Besides starting a career and developing healthy lifestyle habits, the most important thing young adults in their 20s can do is to make good financial decisions. The choices you make today can impact the rest of your life. This is especially true when it comes to your overall financial well-being. The following are 10 Financial Planning Commandments to adhere to in your 20s to establish a firm foundation for your finances. Thou shalt…
1. Create a Budget
Most people think that a budget is only about paying your bills on time. However, in reality, a budget is about determining how much you should be spending on certain items. There are many different types of budget strategies you can use. My favorite method is the 50/30/20 rule. This rule stipulates that 50% of your income should go toward paying bills that are necessary for survival. For example, this could include rent or mortgage payments, car payments, groceries, insurance, debt payments, and utilities. Second, this rule suggests that 30% of your income should go toward non-essential expenses. This varies from person to person. Third, 20% of your income should go toward saving and investing your money. This includes building an emergency fund and investing if applicable. In my experience, creating a budget is only half the battle. You must track your actual monthly expenses to make sure it matches your planned expenses in your budget. If there is a big discrepancy, you must evaluate and change your spending habits. In another article, I talk about the Strengths and Weaknesses of the 50/30/20 Budget.
2. Build an Emergency Fund
This commandment might seem obvious to some people. However, according to a survey by Bankrate, 1 in 4 Americans have no emergency savings. Additionally, Bankrate finds that only 39% of Americans have enough to cover a $1,000 emergency. What makes this more alarming is that in the same survey, about 62% of Americans say that they are very satisfied or somewhat satisfied with their emergency reserves. This shows that there is a big disconnect between how people feel about their own financial well-being and reality. Most financial advisors recommend that people save about 3-6 months’ worth of expenses in their bank account to cover any emergencies. However, make sure you do not have too much saved up in your savings account or you run the chance of inflation risk. This reality brings us to the next commandment, pay yourself first.
3. Pay Yourself First
Once you have your emergency savings built up, it is time to think about paying yourself first. This means that you should invest a portion of your paycheck on a consistent basis before considering discretionary spending. For example, if your employer offers a 401(k), which allows you to defer taxes on your investments until retirement, you should consider contributing to this plan. This is especially true if your employer offers a match for your contributions. Note that there are other vehicles you can use to invest for future goals. I will discuss them in a future article.
4. Tackle Debt Head-On
Debt is a reality for most people in their 20s. According to the Student Loan Report, the average student loan debt per borrower is $27,975. However, not addressing debt can set you back many years in the form of greater interest payments. If applicable, any consumer debt, such as credit card debt with high interest rates, should be paid off first. Afterwards, using a budget is a way to help you from accumulating this type of debt in the future. If you have student loans, you should work towards paying it off. If extra money is left over after “paying yourself first”, then it does not hurt to pay down your student loans faster.
5. Maximize Employee Benefits
When you start a new job, the human resources department provides you with an employee manual which describe your employee benefits. According to a study performed by the International Foundation of Employee Benefit Plans, approximately 50% of people do not understand their employee benefit plans. Employee benefits may include a matching contribution to a retirement plan, stock options, health insurance, disability insurance, employee assistance programs, educational stipends, child care, and other services. When it comes to retirement savings, an employer-matching contribution is essentially free money. Additionally, obtaining health, life, or disability insurance through an employer is almost always cheaper than purchasing it on an individual basis. Thus, it is important to review your employee benefits with your human resources department on a regular basis.
6. Focus on Quality Purchases
In your 20s you may feel strapped for cash. Therefore, you might make purchase decisions based on cost alone. Based on my experience, I believe it is important to focus on quality over quantity. Recently, in order to save money on my morning latte, I purchased an espresso machine for home use. After accounting for the cost of the machine, ingredients, and maintenance, I figured out that the purchase would pay for itself in less than five months. Examine your own life and determine where you can make quality purchases. I am sure your future self will thank you for putting money toward items that pay for themselves over time. Note, do not use this commandment as an excuse to overspend.
7. Set Personal and Financial Goals
Like any goal in life, it helps to stay motivated. Thus, it is important that you give each dollar you save or invest a purpose. For example, you may want to set aside money for a vacation, down payment on a home, etc. If you keep track of what goal your money is going towards, it is much easier to visualize your progress.
8. Establish your Credit History
Your ability to rent an apartment, purchase a home, buy a car, or get a credit card without the help of a co-signer is one of the first financial challenges people in their 20s face. A good credit history is the number-one key you have to financial independence. If you have a high credit score, you will receive better interest rate terms when borrowing money. This may not sound too important now, but down the road, this could save you money when making big financial decisions. In fact, a good credit score can save you thousands of dollars. In the fourth commandment, I talk about paying down consumer and student debt. These are some of the easiest ways to boost your credit score. In another article, I talk about the importance of credit in depth.
9. Keep Financial Documents in Order
In your 20s you should have all your financial documents in your possession. This includes your birth certificate, Social Security Card, banking information, investment information, insurance policies, car registration, car title, online login information, etc. It is important to store all this information in a secure place. Additionally, it is important for someone you trust to know the location of your financial documents in case of an emergency.
10. Understand your Relationship with Money
Everyone has a relationship with money. This relationship plays a critical role in your physical, emotional, and financial well-being. This is because your relationship with money provides the foundation for your money habits. For example, if your relationship with money revolves around “security”, you may be less likely to take many risks with it. Conversely, if your relationship with money revolves is around “power”, then you may be more likely to take on more risks and use your money to influence other people. If you are able to understand what motivates your financial decisions, you will be able to determine how to improve your relationship with money. In my opinion, if you are able to follow this commandment, the rest of them will easily follow.