The One Thing a Finance Expert Wishes She Knew About Money in Her 20s
When you're living paycheck to paycheck in your 20s, more focused on making rent and having money to spare for dinners out with friends and the pair of shoes you've been praying would make it to sale season, the concept of investing may not be top of mind (though it should be).
"It's important to enjoy life today and the experiences that come with being a young adult, but today's enjoyment should not come at the expense of tomorrow's financial stability," Kelly Lannan, Director of Young Investors at Fidelity Investments, explains. Looking back on her 20s, the finance pro certainly wishes she could go back and tell her younger self a few things about building wealth. "I wish I understood the power of investing and compounding when I was in my early 20s," she admits.
Lannan fell victim to one common pitfall young people often make when it comes to money. Instead of opting into her company's 401(k) plan, she chose to keep that small amount of cash in the bank account each month. "I didn't take advantage of those early years and how that money could have continued to compound and grow," she continues. With a bit of perspective and years of experience, Lannan is sharing how to build wealth in your 20s. If you're currently in the midst of this defining decade, take note of the finance expert's tips for growing your savings, starting today.
Vocab to Know
If you're new to this whole finance thing, don't sweat it. Here are the basic terms Lannan recommends you learn to get up to speed and hold your own when discussing the tricky topic.
Compound Interest: "Starting to save as early as possible can make a big difference over time because of the snowball effect of compound interest," Lannan explains. "This means you're earning interest on the combined total of your principal investment plus any interest you've accumulated so far."
401(k): "This is money that your employer may contribute to your workplace retirement plan. While there are many different ways this can be calculated, in general, the employer may 'match' up to a certain portion of the money that you save," according to Lannan. "Remember, every employer plan has different provisions—it’s best to talk to human resources to make sure you fully understand what your employer offers," she says.
Interest Payments: "Every loan, whether it's a student loan, a car loan, or a credit card balance (which is basically a loan you take out each month from the credit card issuer), has two components—principal (the amount you borrowed) and the interest (the amount the lender charges you for the right to borrow money from them)," the finance expert points out. "The principal is something you must repay by the end of the term of the loan. So a five-year car loan must be repaid in full at the end of five years, usually in monthly installments," she continues.
Retail Brokerage Account: "This is an account that allows an individual who is ready to start investing to have access to investment choices like stocks, ETFs (exchange-traded funds), mutual funds, bonds, CDS (credit default swaps), and more," says Lannan. "Many different providers offer brokerage accounts, so it’s important to understand the full features, benefits, and the fees," she adds.
Once you've mastered the lingo, you can set your financial goals. Although goals will be unique to each person and their circumstances, there are three general goals that Lannan thinks most young people should strive for.
1. Build an emergency fund. That means saving up three to six months worth of essential expenses in case of an emergency like losing your job or needing to take time off work for personal reasons.
2. Make a plan to pay off debt. Paying off debt and freeing yourself from interest payments is an essential part of building wealth in your 20s. If you're lucky enough not to have any debt, Lannan suggests putting that money toward other savings goals.
3. Create a budget. It's vital to understand how you're spending your money each month in order to begin to grow real savings.
Now that you've set your goals, it's time to take your first steps toward building wealth in your 20s. First thing's first, enroll in a 401(k) or 403(b) retirement savings plan if your employer offers it. According to Lannan, many employers will offer to match your contribution as an incentive to help you save for retirement. So in order to get that match, which Lannan calls "free money," you have to kick in some money yourself. "A 401(k) match is a great benefit—don’t pass up this opportunity to invest in your future," she says.
Next, Lannan advises you create some budgeting guidelines for yourself to help you keep track of your spending and saving. She explains that Fidelity recommends the 50/15/5 approach to budgeting. "On a monthly basis, 50% of your income should go to essential expenses (think shelter, utilities, cell phone, groceries); 15% should go to retirement savings; 5% should go to short-term savings (paying down debt, emergency fund, vacation)," Lannan says. With the remaining 30% of your money, you can do as you wish—that's right, you can buy the shoes. Of course, these are only guidelines and they may change depending on your location, salary, and expenses.
Finally, it's time to negotiate. "Often young professionals are hesitant to negotiate a job offer or a raise in a current job," Lannan points out. "If you do your research and have specific examples of the value you bring to the company and position, don’t be afraid to share your insights," she says. By negotiating for higher pay in your 20s, you'll set yourself up for greater earnings and savings as you grow in your career.
Dealing With Debt
Whether it's student loans or credit card debt, the first step to take toward repaying the money you owe is to take an inventory of all your debt, according to Lannan. You'll want to understand exactly how much you owe and what the interest rate on any loan is. "Typically, you'll want to focus on the debt with the highest interest rate, but in the meantime, continue to pay the other loans on time," she informs. So if you're able to scrounge up some extra cash, you'll want to make extra payments to the loan with the highest interest rate in order to reduce the principal balance you owe. Oh, and if you think you can't start investing until you've paid off all of your debt, think again (more on that below).
You may not think of your 401(k) as investing, but for many, it's their first foray into building wealth. "Take some time to talk to your provider," she says. "Tell them your goals and how long you have to reach them," Lannan continues. This way, you can obtain information about things like how your money should be split up among things like stocks, bonds, cash, and equities.
According to Lannan, however, there are many misconceptions out there keeping young people from investing. "We've heard everything from it feels like gambling to you have to be rich to invest," she says. Another misconception that Lannan swears isn't true? You can't invest when you have debt.
"Many think that paying off debt and saving is a linear process," she explains. "However, it's possible to start saving and investing, while simultaneously paying down debt. Here's how she recommends you ditch debt while building your savings.
1. Build an emergency fund.
2. If your employer offers a 401(k), contribute to the match.
3. Pay off high-interest credit card debt.
4. Pay off private student loans.
5. Contribute even more to your 401(k). Aim to save 15% including your contribution and what your employer contributes.
6. Tackle lower interest loans last.
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