Financial literacy should be mandatory in high school to make up for the work that some parents don’t do in educating their kids financially. Sadly, it’s not. While I did most things well – like working and paying my way through college and graduating with savings – I certainly was not perfect. And I am aware that many 20-something are not prepared for adult life, financially speaking.
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Take Advantage of Being Single
You are probably single now, with no major responsibilities. Your income will grow, as these are your most productive years. And you may be thinking, after all that time living like a broke student, you deserve a bigger place or a nicer car – and you deserve them right now.
But you can’t 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. But what if you get married, and suddenly have the added financial burden of paying for your spouse’s student loans? Or what if you have kids, and you need more money to feed them and pay for day care?
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 too fancy a car, and then have to tighten the belt. Imagine what your parents would go through if they had to downsize to a house half the size of their current one because they couldn’t afford their lifestyle anymore. It would be much harder than if they’d always lived in a modest house.
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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 and invest most raises, bonuses, parents’ gifts, and so on. Need extra motivation? Just have a look at a compound interest calculator. If you are able to save $100 a month all the way 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 in retirement. That is how powerful compound interest is.
If you are wondering where in the world I got the seven percent, I am fully with you as no bank offers any such savings account. I used a seven percent rate of return based on the average Standard & Poor’s 500 returns from 1960 to today. You can see here that the S&P 500 returned 9.7 percent a year if you reinvested the dividends. True, there is no guarantee of similar returns in future, but since we are in it for the long haul, using the past 50-plus years of the market’s history seems like a safe bet.
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Don't wait to save for retirement.
On the other hand, if you wait until you are 40 to save $100 a month for retirement, and do so for 25 years (instead of 10 in the previous example), at seven percent return, you will only have $81,479 for retirement. I hope the numbers are reason enough to urge you to save early.
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, 10 years later, you will be making $3,257 a month. If you save and invest 50 percent of your raise, you will manage to save over $600 a month by your 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, a much higher ratio than most Americans manage to save. Over three times the average five percent-ish rate, in fact.
One way to save easily is to make the maximum contributions to your company retirement accounts. You won’t notice the money is missing because your employer will deduct it before you even get your paycheck. If you're lucky, your employer will match it.
Be mindful of your spending.
Do you really need that? If you think it’s just a few dollars here and there, add it up, and put it through the retirement calculator. If you spend $100 today, that’s $2,312 you won’t see in retirement 45 years from now. Is your $100 store purchase worth $2,300?
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