Starting your financial journey as a young adult can be challenging. Student debt, a lower starting income, and the desire for independence can make managing money difficult. But developing positive financial habits early on is the key to long-term success and peace of mind. The choices you make now will add up over time, making your twenties the best time to build wealth and achieve financial security.
Understand Your Income
You need to know exactly how much you earn each month to better manage your finances. Your gross income may look good on paper, but your net income is what really matters. After deducting taxes, health insurance, retirement contributions, and other expenses, your actual net income could be much lower than you say.
Understand your monthly net income and observe its changes over the course of a few months. If you work irregular hours or have multiple sources of income, carefully estimate it based on your lowest income month. This approach can keep you from overspending during difficult times and prevent unexpected surprises when your income exceeds your expectations.
Basic Budget
A budget is like a financial map that helps you plan every euro you spend. The 50/30/20 budgeting principle is a good way to start: spend 50% of your income on essentials (rent, utilities, groceries), 30% on “desired” expenses (entertainment, dining out, hobbies), and 20% on savings and debt repayment.
However, you may need to adjust these ratios based on your situation. If you have a high student loan debt to pay off, you might need to temporarily reduce your “desired” expenses. Your housing expenses may surpass the acceptable 30% of your salary if you reside in a costly city. The key is to find a ratio that works for you while prioritizing savings and debt repayment.
Savings Methods
Your primary goal when saving should be building an emergency fund. You should have three to six months of living expenses in a high-yield savings account. This safety net prevents you from having to use your credit card in emergencies like job loss or illness.
Start small, if necessary. Even $25 a month can help you develop a saving habit. Set up automatic transfers to your savings account as soon as your paycheck arrives and treat your savings as a permanent account. Many banks offer automatic transfers that transfer money before you spend it. In addition to building an emergency fund, you can also open other accounts for expenses like vacations, car repairs, or holiday gifts. This approach prevents you from using your emergency fund for situations that can arise but don’t always.
Managing Debt
Credit card debt and student loans can feel overwhelming, but they become more manageable if you repay them wisely. Write down all your debts, including the amount owed, the minimum payment, and the interest. The debt avalanche method requires you to pay off the loans with the highest interest rates first. This allows you to save money in the long run. The snowball method starts with the lowest balance, giving you the psychological satisfaction of sticking with it.
If your monthly federal student loan payments are exceeding your budget, consider an income-driven repayment plan. These plans adjust payments based on your income and family size. Such plans can lower your monthly payments. However, keep in mind that lower payments usually mean more interest over the life of the loan. Avoid additional debt in the early years of your loan. While credit cards are convenient and can help you build your credit history, carrying a monthly balance can quickly lead to high debt.
Invest Early
When it comes to investing, time is your best friend. Thanks to compound interest, the money you save in your 20s has decades to grow. Even a small amount can be the most important part of your retirement fund. If your employer has a 401(k) pension plan and offers matching contributions, make sure you contribute at least enough to receive the full matching amount. In other words, those contributions will result in an immediate 100% return on your investment. Even if you can only match the initial contribution, it’s vital to make it a habit.
If you want to grow your investments, consider opening a Roth IRA. Depositing now can lead to a lower tax rate, meaning you won’t have to pay taxes on withdrawals during retirement. Targeted mutual funds are ideal for new investors because their portfolios automatically evolve as you get older.
Getting Credit
Your credit score affects everything from rent to insurance premiums to the jobs you can find. Building good credit takes time, so start developing good credit habits early. If you don’t have a credit card, apply for a secured credit card or become an authorized user on your parents’ account. Use your credit card for purchases you can afford monthly, but don’t exceed 30% of your credit limit. Pay all bills on time, as your payment history is the most important factor affecting your credit score.
Don’t close your oldest credit card, as the length of your credit history can also affect your score. If you have an older card with no annual fee, keep it active and make small purchases occasionally to keep it active.
Financial Planning Tools
Thanks to technology, managing your finances is easier than ever. Mint, YNAB (You Need a Budget), and PocketGuard are examples of budgeting apps that automatically categorize your expenses and track how they compare to your budget. You can link many apps to your bank and credit card accounts to access real-time financial data.
Apps like Personal Capital can help you track your investments, get a complete overview of your portfolio, and help you plan for retirement. Betterment and Wealthfront are two examples of robo-advisors that offer professional wealth management at an affordable price. This attribute makes them ideal for beginning investors with smaller balances. If digital tools seem difficult to use, consider using simpler tools like spreadsheets or even pen and paper. The ideal system is one you use consistently.
Take Control of Your Financial Future
Financial health isn’t about perfection; it’s about progress. Little steps, one by one, accumulate over time. Start by focusing on the areas you need to invest in the most, such as creating a budget, saving for emergencies, or contributing additional funds to your retirement account.
Remember that as your income increases and your life changes, your financial situation will also evolve. It’s crucial to build a solid foundation now—one that will benefit you for the rest of your life. What you do in your 20s will impact your financial well-being in your 30s, 40s, and beyond.
FAQs
1. How much should I save each month as a young adult?
Aim to save at least 20% of your salary, but start with what you can afford each month. You can start with $50 a month and save more as you go.
2. Should I pay off my debt or invest first?
Before you start investing, pay off high-interest debt, typically credit cards. If your employer matches your contributions to a 401(k) retirement plan, you might consider paying off both at the same time for lower-interest debts, such as student loans.
3. Which financial habit is most important?
The best way to start early and maximize your savings is to automate your finances. Set up automatic bill payments and savings transfers so you don’t have to rely on willpower to keep your finances in order.
4. How can I start investing with a small amount?
Many brokers now offer commission-free trading or minimum deposit requirements. You can start with funds with a maturity date or broad-market index funds. They offer quick diversification and low fees.
5. When should I start saving for retirement?
As long as you have a stable income, even if it’s modest, you can start as soon as possible. The sooner you start, the longer you’ll benefit from compound interest.
