Getting Started in Your 20s: 5 Key Financial Moves
Stuff you’d rather not think about, but will be happy that you did
Getting your adult life off to a strong start financially is going to play a huge role in your happiness. Making a mess of your bills and loans, and missing opportunities to build financial security right now – your 20s are the best decade to start saving for retirement – can make for plenty of regret, if not downright misery, in the years ahead.
So, follow these five key financial moves, and you will be setting yourself up for a solid future.
Don’t hide from student debt. Within six months of leaving college, you must start repayment of your loans, or ask for deferment or forbearance if you have yet to land a job. Simply ignoring your student loans is a recipe for disaster. (Even declaring bankruptcy won’t make them go away.) They’re like industrial strength Velcro. And if you fall behind on payments, you are going to make a mess of your credit score. If you’ve let this slide, contact your lenders ASAP to work out a repayment plan.
Get a credit card. You are perfectly reasonable to think this is absurd, given that credit cards are the plastic gateway to overspending. And kudos to you if you’re happy with your bank debit card. Debit cards are a fantastic way to force yourself to live within your means (assuming you don’t have any overdraft coverage).
But in the screwy reality of consumer finance, your history of using a debit card doesn’t help build a credit score. Any time you need to borrow money – for a car, a home – your credit score will play a big role in whether you qualify and the interest rate you‘re offered. A version of your credit score can be used in some states to set your auto insurance premium. Landlords look at it, too.
Using a credit card correctly builds your credit score. Get one. Use it a few times a month, pay the balance in full, get on with your life.
Start saving for retirement. Seriously. OK, you’ve got other pressing financial goals: repaying your student loan, renting a place so you can move out of your childhood home or the apartment you’re renting with too many housemates.
But here’s the thing: Your 20s offer an amazing opportunity to cash in on long-term saving. Money you manage to save today can keep growing for decades. That’s the so-called “magic” of compounding. Wait until your 30s and 40s, and you’ve got less time for compounding to do its thing.
For example: If you save $250 a month from age 23 to 30 and earn an annualized 6%, you will have made $21,000 in deposits, and your account will grow to $26,000. If you stop saving and just let that $26,000 compound for another 40 years, you will have more than $260,000 at age 70. (To be clear: Don’t stop saving!) Americans generally don’t save enough.
Now, assume you wait until you turn 40 to get serious about retirement saving. Save the same $250 a month for the next 30 years and you still won’t have as much saved compared to seven years of saving in your 20s. And in those 30 years you will have had to fork over $90,000 of your own money, compared to the $21,000 you would have saved between 23 and 30 in the earlier example.
Have a workplace retirement plan, with a match? Check with HR that you are contributing enough to earn the maximum company match. That’s a bonus you don’t want to pass up. Oddly, plenty of employers automatically enroll new hires in the plan but not at a savings rate that entitles them to the full company match. You’re not gonna fall for that.
No workplace plan? Consider a Roth IRA (individual retirement account). Every discount brokerage offers IRAs.
There are two types of IRAs: traditional and Roth. A Roth IRA can be a super-smart way to get rolling on retirement savings. You will pay zero taxes on money you withdraw from a Roth in retirement, whereas every penny you pull out of a traditional IRA is taxed as ordinary income. That can make a huge difference in retirement. (Just ask your parents or grandparents if you’re doubting.)
Chances are you qualify for a Roth. In 2019, an individual with modified adjusted gross income below $122,000 (married couples filing jointly, below $193,000) can save up to the $6,000 per person maximum.
A Roth IRA works great if you’re self-employed. Able to save more than $6,000 a year? Check out SEP-IRAs (simplified employee pension), also offered at discount brokerages. If you’re self-employed, you can save 25% of your income in a SEP-IRA, up to a $56,000 maximum in 2019. Something to be aware of: SEP-IRAs are only “traditional”; there is no Roth option with a SEP-IRA.
Start building your emergency fund. Life will throw you curveballs and emergencies: A roommate becomes unbearable, or a boss does. You’re hit with a car repair you didn’t see coming, or a co-pay for the MRI after wrenching your knee being a weekend warrior. Having cash to deal with speed bumps is not just smart, it’s empowering. Who wants to live life wondering what they’ll do when an unexpected $300 or $1,000 expense comes outta nowhere?
Search online for “high yield online savings accounts.” They pay a higher interest rate than old-school banks. Set up a direct transfer weekly or monthly (they’re free) from your checking account into your savings account. Push yourself to save more than you think you can. If your first thought was to save $50 a month, start with $75. If $100 seems comfortable, try $150. You can always adjust. Chances are you’ll be able to deal with the higher amount and be motivated when you see your balance growing.
Protect yourself. If you’re not living at home, get renters insurance. Your landlord doesn’t owe you a penny if you are robbed, or the apartment burns down. Don’t worry, it’s super-cheap.
Same goes with health insurance. If you’re self-employed, or your employer doesn’t offer health insurance, go to Healthcare.gov to shop for plans offered in your state. Premiums for 20-somethings aren’t going to be very high. You might even qualify for subsidies that will reduce your premium. The price you pay will be a fraction of what you would owe if you are injured or sick, and don’t have health insurance.
And if you happen to get married and/or start a family in your 20s, be sure to scope out term life insurance.