At the age of 30, I escaped the corporate cubicle and changed my career and lifestyle dramatically. Had I not been well set up financially due to the financial moves I made in my 20s, it might not have been such an easy transition.
Dear Nora,
I’ve just graduated, I’ve got a ton of student loans, and I want financial freedom to do stuff, like maybe travel around the world full-time like you do. Or maybe just have a cool life at home. Looking back with everything you know now, what would you tell your 20 year old self to do? -Adam
That’s a great question, and has inspired me to think about what I did right – and wrong – in my 20s. Lucky for me, I did a lot of things right, which is why my career and lifestyle is as flexible as it is now, in my 40s. But there’s always room for improvement. Here are 11 financial moves you can make in your 20s to set you up for life.
INVESTING
Money management isn’t all about investing, but the more you know about the basics thereof, the more impactful your financial moves will be. Here’s the crash course.
Start Now (Compound Growth)
Of all financial moves, this one can make (or break) your finances for life. If you want financial freedom, I cannot emphasize this point enough. Start investing now. You may not think you can afford to; on the contrary, you can’t afford not to. I had the financial freedom to quit my job at 30 (and start a fledgling low-income business) while travelling the world because I started investing a (significant) portion of my income from the very first day I started working at age 16. Because of the money I saved for retirement in my 20s, I don’t have to worry about saving any more for retirement. This allows me to live on much less money, or conversely, to direct my earnings towards other ventures. (See also: How Compound Interest Set Me Free)
Let’s look at the mechanics of this. Hypothetically speaking, you invest a chunk of money – $10,000 – at the age of 20, and leave it for 40 years, growing at an average of 8% per year. By the time you’re 60, that $10,000 is worth $217,245.
If you wait until 30 to invest the same $10,000, it will only be worth $100,626 by age 60. In order to get the same $217,000 at 60, you’d need to invest $22,000 at age 30.
If you wait until 40, $10,000 is only worth $46,609. To get $217,000 at 60, you’d have to invest $47,000.
Automate It
Most people don’t have a huge chunk of money to invest at age 20 (as in the above example), which is why it’s important to start as early as you can, with what you can. The easiest way to create good spending habits in your 20s is to automate your savings plan. Do this by designating a percentage of your earnings to go towards savings.
Problem is, if you wait until the end of the month to invest whatever money is left over after expenses, you’ll turn up empty-handed more often than not. Instead, try paying yourself first.
Let’s say you take home $1,000 (after tax) on a paycheque. After some preliminary budgeting estimates, you figure your cost of living (including student loan payments) allows you to save 10% of your income, or $100 per paycheque. Set up a $100 automatic transfer from your bank account to your savings/investment account a day or two after you get paid. This way the money is gone before you even knew you had it, and you realize you can comfortably live on the remainder.
Use Dollar Cost Averaging (Automate It, Part 2)
Investing may sound scary, but with automation and dollar cost averaging, it’s one of the easiest financial moves you can make. The technicalities are simple: you invest a set amount of money on a regular basis (and you do it automatically so you don’t have to think about it).
How much money can you save through automatic investing and dollar cost averaging? Let’s say you invest $100/month, starting at age 20, with an average rate of return of 8%/year. By the time you’re 60, it’s worth $324,180, and the money you invested totals only $48,000.
If you wait until 30, your $100/month would be worth $141,761 at age 60 (and you’ve invested $36,000). Starting at 40, your $100/month is worth $57,266 with $24,000 invested.
Dollar cost averaging not only uses the principles of compound growth and automation; it also helps take the mystery out of market timing. It gets you a good rate of return in a variable investment market (since the markets are always variable), without requiring you to spend your life and sanity trying to time the market (which is often a losing game).
Diversify (Asset Allocation)
Terms like “market timing” may sound like serious investing, and perhaps you already feel in over your head. But from a big picture point of view, once you master these financial moves, you can (basically) forget about it.
Next up in the progression of interrelated financial moves in your 20s that will set you up for life is learning about asset allocation. Learn what kinds of investments suit various goals and time frames. And once you understand these principles, you can diversify your money between these different asset classes. Here’s some more information about asset allocation.
Understand Inflation
The last of the smart financial moves in your 20s from an investment perspective is to understand the effects of inflation and how it is instrumental to financially setting yourself up for life. Inflation is the cost of living increasing (aka value of a dollar decreasing) over time. It’s that chocolate bar that cost a fraction of what it does now when you were a kid. And ultimately, it’s the value of your money and savings losing buying power over time. If you think a million bucks is going to be a decent amount of money to retire on with today’s buying power, then plan on needing about four million in forty years.
It’s also important to understand how inflation can actually decrease the value of your investments if they aren’t earning keeping up with inflation – which over time has averaged 3%/year. This means if you keep all your investments in a bank account, you’re actually losing value year over year. For long term investments like retirement savings, even if you don’t have a strong stomach for investment volatility, consider at least a percentage of equity investments with better average annual rates of return over the long run.
DEBT
With the cost of higher education on the rise, more and more people are graduating with hefty student loans, which is a crappy way to start off your adult life. But don’t lose hope and dig yourself further into trouble; here are some tips.
Understand Good Debt and Bad Debt
Although most debt on the whole should be avoided, it’s not all harmful to your finances if it’s managed properly. “Good Debt” is debt that helps you accumulate assets; ideally assets that earn a rate of return higher than your interest payments on the debt. For example, a mortgage is good debt, because your debt payments are building equity in an appreciating asset (your house). A car loan is not good debt, because cars depreciate in value; by the time you pay off the loan, the car won’t be worth what you paid for it. Student loans are arguably good debt; although you’re not paying off a tangible appreciating asset, the idea is that your education will help you get a higher paying job than you would be able to have without that degree (and thus, the student loan).
Bad debt is pretty much everything else! If you have nothing to show for it at the end of the day that is earning you more money than you’re paying in interest, that debt should be avoided.
Take on Debt ONLY Within Your Means
Even if it’s good debt, if you can’t make the payments, it’s not worth it. Not only will your quality of life suffer as you struggle every month, but if you can’t make the payments, your credit score will be affected at best, and at worst, your assets will be seized and/or you’ll have to claim bankruptcy.
Don’t Rush into Buying a House
Kudos if you want to buy a house! But you’re asking for trouble if you over-leverage. One of the biggest mistakes I’ve seen clients (and friends) do is rush into buying property because they’re convinced that every month they pay rent, they’re throwing money away. So they buy with almost no money down, before realizing that the cost of owning and maintaining property goes way beyond mortgage payments and is considerably higher than paying rent – especially after a small down payment.
One such client bought a condo she couldn’t afford in her 20s, and five years later she lost the condo when she was laid off and had no financial reserve (as she had sunk everything – which wasn’t much – into her house and hadn’t yet accumulated enough equity).
If you want to buy a house, save aggressively for a down payment. This will reduce your mortgage payments, insulate you against interest rate hikes, and give you a jump start on building equity. (Lifestyle design note: saving for a down payment is a great exercise even if you don’t end up buying a house; this money could be used to start a business, pay for additional education, or even fund long-term travel aspirations).
Remember Compound Growth? Compound Interest is the Opposite
Compound growth is earning profits on profits. Compound interest is paying interest on interest. If you charge $1,000 to your credit card (which charges 19% interest) and only make the minimum payments, it will take you over six years to pay off that debt, and you’ll make over $1,500 in payments; that’s a total of 50% interest, not 19%! If you ignore all the financial moves in this article and heed only one, heed this one: avoid debt whenever possible, and only charge things to your credit card that you can pay off immediately. (See also: 9 Mistakes to Avoid With Credit Cards)
THE BIGGER PICTURE
When we think of financial moves, we think of building assets and paying off debts. But there’s more to the picture. Here are a few final financial moves to consider in your 20s to set yourself up for life.
Consider Insurance
Insurance isn’t just for old people, and the younger you are, the cheaper it costs. While I was in my 20s, I set myself up with critical illness and life insurance policies that had rates locked in for life. What’s more: my critical illness insurance policy has a “return of premium” option that means if I don’t end up making a claim, I will get all my money back at a certain age! Because I was young and healthy when I applied for these insurance policies, the rates were really low; even with the extra years of paying premiums, I will pay less overall than if I applied for the same policy 10 or 20 years later (and 10 or 20 years later, there’s no saying I would still be healthy enough to get great rates).
Practice Patience
Hardly an innate quality for most people in their 20s, patience is a virtue worth practicing. Most of the financial moves that set you up for life aren’t instantly gratifying. Paying off student loans is a long hard road. So too is building an investment portfolio, $100 at a time (automatically invested, of course). Building a business or climbing a career ladder is also long and hard.
But understanding compound growth means your $100 will double, then again, and again – up to five times – before you retire. (That means, for every $100 you invest at age 20, it will probably be worth $3,200 at 65). Understanding the cumulative erosion of debt will prevent you from charging that expense to your credit card if you can’t pay if off.
A little bit of financial discipline out of the gate will earn you more than money as time goes on; it will earn you opportunities. And opportunities – are priceless.
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