With the new year now just underway, we have decided to start a new segment on our blog. Each post will focus on a specific age group.
As we age and journey through life we also go through very different financial stages. There are five general financial life stages: Early Earning Years (20-30), Family Commitment Years (30-45), Peak Earning Years (40-55), Pre-Retirement Years (55-65), and Retirement (65+).
Note: there are always exceptions to the rule.
We start this segment with finance tips for people in their 20’s (as the title suggests). People in this age group are generally in their early earning years.
There are a few defining factors for someone that is in this financial life stage. They have often just graduated, they are shaping a career path, they have lots of room for growth in earnings, and do not have children.
With all that in mind, lets look at some great tips to keep your finances on track going forward:
Save Early and Save Often
20-somethings have many years ahead of them to save and build wealth. However, that should not be an excuse to procrastinate saving. The sooner you can start the better. Here are several reasons for saving early:
Compound interest allows the saver to earn interest on interest. Example, if you have $100 and earn 5% interest annually. After year one you will have $105. In year two you will earn interest on your original $100 and the $5 of growth. At the end of year two you will have earned an extra $0.25, or total of $110.25. Now just imagine what compounding interest can do combined with a long time horizon and continued and consistent contributions.
For more information on compounding interest click here
Developing Good Habits
Saving early and saving often will help you develop good habits that will help to ensure financial safety in the future. Developing these habits while you’re younger, have relatively low expenses, and a flexible budget will help set you on a path of financial independence.
Reduce stress later on
Saving early and often will not only help relieve financial stress during retirement. It will also help reduce stress on your path towards retirement.
If you can be a diligent saver in your younger years, the pressure to save more of your income as you get older is lessened. When your future child `Timmy` wants to play hockey, learn 5 instruments, and indulge in 4 other after-school activities, you can be financially free to fund these learning activities. If your savings rate doesn’t need to increase, your future will be a lot less stressful.
Be cautioned as we are not saying you shouldn’t save as you get older. You should always be saving. But as you get older, expenses typically get higher and you might not be able to save as much as you want. But since you started saving younger, you can rest a little more easily knowing that your financial future won’t be as dire.
As for how much you should be saving, that depends on a lot of variables. When do you want to retire? What do you want retirement to look like? How much can you afford to save? What are your short and long-term goals?
As a general rule of thumb 10-15% of your gross income is often what is quoted as a savings rate for someone in their 20’s. Although that is better than the average Canadian Savings rate of 7.29% since 1981, increasing your savings rate might not be a bad idea.
Here’s a chart that shows roughly how many years you will have to work to retire based on your savings rate:
Develop Good Financial Habits
This was already briefly mentioned in the previous section. Good financial habits are not limited to saving. Having good financial habits simply means living within your means (which you are probably doing if you’re saving), and not taking on unnecessary debt. It also means that you’re budgeting.
Budgeting is extremely important (often mentioned but cannot be overstated). Having a budget is a critical step in setting yourself up for future success. Within a budget, you should be tracking all your spending, income, assets, and liabilities.
Having a detailed budget can help tell you if your goals are viable. Maybe you’re spending too much on that trip. Maybe you’re spending too much of your income on eating out or entertainment. On the other hand, maybe you have enough surplus monthly cash flow that you could afford to put away a few hundred dollars extra each month.
Without a detailed budget where you are tracking your finances, obtaining future goals becomes exponentially more difficult.
Define Your Goals
The goals for a 20-something will most likely look a lot different than that of someone older. They will often be more vague/broad, and longer term.
However, no matter what age it is still important to have goals. The more clearly you can define and articulate those goals the better off you will be.
Goals can take on various different forms. Someone may want to pay down “$X” amount of debt. Someone else may want to increase net worth by “Z”%. Maybe you know when you want to retire, and what you want retirement to look like. These are just examples of great goals to set and work towards.
You may not be able to put your goals into words. You might not even know how to start formulating goals, or what questions to ask. No need to worry. This is all part of the role of a good financial planner. If you don’t already have a financial planner read 10 Questions You Should Have Already Asked Your Advisor.
Watch your Debt Load
As a 20-something it can be easy to justify debt because you have a long time to pay it off. However, be weary of the type of debt and the amount of debt that you take on.
Taking on large amounts of debt at a young age can be a slippery slope. This is especially true when mixed with high-interest rates (i.e., credit cards, pay-day loans, etc.) and rising interest rates.
It is important to classify your debt as “good” and “bad” debt and make decisions based on that. Mortgages, and student loans are generally examples of “good” debt, as they can be viewed as investments in your future. Credit card and payday loans are generally examples of “bad” debt. (Read more about Credit Card/Consumer Debt, and The Canadian Mortgage Conundrum).
Even with good debt, it is best to take it on with caution. Without too much effort, you can find very uncomfortable stats about crippling student loan debt (which is generally classified as “good” debt).
Read our previous article on student loans: The Harsh Reality of Student Debt.
Side Note: When choosing a post-secondary school, choose one that can be affordable, without requiring massive amounts of student debt. When choosing a major, choose one that has high employability and earning potential, or at least enough earning potential to cover the cost of the education.
At a certain point, if your debt load is too high, you expose yourself to a lot of risks. Risk of default on the loan due to inability to pay, or due to rising interest rates. Also, a risk of not being approved for more important debt.
If your debt to equity ratio is too high, it is possible to be turned down for further financing. We are not saying having debt, or that all debt, is bad. Just be cautious and vigilant in discerning what type debt it is and how much debt you take on.
Build a Good Credit Score
Having a good credit score is important. Most of the larger purchases in life will be done through some kind of financing (i.e., mortgages, car loan, line of credit, etc.)
Having a good credit score is one of the key factors that financial institutions and other lenders look at when deciding the terms. The better the credit score, the more likely you are of obtaining favorable financing rates.
Building a credit score takes time and diligence. The earlier you can start the better chance there is that your credit score will be higher. For more information on credit scores, read Your Credit Score Matters.
Saving early and often, having good financial habits, defining your goals, watching your debt load, and building a good credit score are all great ways to build financial success.
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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy.