Financial Boot Camp for 20-somethings: 5 out of 5 days
Now is the time to organize your money.
By the time you're in your 20s, retirement may seem so abstract that it may be thousands of years away.
Maybe you feel that way right now too. Why save for decades into the future when every last dollar has to be accounted for here and now? It can feel impossible to actually save anything.
But what if we laid the foundation to make saving even a little easier? That's what we'll be working on today.
As with any reason you might want to delay retirement, it's smart to start retirement early. Time is on your side. If you set aside what you can do now, the magic of compound interest will allow you to do more over time when you start earning interest.
This means that saving early means you'll save less in the long run, which can take some of the pressure off you when it comes to dealing with other needs that inevitably arise. Maybe that need is the kids and all the money they're sucking up, or maybe it's the need for time off to care for an aging parent.
And (most) no one wants to work forever. The earlier you start saving, the sooner you can stop working and spend more time doing meaningful things.
In fact, the easiest way to save on anything is automation. When your money moves automatically and regularly to its destination, you don't have to remember anything. This also applies to purely enjoyable financial goals, like saving for a big trip.
It's empowering and will put you closer to the things that make you happier and more financially secure. It may take time and patience, but your future self will thank you.
Before you start, you need to figure out how much work you have to do.
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Deal with your debt. Before you start saving, make sure you have a plan to pay off high-cost debt, such as credit card debt, where interest rates (around 22%) far exceed the money you could earn by investing your savings in the stock market. time (7-8%).
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organize Get a copy of your pay stub or check your direct deposit to know your actual salary. (Freelancers should calculate their average monthly income.) Then write down all your expenses: rent, any insurance not already deducted from your paycheck, utilities, groceries, transportation, car payments, cell phone, student loans, and other debts.
How much is left? what? congratulation! There is space to store it. Do you cut close? Is there anything you can cut back on to make room to save money?
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Build a buffer. Building a financial buffer in the form of an emergency savings fund can help you avoid using your credit cards if you find yourself in financial trouble, such as suddenly losing your job or needing a $1,000 car repair bill.
Financial planners suggest keeping three to six months' worth of expenses in emergency savings (kept in a high-yield online savings account that offers the best interest rates). That may seem like a lofty goal if you're living on a starting salary that barely covers your bills. So start small, even if it means saving $50 a month. For just $83 a month, you can earn $1,000 a year. And add more when you can afford it. Set up an automated plan to transfer that money from your checking account to your savings account. Then don't touch that money.
saving for retirement
Many people with student loan debt often wonder if they should focus on paying off their loans before saving for retirement. Short answer: Probably not. (If you're really struggling to pay your federal student loans, check out the income-driven repayment plans we mentioned yesterday.)
However, there is a strong case for investing and repaying loans simultaneously, if possible.
The picture below really screams why. Can you see how much you're likely to give up if you just focus on paying off your loan over 10 years?
You might be lucky if you have access to a 401(k) or similar workplace retirement savings plan. Only 69% of private sector workers do so.
You may have already heard that some plans come with the cool benefit of being free. Your employer may offer matching contributions as you save. For example, they may match every dollar you contribute up to 4% of your salary.
This means you are effectively contributing 8% of your income, which is very close to the 10% recommended by experts (they often recommend saving more, up to 20%, but 10% is a good start. Consider increasing it by 1%) do it). Award points if you get a raise each year).
What happens if you don’t have a workplace retirement savings plan?
A Roth Individual Retirement Account (or Roth IRA) is often the right choice for young people (but income and contribution limits apply). That's because you're saving money that's already been taxed, and you're likely to be in a lower tax bracket now than later in life when you're likely to earn more.
Compare this to a traditional IRA, which offers a tax deduction now, but pays income tax once the money is withdrawn. That means your Roth IRA balance is the amount you have to spend, while your traditional IRA balance is reduced by the amount of taxes you owe later.
How should I invest my money? Short answer: various combinations of index funds. These are low-cost mutual funds that track broad swaths of the stock and bond markets (exchange-traded funds, which are similar to mutual funds but traded on exchanges, are a similar option). Check out this guide to learn more about investment options.
More immediate spending goals
Aside from retirement, you probably have other savings goals as well. Maybe you're saving for a car, a wedding party, or a special trip. Because these goals are shorter in duration than retirement or goals that must be achieved within three years, you'll want to take less risk with this money. The easiest strategy is to automatically transfer money to a high-yield online savings account each month. For short-term goals, how much you save is much more important than what you earn.
However, if you need money 3 to 10 years down the road (let's call it a medium-term goal), you may have more options, depending on how flexible you are with your timing.
For example, you may be tempted to invest your savings in the stock market to generate higher investment returns. But it carries more risks. As one financial planner wisely put it, you should consider how you would feel if you lost half your stock investment in a particular year, and it may take time, or even years, to recover. Do you have the time (or guts) for that?
For example, you could take a hybrid approach and invest in a mutual fund with a mix of 60% bonds and 40% stocks. Alternatively, you could look into bond investments, which offer more stability (which themselves carry risks). But tread carefully.
Even if you don't have a lot to save right now, building the infrastructure to save is the hardest part, and as your income increases, it will become much easier to save and invest more.
Action items:
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Do you have a high-yield online savings account? Some banks, including Ally and Capital One, allow you to set up different savings buckets that you can label for specific goals (emergency fund, vacation, down payment). DepositAccounts.com has a helpful guide to help you sort through your options.
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If you have a retirement plan at work but haven't thoroughly researched your investment options, set a reminder on your phone calendar to check it out. What index fund options are available? Also, familiarize yourself with target date fund products. (These are ready-made investment combinations that you can pick and forget, a mix of stock and bond mutual funds that automatically become more conservative as you get closer to the year you expect to retire. 2000, 2065, or 2070 funds) may be appropriate for your situation.)
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If you don't have access to a workplace retirement plan, look into robo-advisors, or companies that rely heavily on technology to manage your investments but often have human financial advisors. This is a good option for people with simple needs or those who want to automatically set up and run a savings and investment plan. Morningstar has selected its top picks here.