Your twenties are an exciting time for many reasons. You graduate from college and enter the real world. You get your first job. You are likely on your own in an apartment for the first time. No parents. No roommates. You may develop a relationship with a significant other and get married.
It’s also exciting because you set your own, individual financial house in order. Sure, how your parents handled money is probably a model. I know it was for me. But in your twenties, you get to decide what you’re comfortable doing. Do you want a house? Do you want to travel before starting a family? Do you want to move halfway across the country? It’s all up to you.
That said, there are many things I wish I’d known about financial planning when I was in my twenties. Standing at the ripe old age of 32, I wish someone had emphasized to me what I’m about to emphasize to you.
Here’s a look at the three basics of financial planning for twenty-somethings. Been there. Did that.
Get Your Debt Under Control
What do I mean by getting your debt under control? Get monthly debt payments to a manageable amount. The reason? A lot of people have racked up credit card debt or have student loan repayments kicking in. Either, or both, can leave them paying every single dollar of disposable income to debt service.
Disposable income, by the way, is the amount you have left over after basics like rent, food, utilities and transportation.
If you’re paying every single dollar to debt service, you can’t possibly save for a vacation, a down payment on a house or retirement. The problem is exacerbated by the fact that, in your twenties, your income is probably pretty low.
At 25, I had $5,000 in credit card debt and $25,000 in student loans. My first job paid $30,000 — not a princely sum. I got a personal loan at a lower interest rate and transferred my credit card to it, which lessened my monthly payment immediately. I applied for and got a student loan repayment plan based on my income. Less per month there. I was paying a total of $329 on debt payments every month. It went down to $225.
With the money you save from getting your debt under control, you can start to build wealth more effectively. You want to pay off your debt responsibly, but don’t starve yourself of every penny just to pay it off.
Build Good Credit
You need good credit. Eventually, you will want a mortgage or a car loan. When you apply, banks and other lenders pull your credit score. If your credit score is average or poor, you may not get approved. If you do, poor or low credit may mean you’ll be charged a higher interest rate than people with excellent credit.
A higher interest rate means you’ll pay more every month and that money goes to less of the purchase. In addition, more and more landlords and even employers are using credit scores as a proxy for responsibility. They use it to make rental and hiring decisions.
How do you build good credit? First, pay your bills on time. Always. A large part of a credit score is determined by payment history. Set up your monthly bills for autopay so you don’t forget to make out checks or mail them when they’re due.
Second, ironically enough, if you have no debt, you need to get some. Seriously. Part of what lenders look at is your ability to use credit responsibly. If you’ve never demonstrated that, which you won’t if you’ve had no credit card or bank loan debt, it will ding your credit score. They also don’t like people being maxed out. That will hurt your score even more.
If a bank will give you a credit card with, say, a $500 line of credit and you use $200, you’ll be sitting pretty. You use credit, but you don’t go wild. And you pay on time.
Start a Retirement Account
I didn’t care about starting a retirement account until I hit 25. Then, I read an article that made it clear to me how important it was. It said this: if a person saves $3,000 every year from the time they’re 21 until the time they’re 30, they’d have $227,111 saved by the age of 60, assuming a six percent rate of return annually. That’s more than a quarter million dollars. And that’s without doing anything else. That’s $250 per month. I could do it by the time I hit 28, at least.
The reason the figure grows to be so awesome is that time and compound earnings work like a type of magic. Compare what happens if you don’t start saving until the age of 41. You’d need to save $9,621 each year until you’re 50 to get the same amount by the age of 60. That’s nearly $802 every month. That’s a lot of money, and it’s beyond most people’s grasp.
Plus, if you have an employer-sponsored retirement plan, please, please take advantage of it. First, money is taken out pretax. That means if you make $30,000 and have two percent taken out for a 401(k), you’ll only be taxed on $29,400. It can, depending on your income, lower your tax bracket.
If your employer offers a matching 401(k), please, please, please take advantage. You’re leaving money on the table if you don’t. That two percent from you is $600 per year. With a matching two percent, it becomes $1,200 per year. Sweet.
In your twenties, you’ll have lots of adventures but have lots of financial planning too! The financial planning you set up now will let you get debt under control, have good credit and save for retirement.