In 2018, I made it my resolution to embark on the journey to finally get my shit together when it comes to my money. I’ve been lucky enough (and in some instances smart enough) to avoid debt when possible in my life. But that was really doing the bare minimum. I wanted to prove to myself that I was not the type of person who goes through life without a savings safety net and with zero idea about how investments function.
I wish I could say this journey has been completed and that I am now a millionaire, with stocks that would make Bill Gates proud. However, that is not the case. Still, I hope that you’ll join me on this journey to financial freedom.
I spent 2018 reading books, watching videos, and listening to podcasts about finance, and now I’m here to educate those who have been avoiding the topic of money for a while. I AM BY NO MEANS AN EXPERT. You may know much more than me! However, I’ve also spent time talking to people my age about money and realized they don’t know much. This is meant to fill in critical gaps for those people.
Here are the absolute most important financial things you need to know in your 20’s, all boiled down and in simple layman’s terms. I always encourage you to read beyond what I write. If you’re just getting started, I recommend that you read Ramit Sethi’s book, “I Will Teach You to be Rich” and “Rich Dad, Poor Dad” by Robert Kiyosaki. If you’d like to learn more about how to change your mindset around money and how important that is, I recommend reading Kate Northrup’s book, “Money, A Love Story”. Lastly, if you’re freaking out because you’re past your 20’s and still don’t know the information I mention below, you should read, “Smart Women Finish Rich” by David Bach (don’t worry dudes, it’s still applicable).
Ok, let’s get started!
Important Preface: Psychology & Money
We can’t begin with money before talking about its purpose in our lives both emotionally and tangibly.
First: Money is a ticket that allows us to do and get almost whatever we want. It’s not an enemy, as many in society have labeled it. Getting over that roadblock takes some people lifetimes. If you have a negative relationship with money, that needs to be changed before you can succeed in growing it.
Second: Let’s go deep to discover why we want money. People often say they want more money because they want security. When we break this down further and further, we see how that this security allows them the freedom to make choices. It gives them the autonomy to spend life with who they want, doing what they want. So, in order to know how much you want to save, it’s often best to design your life first, then see how money can help get you there. This will also help you make better spending decisions. When you know your freedom is on the line, that $25 shirt is not as appealing.
1. Know where your money’s coming/going
If you’re anything like my brother who somehow gets through life never checking his bank account (literally HOWWWW), then you’re probably going to be hopeless at saving and investing. Before you do any of the steps below, go through and create a spreadsheet or a Mint account showing all your income, your debt, your cyclical bills aka “fixed costs”, retirement/investments, etc. Take a look at past spending and get an idea of how much of you spend in each area and examine what you can REALISTICALLY cut down on.
The goal is to focus on reducing our spending or keeping it steady despite earning a higher wage. That’s always the challenge for people: upgrading your paycheck does not mean you should upgrade your lifestyle.
If new money pops up unplanned like from a birthday present or your tax return, DO NOT SPEND IT- at least not all of it. Put at least half into your savings/goal savings and spend the rest.
Should I save or pay off my debt?
So you’ve been chugging along, making the minimum payment to your debt each month- good for you. Then you suddenly get a raise. What do you do with that extra money? Pay off a huge chunk of the debt or put it in your savings account? Well, this depends. Do you have an emergency fund?
You should really have 3-9 months of income set aside in an emergency fund in case you lose your job, get sick or, you know, some other type of emergency. At the very least, you should have $1,000 stored away for the untimely breakdown of your car. If you have a healthy emergency fund then using that extra cash money flow to pay off your debt makes sense. Otherwise, if you pay off that debt and encounter an emergency later which you can’t afford, you’ll end up renewing this nasty cycle.
But I have multiple sources of debt? Which one do I pay off first?
There are mixed answers to this question.
Route A: Some financial experts have gone the psychological route and claimed that you should pay off your smallest debt first so you feel that ‘win’ and excitement of making real progress. This will help you continue to pay off your debt at an accelerated rate.
Route B: Others take the fiscally responsible route of paying off the debt with the largest amount of interest first. This one makes a lot of sense to me, but I think this largely depends on your relationship with money. Do you have resistance to paying off debt? Do you feel discouraged about not making enough progress? Take route A. Are you comfortable with your current rate of paying off debt? Pick route B.
3. How to organize your finances & Set goals
In order to manage your money, experts recommend you break your paycheck down into the four categories below. So 60% of your paycheck should automatically be set aside each month for your fixed costs, then 10% should go to meaningful savings and so on.
60% Fixed expenses: Student loan payments, rent, gym memberships, bills, etc… – consistent costs each month (*Spend max 28-30% of your paycheck on housing*)
10% Meaningful savings: Pay down debt, invest, put money in nest egg/emergency fund (*Try to save between 3-9 months of your current paycheck for emergencies*)
10% Short-term savings: Spending money for vacation, saving for specific goals, Christmas gifts
20% Spending money: You can use this cash how you’d like! Groceries, transportation, shopping, eating out, etc…
Separate your paycheck into two different bank accounts. One will contain the first three categories that you can’t spend! And the other will contain your spending money so you can use this flexibly and monitor it throughout the month. You should set this up to be done automatically in order to realistically maintain this level or organization month after month.
If you have little self-control with plastic, take it back to 1965, a year before the debit card was invented. Once you separate your money into the two different accounts, you can withdraw your spending money so that you have cash on hand for all your expenses. This will make it easy to see where your money is going and how much you have left.
As I mentioned above, it’s psychologically advantageous to save for a specific goal. When you have an amount set and a dedicated place for it to go, it becomes a lot easier and more exciting to save for it.
Pay yourself first: If you’ve ever read a financial book, then you’ll be familiar with this concept. The idea is that you have to set aside your money to invest and save from the moment you receive your paycheck. Of course, you still need to pay for your fixed costs and other expenses, but saving should not take a back seat to this.
Happy Spending & Smart Budgeting: Reduce your big expense items and worry less about the little ones. The point is that you can save a lot more money each month by living in a cheaper apartment or buying a cheaper car than you can by pinching pennies and not eating out with your friends. Another financial expert recommends monitoring your ‘middle’ expenses, especially reoccurring bills. All the costs in the 20-100 range can really add up quickly over time. The most important point of this is to make sure you’re spending on things that make you HAPPY. If that $5 coffee did not bring joy (Marie Kondo style), you know that you can cut that regular expense. Cut down on the mediocrity so that you can have more money to spend in the other areas of your life that truly light you up. This will also make budgeting easier because its based off of your lifestyle and your feelings and not someone else’s.
The Latte Effect: Let’s say you’re 25 years old. If you stopped buying coffee each day and instead invested that $100/month in an account that has the average annual return of 7%, you’d have $264,012 by age 65. Compound interest is king. I don’t think anyone’s coffee is worth the price of a house, do you? This is all to illustrate that the small expenses do matter over time, but again, not as much as the big ones like your rent or car.
4. Your retirement
You’re not going to be young forever and the single greatest asset you have is TIME for your investments to grow. If you start putting $458/month in a retirement fund starting at 20 years old and ending at 65 years old, you’ll have $1,629,410. However, if you start at age 30, you’ll only have $788,259 saved for retirement. The best thing you can do for your future self is to start prioritizing your retirement while you’re young.
By age 29, the goal is to have as much saved in a retirement account as you earn in a year.
Typically employers will have a 401(k) plan that you can opt into and allocate a percentage of your monthly income straight to it before it’s taxed. Your employer will often match your contributions, giving you double what you put in! That is huge!
Whether your employer matches or not, it’s in your best interest to max out your retirement contributions (usually 12%). You will never see that money in your paycheck; it will go straight into the fund. If you don’t see it, it doesn’t feel like you’re losing anything! Just take it out now and bask in your riches later. When you do retire, that money will be taxed.
If you work for yourself or your employer does not have a retirement fund, you can set up your own. I have personally established a Roth IRA, although you can choose a regular IRA if you so please. The main difference between the two is that the Roth IRA taxes the money before it goes into the account (and not when you retire), while a traditional IRA taxes the money when it comes out (not now). I like to see the money grow and have it be an accurate reflection of what I can use to retire, but you can choose whichever you’d like.
Both the traditional IRA and Roth IRA allow you to contribute a maximum of $6,000 a year (or $500/month). If it’s feasible, always max out your IRA with monthly, automatic payments.
5. Use your credit cards to your advantage
I see a lot of young people shy away from credit cards because of fear of debt. In a way, this is positive because it goes against the mentality that you can spend what you don’t have. However, the way the US has been set up does not favor people who go completely against credit cards. If you use the system correctly, you can actually be rewarded and paid for the money you spend without risking debt.
First, why is credit important? If you want to live on your own, buy a car, or ask for a loan at any point in your life, you need to have established credit. You can’t get away with saying, “I promise I’ll pay my mortgage”. No one believes that. Instead, they want to see a proven track record of you being able to pay off “mini loans” before having access to a bigger loan. These mini loans are you simply using your credit card and paying it off each month. Mine functions exactly as a debit card because I know how much money I have, I monitor weekly how much I spend, and I can judge whether or not I can make a purchase based off the money left in my account.
I swipe my credit card and pay it back almost immediately each week through the cash in my debit account (at first, you can start off paying it off each day to develop the habit). The point is to be conscious about where your money is coming and going- which you already should have done in step 1. If you’re smart, you’ll get a rewards card. Since I’m always traveling, I have a Bank of America travel rewards card. Whenever I have a travel-related purchase, I earn 1.5 points for every $1 spent, which later I can redeem for cash. Once you have 2,500 points, you can cash it out for $25. Other cards give you miles for flights or other bonuses. This is why I put all my purchases, especially big ones like flights or rent, on my credit card. Those points tally up fast and every few months I cash out $100 – just free money.
I have never had to pay interest on my credit card, and that’s the whole point. You can use the system to your advantage and not let it own you.
If you’ve followed step 2 and 3, you should have a saving’s nest egg and a happy retirement fund. After that’s been established, you can move into the realm of investing. Again, I am by no means an expert and do not have the sort of knowledge to truly inform you about how or where to invest. However, I can use my knowledge to provide a very basic understanding of investment types and reasons why I invested where I have. Let’s begin.
Key 1: How to invest
Invest incrementally and automatically each month. Do not sit and watch your investments move up and down and then buy more or less according to those numbers. Investing is a LONG-TERM game. Put the money in there and let it sit. It will rise and fall- don’t worry about it, just keep investing. Most people pull out when the market goes down because they get scared. This makes ZERO sense. When the market goes down, you can buy more shares with less money. It’s actually a time to invest more with optimism about the future because we know we won’t be needing that money for another 40 years.
Key 2: What’s what?
Bonds are stable and grow slowly over time with an average annual return of a little over 4%. They are secure but no way to build serious capital for people our age. When you get older, bonds will become more of an interest because you don’t want to lose half your money in stocks two years before retirement.
Stocks are volatile but return twice as much as bonds at 8% each year. Right now, we should be investing in 90% stocks and 10% bonds because we want to have an opportunity to see a significant return and we have time on our side to even things out if the stocks fall dramatically.
A fund: A fund is a combination of (national and international) stocks (“equities”) and bonds managed by a company.
Often, people choose a prepackaged fund to invest in rather than individual stocks. There are various types of funds but the following two (index, mutual) are the ones I’ve heard most about. These are managed two different ways:
Index funds: These funds are managed passively by computers. Research has shown they are just as effective as humans and since there aren’t many people involved, they have fewer costs per month to use. This cost is called the “expense ratio” of a fund. Don’t ignore this percentage, it’s important. It will make a big difference in your return over time. Typically, their expense ratio is 0.2% or lower.
Mutual funds: Mutual funds are managed actively by people. Normally, they have an expense ratio between .5%-2% . It may seem like a minuscule difference from index funds, but this adds up over time!
*An expense ratio of .75% is considered expensive. Check out the chart below to see how it adds up.
Be careful with financial advisors because some of them do not have your best interest at heart. Some make money per transaction and others have a reason to recommend some stocks over others. Ramit Sethi recommends that people our age start small with a Lifecycle fund.
Lifecycle funds: Ramit recommends Lifecycle funds because they are something you can set up, automate, and then ignore! Lifecycle funds work by decreasing the aggressiveness of your investment over time. So, if you invest now your Lifecycle fund will likely have 90% stocks and 10% bonds. This ratio will change as you get older so that the closer you get to retirement the more stable and safe your money will be. So when you’re about to retire, your fund will likely be inversed with 90% stable bonds and 10% volatile stocks. This is all done automatically in a lifecycle fund, allowing you to live your life knowing things are taken care of.
I have a lifecycle fund through Vanguard within my retirement Roth IRA. You simply choose the year you want to retire, then select that fund. It’s that easy! Vanguard has low expense ratios and is a good company to start investing with.
As I said, I don’t know much about investing so you’ll have to explore this area on your own.
Hope this was helpful! 🙂 If you have any questions, feel free to leave a comment below.