Avoid these five financial pitfalls in your twenties(Read article summary)
If millennials can pay attention to where their money is going today and stay away from luxuries they can’t afford, they will be better off down the line. Here’s how young adults can avoid five potential pitfalls that can derail long-term financial health.
With graduation season approaching, hordes of young people will be thrust into the real world to face all of the harsh financial realities that come with it. You have to pay rent now that you’ve moved out of the dorms; you have to start paying your own bills; and, of course, you want to be able to go out and have fun now that you’re living on your own.
These expenses can add up quickly and, if you aren’t careful, create financial strain. According to the American Psychological Association, money is the top cause of stress for people over 18. But if millennials can pay attention to where their money is going today and stay away from luxuries they can’t afford, they will be better off down the line.
Here’s how young adults can avoid five potential pitfalls that can derail long-term financial health.
Resist the urge to get an expensive car
When they get their first job, fresh college graduates may want to impress their new co-workers and boss, but they shouldn’t do it with a fancy ride. Yet millennials accounted for 26% of new car sales as of 2014. Upon signing the lease for a new BMW, you are handcuffing yourself to high payments throughout the term of the lease. That money could have gone toward your 401(k) retirement plan or paying off student loans. So pass on the heated steering wheel and leather seats and stick with something more practical — and less expensive.
Eat at home
I like food just as much as the next guy, but I understand the difference between enjoying a $100 five-course meal at a restaurant and cooking a meal at home. According to 2013 Bureau of Labor Statistics data, consumers under age 25 devoted approximately 45% of each dollar spent on food to eating out, compared with 37% for those ages 55 to 64. Be judicious about how often you eat out and how expensive the restaurant is — money spent on food at home can go a lot further. The same goes for spending on drinks and going out with friends. Millennials may thrive on the social setting a bar provides, but as with food, the enjoyment doesn’t last long and it can be costly. Instead of going to a bar or restaurant, invite friends over or try other activities that don’t involve dining out. Occasionally going out for a nice dinner or drinks with friends is understandable, but indulging too often can thwart your financial progress.
Opt in to your company 401(k)
With a 401(k), employees save and invest part of their paycheck before taxes are taken out and don’t pay taxes until they withdraw the money. Because of compound interest, the earlier you start saving and investing for retirement, the bigger the impact. According to the Bureau of Labor Statistics, in 2013 the percentage of workers with access to a plan who participated in their plan was about 70% at companies with more 100 people. If you have access to an employer-sponsored 401(k) or similar retirement savings plan you should start saving in it as early in your 20s as you can. If your employer doesn’t offer such a plan, consider opening a retirement savings account on your own to put your money to work for you.
Track your expenses
With new technology, there’s no excuse not to keep track of your expenses. It’s easy with applications such as Mint.com and QuickBooks Online that allow you to hook up your bank account and see where your money is going. Track your expenses throughout the month. It’s much easier than trying to account for all of your purchases at the end of the month or, worse, discovering two weeks into the month that all of your money is gone.
To make sure you have enough money to pay for everything you need, while still enjoying yourself every once in a while, it’s important to set specific financial goals. For instance, make sure to set aside money for emergencies and unexpected expenses like medical bills or job loss. I recommend saving enough to cover nine months of your expenses. You can put the money in an individual or joint bank account that will allow you to draw on your savings without penalty. But remember, this is an emergency fund; it is not to be touched unless it is absolutely necessary.
Then, look ahead and figure out what longer-term aspects of your future you want to prepare for. For example, what type of house will you want to buy? Consider the cost of such a home and calculate what a 20% down payment would be. Then start a savings account toward that goal. It will be much easier to achieve this goal when you set clear terms and have a vision of what you are saving for.
Saving for retirement is also imperative for your future financial health. If you can, I recommend that you put 15% of your income into your retirement plan every year. If you can’t do that, save as much as you can and increase the percentage over time.
By making smart financial decisions like these now, you are building a solid foundation that will give you leeway later on to live without the constraints of financial stress. Of course, while it’s critical to plan for the future, don’t forget to enjoy your youth while you can.