Many 20-somethings are not prepared for adult life, financially speaking. While I did some things right, I certainly was not perfect at that age, either. Since then, I have learned some lessons. So let me try to help you here.
As you prepare for your first year of independence, getting in shape financially is the best way to get a great start in life. You are probably single, with no major responsibilities. Your income will grow, as these are your most productive years.
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You may be thinking, after all that time living like a broke student, that you deserve a bigger place and a nicer car, and that you deserve them right now. But you can’t afford that just yet, so you may go to the bank and ask for a loan, backed up by your new salary.
The bank will probably be eager to oblige, motivated by the prospect of you earning even more money a few years down the road. But what if you get married and suddenly have the added financial burden of paying for your spouse’s student loans? Or have kids and need more money to feed them and pay for day care?
You should be very careful with your money early on. Keep living like a student for a year or two.
It is much easier to keep the lifestyle you are used to than to buy too big a house or car, and then have to tighten the belt.
If you are able to maintain the same budget for a few more years – including a few splurges, but without going overboard – you should be able to save most raises, bonuses, gifts from parents… and invest it all. Need extra motivation? Just have a look at a compound interest calculator.
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If you are able to save $100 a month throughout your 20s at an average return rate of seven percent, you will have $17,409 by the time you hit 30. If you don’t add a cent to your nest egg and let it grow at seven percent until age 65, you will have $200,310 to spend when you retire. That is how powerful compound interest is.
On the other hand, if you wait until you are 40 to save $100 a month for retirement, and do so for 25 years (negating the additional 10 years from the previous example), then at seven percent return, you will only have $81,479 saved up by the time you retire. I hope these numbers are reason enough to urge you to save early!
The seven percent rate of return is not a wild guess, either. I used that figure based on the average Standard & Poor’s 500 returns from 1960 to today. Actually, the S&P 500 returned 9.7 percent a year if you reinvested the dividends, though I knocked off a couple of points, just to be safe.
Obviously, no easy-access savings account will give you that rate of return, and this is not a guarantee of future returns, but since we are in it for the long haul, using the past 50-plus years of the market seems like a safe bet.
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Let’s say you start working after college and make $2,000 a month at your first job. With a reasonable five percent raise every year, you will be making $3,257 a month 10 years later. If you save and invest 50 percent of your raise, you will manage to save over $600 a month by that tenth year.
Of course, life will happen. And you don’t want to perpetually live like a student. But that is what the other half of the raise is for. Little pleasures that make life better. Saving $600 of a $3,257 income is 18 percent of your income, which is three times the average American savings rate of five percent.
One way to save easily is to make the maximum contributions to your retirement accounts. You won’t notice the money is missing because it will be taken directly from the source, before you even get your paycheck. And if you're lucky, your employer will match some of these contributions, giving you an instant 100 percent return on your money. No savings account can beat that.
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The other advice I can give you is to be mindful with your spending. Do you really need that item? Really? If so, go for it. When in doubt, wait until you’re sure. I didn’t need a car until I was 29, and I saved thousands by not buying one. Even waiting six more months to buy the latest smart phone – or an extra week before you get a haircut – will save you money. If you think it is just a few dollars here and there, add it up, and put it through the retirement calculator. $100 spent today are $2,312 that you won’t see in retirement 45 years from now. Is your $100 expense worth $2,300?
