that are difficult to break and may cause long-term debt. When someone pays with credit instead of cash or savings, it becomes easier to overspend, as the immediate impact of the expense isn’t felt. Young adults who aren’t yet accustomed to managing personal finances may struggle to stay within budget, which could result in accumulating balances that they cannot pay off quickly. Developing a habit of mindful spending early in life is crucial to fostering financial independence.
Additionally, paying with credit often comes with high-interest rates if the balance isn’t paid in full each month. This means that a purchase could end up costing significantly more than its original price. For young adults, who might still be building their careers and managing limited income, these additional costs can create unnecessary financial burdens. Once debt begins to accumulate, it can quickly spiral, leading to missed payments, late fees, and a damaged credit score. A poor credit score can then affect future financial opportunities, like qualifying for loans, renting an apartment, or getting better interest rates.
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.
3. 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 an investment calculator.
If investing seems intimidating, you can start simply. 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.
4. 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 savings and investment.
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.
5. 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.
6. 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.
7. 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.
8. 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.
9. 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.
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.
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 a financial advisor 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 have a free introductory call with your advisor matches to decide which one you feel 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.
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