The steps you take in your 20s can set you on a path toward financial security for the rest of your life. You may eventually be able to retire early, have the option to take some time off from work when you have children, choose a lower-paying career you love, buy a house, start a business, travel or afford other special experiences because you started making smart financial decisions when you were just getting started in your career — or even earlier.
“If you dream of being well on your way to financial independence by the time you’re in your 40s or 50s, it’s amazing how much of a head start you can get by starting in your 20s,” said Mari Adam, a certified financial planner in Boca Raton, Florida. “The key is to start saving early to take advantage of compounding and avoid the wealth destruction that comes with debt.”
Start Building Tax-Free Savings Early
If you start saving when you’re young — even just a small amount — that money can grow significantly over time.
“Retirement may seem like a lifetime away, but when you start saving early, you’d be shocked how much those savings will grow during your remaining working years,” said Rachael Burns, a certified financial planner and founder of True Worth Financial Planning in Folsom, California. “The earlier you start, the less money you need to save each year in order to hit the same target at retirement.”
It may seem difficult to afford to save for the future when you have to cover everyday living expenses on a starting salary. But even setting aside a little bit can make a big difference and make it so much easier to reach your goals.
“The reason it’s so important for people in their 20s to start saving for retirement is because they have the gift of time,” said Shelly-Ann Eweka, senior director of financial planning strategy for TIAA. “Retirement might seem like something far away, but you’d be amazed at the magic of compounding.”
For example, look at the results for two women who both turned 65 last year, she said. “The first one started saving just $100 a month — that’s only $25 per week — when she was 25 years old. That was back in 1981. The other woman decided to wait until she was 40. That was in 1996. But at that point, she started saving twice as much; instead of $100 per month she started saving $200.”
If both women invested their money in the S&P 500, the woman who started saving just $100 per month when she was 25 would have almost $450,000 at age 65. But the woman who waited until she was 40 and started saving $200 per month would now have barely $200,000, said Eweka.
You can start building tax-free savings even before you start a full-time job. There’s no minimum age requirement to contribute to a Roth IRA; you just need to have earned some money from working to qualify, even if it’s a summer job or part-time work while you’re in school. A Roth doesn’t give you a tax break now but the money grows tax-free for the future. You can withdraw the contributions without taxes or penalties at any age, and you can take the earnings tax-free after age 59 ½. The account is most powerful if you keep the money growing for retirement, but knowing you can access the money before then for emergencies can make saving for such long-term goals less intimidating.
“Set up a Roth IRA and sock away your summer earnings, your internship pay, your income from your first job,” said Adam. In 2022, you can contribute the amount of money you earned from working for the year up to $6,000, whichever is less. That money will continue to grow for decades, no matter what else you do during that time.
“If you start putting aside the max of $6,000 per year from age 22 to age 30, and then stop and make no further additions, you’re still on track to end up with over $550,000 by age 65, assuming fairly modest returns of 6% per year.”
Even smaller contributions can make a big difference over time. “The secret — start now,” said Adam. “Start small if need be. Save on a schedule, set up automatic transfers. Invest for growth. Leave it alone.”
When you start your first job, contribute at least enough to your 401(k) at work to get matching contributions from your employer, which is free money and is often 3% to 5% of your pay. Get in the savings habit while you’re earning your first paychecks, and increase your contributions when you get raises and bonuses over time, before you get used to having the extra money. Try to build up your contributions to 10% or more of your salary — your savings will grow with you.
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Set Motivating Financial Goals
Think about what financial security means to you, whether it’s retiring early, buying a house, changing jobs, paying off debt, starting a business, taking time off from work to raise a family or experience other life goals. Financial security gives you options, and thinking about your financial goals can help motivate you to manage your spending and set specific savings targets.
Financial security might mean different things to different people, said Pam Horack, a certified financial planner in Lake Wylie, South Carolina. “To me, this means that you are prepared to handle a financial emergency. To someone else, it may mean they are prepared to grow into the next stage of their life. Whether that’s buying a house, changing careers or retiring early. Either way, it’s important to be ready for change,” she said.
Then, look at the money you have coming in and going out and set a timeline and budget for these goals — rather than just considering them as vague dreams.
“Plan your financial goals,” said Eweka. “There are things you need to pay for and things you simply want to buy. Whether it’s paying down debt or making a down payment, saving for your child’s education or preparing for your retirement, this roadmap will help you prioritize what matters most to you and when you can afford it.”
You’ll have an extra incentive to cut back on unnecessary expenses if you think in terms of working toward your financial dreams, and it’s easiest if you start with this focus when you’re in your first job.
“Getting on a path toward financial security is important at any age, but setting up good financial habits while you are young is a great habit to put you on a path to success,” said Hong Bloom, head of customer engagement and experience at TD Bank. She recommends tracking your spending for a week to differentiate between “needs” like rent, groceries and other utility bills, and less crucial “wants,” like grabbing a quick coffee, buying lunch out at the office or online shopping.
Even if you don’t follow a formal budget, it’s important to understand how your income compares to your expenses, what you’re spending your money on and how you plan to reach your financial goals.
“Look at your money, be aware of what is coming in and going out,” said Kristen Griffith, a financial counselor with the Pittsburgh Financial Empowerment Center. “Don’t stress about investing too much until you get your budget and savings habits under control. A budget will tell you how much you have to invest and savings will protect you.”
If you’re married or sharing expenses with a partner, discuss these issues together. “Couples — talk about your finances. Have a monthly meeting to review spending,” said Griffith. “Communication, without judgment and shaming, is key.”
At this age, you may be building long-term relationships that can also have an impact on your finances. “If you live with a partner, make sure your money habits and values are compatible,” said Adam. “It’s hard to keep yourself on the path you want if your partner risks derailing you with his or her bad money decisions.”
Build an Emergency Fund
An emergency fund can be one of the most important tools to help maintain financial security. Having this cash available can help you avoid landing in expensive debt or raiding your savings if you have unexpected expenses.
“Aim to save three to six months’ worth of your expenses in a separate savings account that you are unlikely to be tempted to dip into,” said Burns. “When you have an emergency fund, you don’t need to borrow money or make bad financial choices out of desperation if something comes up.”
You can start small and build up this cushion over time. “Whatever that looks like for you and your finances,” said Griffith. “We started with $500 and worked our way up to six months of living expenses. Start saving and leave it alone — preferably in a high-yield savings account. Savings is more about the habit than the amount.”
Consider both big and small emergencies when building this fund. “To handle financial emergencies, cash is king,” said Horack. “You want to be sure that you have three to six months of expenses on hand in case you lose your job, become disabled for a time or need to take time off to care for a parent. Whatever the reason, this emergency fund is the bedrock of financial security.”
It’s also important to be prepared for smaller emergencies that are much more likely to happen. “Maybe you need new tires, or your TV is stolen from your apartment. Maybe you have a medical event and need to meet a large deductible,” she said. “If you have cash on hand, you can weather these storms without impacting your future goals.”
Manage Your Debt
Expensive debt can make it much more difficult to achieve financial security, and it’s easy to get in debt in your 20s that affects your finances for decades in the future.
“Don’t dig yourself into a hole you can’t easily get out of,” said Adam. “Too many 20- to 30-year-olds we talk to are already burdened by expensive debt, especially credit card debt, overly large car payments or student debt. Or they’re not even 30 yet and they have debt coming out of an expensive breakup with a partner. The best way to protect yourself is get a really clear idea of what you’re making and what you’re spending, and plan your lifestyle so spending is always less than earnings. Before you take on any new debt, whether for school or to buy a car, make sure you understand the monthly payment and how it will affect your budget. People get into trouble because they make decisions without understanding the true cost.”
Consider the long-term impact of debt on your finances — even before you start your first job.
“If you’re not done with college yet, be extremely cautious if you have to take out student loans,” said Burns. “Explore every opportunity to minimize the amount you need to borrow — apply for scholarships, work part time, see if your employer offers tuition assistance. And if you must take out loans, only borrow what you absolutely need to. Estimate what your payments will be once it’s time to repay your loans, and compare that with your expected salary as a new grad.”
Be careful when you get your first credit card. “Older generations often look back to their late teens and early 20s as a time when they made mistakes and got themselves buried in credit card debt,” said Burns. “Open a credit card early so that you can start building credit, but only use it to make purchases you can afford, and pay it off at the end of each month.”
If you already have debt, make a plan for paying it off while continuing to save, too. Look at all of your debt, the amounts, interest rates and time frames when setting your priorities for paying it off.
“Calculate the best ways to pay off debt,” said Eweka. “Chart your credit card debt and personal loans. You’ll see how much you owe, how much interest you’ll pay and how to make your debt-free date come a little sooner.”
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