5 Financial Tips for Young People
No doubt many of us wish we could go back in time to guide our younger selves toward what, in hindsight, might have been different choices.
You probably know people who are still feeling the impact of financial decisions made years ago. While no one can change history, we can try to educate the young people in our lives so they don’t make the same mistakes.
Here are 5 Financial Tips for Young People, an article of advice that can help boost the financial wellness of those just starting out. You may want to share them with your kids and grandkids. As Maya Angelou said, “When you know better, you do better.”
Tip #1: Invest – Starting Now
That’s easy to say, but harder to do. Here are some tried and true ways to meet the challenge:
Automate it: Designate a certain amount of money to be automatically deducted from your paycheck and invested. Nobody misses what they don’t see in the first place.
Save it: If your employer offers a 401(k) plan, sign up as soon as you can and contribute as much as you can. If your company offers a match, take advantage. It’s like getting free money!
Start it: If you wait to start investing, you are foregoing the tremendous power of compound interest. Time makes money. How does compound interest work and why is it so important? We’ll dive into that topic next month.
Tip #2: Understand the Power of Time + Compounding
When it comes to investing, time is one of your greatest allies. Why? When time joins forces with compound interest, your account value grows dramatically. Think of compounding as getting a return on your return. Here’s an example:
- A 25-year-old wanting to have a $1 million nest egg at age 60 would need to invest $880.21 each month assuming a constant return of 5%.
- If that 25-year-old waits 10 years to start investing, he would need to invest $1,679.23 each month using the same assumptions.
- If he waited 20 years? That 45-year-old would need to invest $3,741.27 each month to accumulate the same $1 million by age 60.
The only difference between these three scenarios is the impact on the investment of combining time and compound interest. It can make a huge difference between retiring in comfort and, well...not.
Tip #3 is: Prepare for the unexpected with an emergency fund
It’s a great idea, and it’s necessary. But how do you make it happen? Here are some steps to think about:
- Get all your bills and expenses together to figure out how much money you spend each month. A general rule of thumb for an emergency fund is to save enough to cover six months' worth of expenses. You don’t need to necessarily replace all your income, just have enough to cover the essentials.
- Find a place to keep the money; ideally somewhere easily accessible – but not so easy that you’ll make spur-of-the-moment withdrawals.
- Start saving, but start small. The thought of coming up with thousands of dollars can be overwhelming. Concentrate on getting that first thousand under your belt.
- Treat funding this account like a monthly bill. Make it part of your budget and pay it every month, just like you do your rent, car payment, or credit cards. Remember, this fund is for unexpected events.
If you follow the steps, building in an emergency fund should become second nature, and you’ll give yourself a pat on the back as you see your financial stockpile add up.
Tip #4: Use credit responsibly
- Recognize that there is “good” debt and “bad” debt. Generally, if it increases your net worth or has future value (like a mortgage), it’s good debt. If it doesn’t (think that 60-inch flat-screen TV) – and you aren’t able to pay the bill when you get it – it’s bad debt. Engage in the good and avoid the bad.
- Don’t “carry” debt. A credit card isn’t a license to spend, and it’s not free money. Waiting until you have enough cash for a pricey item may give you time to consider whether you need to make the purchase at all. If you already have credit card debt, stop using the card and repay it at more than the minimum monthly payment.
- Know your debt-to-income ratio. This figure is perhaps the best indication that you may – or may not – be in trouble. To find it, add up all your monthly debt payments and divide them by your monthly gross income. Anything higher than a 43% debt-to-income ratio is a red flag to potential lenders.
- Check your credit score at least annually. Visit https://www.annualcreditreport.com/ to get reports from the three major reporting companies – at no cost. Not only does your credit score offer insights into your financial health, they can help you spot possible issues with identity theft.
Tip #5: Place a value on your money by thinking about it in terms of time.
What is the time value of your money?
Let’s say you earn $20 an hour, and you’re eyeing a TV that costs $1,000. So, you figure you’ll spend 50 hours at work – more than 6 days – earning the money to make the purchase, right?
Not so fast. What about income taxes? When you earn $20 an hour, you don’t actually bring home $20 an hour. If you’re in the 25% tax bracket, you would actually spend about 66 hours – more than 8 days – earning the income required to buy the TV.
Is the pricey TV still worth it? That’s up to you. But by using this calculation, you’re making an informed decision. Anytime you’re considering making a large purchase, figure out how much of your valuable time you’ll be investing in the item, and then make the decision whether or not to buy.
There are a number of obstacles on the road to financial prosperity, but many rewards too. Developing good financial habits early on can reap great benefits later. Hopefully, you and the young people in your life have enjoyed these tips. Remember to reach out if you need help implementing any of the ideas from this email series.