Whether you’re a recent grad or preparing to strike out for the first time, it is important to start on a solid financial footing. Today, we’re going to take a look at some common mistakes that young people make when they’re financially getting on their feet:
Not understanding debt obligations
When it comes to understanding debt obligations, it’s important to know the difference between paying down interest on a loan versus paying down the principal. Steep loan debts can be intimidating, so sometimes people opt to make the minimum required payment on interest so as to put off making larger payments. This can be tempting, but by only paying down interest on a loan, you will continue to be saddled by the debt and will not make any headway toward paying off the obligation.
By focusing on paying down the principal, not just the interest charged on the loan, you will decrease the amount of total interest you pay. While it is important to keep up with interest and minimum payments, by paying down the principal amount on the loan, you will slowly be able to chip away at large debts until they are increasingly manageable.
Not budgeting regularly
Without having a budget, it’s impossible to know whether you’re on track or not. Living paycheck to paycheck can be tempting, but with a little bit of work and planning ahead, you’ll be surprised by what you can save. And more importantly, budgeting will help you avoid falling behind on financial responsibilities, racking up debt, or ultimately damaging your credit.
If you’ve lived without a budget until now, you’re not alone. Start out by calculating income and expenses on a monthly basis, while also working to build an emergency savings cushion for the unexpected car repair, medical bill, or other unforeseen expense.
Many young professionals also are tempted to take out credit cards to cover living expenses and basic needs, thinking they will be able to easily catch up. This is an easy way to get yourself into a financial hole, and instead you should focus on maintaining fiscal discipline. Also, don’t underestimate the power of compounding. A dollar saved when you are 25 will compound to much more than a dollar saved when you are 40.
Not taking advantage of employer retirement plans
For many young people starting out, 401ks, IRAs, and other employer-offered retirement plans can sound confusing and downright intimidating, but contributing early and often to your retirement account is a great way to set yourself up for long-term financial success.
As we explored in a previous post, Disciplined Investing: Minimize Loss & Maximize Returns, the key to long-term financial growth is to maintain a portfolio of diversified holdings that can appreciate over many years in the market. In other words, the earlier your start saving and planning for retirement, the longer your investments have time to accrue compound interest and grow over a long time horizon.
While contributing to a retirement fund now is a less than thrilling prospect, you should also take advantage of any 401k matching contributions your employer might offer. Often times, employers will match a certain percentage of your own contribution. This is essentially “free money”, so ask your benefits rep about retirement plans offered by your employer and try to take full advantage of matching contributions! Finally, pre-tax contributions to a traditional 401k reduce your pay and, therefore, your taxes due at the end of the year.
Leaving a job before retirement funds are fully vested
To be “vested” means to have ownership over the funds in your retirement account set up through an employer, which you can read more about here. You might think “But wait! Shouldn’t all of the money in my retirement plan be mine?” The answer to that question is: maybe.
While you own any dollars personally contributed to your retirement plan, you might only be entitled to an employer’s matching contributions after you become fully vested, usually after a certain specified number of years of service to your employer.
Depending on what your company’s policy stipulates, after a certain period of employment with the company—either a number of years, or gradually over time—you gain ownership of the employer’s contribution as well, meaning you have become vested. So what does this mean for you and your retirement savings with your employer? It means one more variable to consider before leaving a job.
If you only have a few hundred dollars of employer contributions to lose, then it probably shouldn’t prevent you from taking your dream job with another company; however, if you have been contributing regularly and have thousands of matched dollars to lose, it means you should think carefully and take those dollars into consideration before changing employers. NOTE: your deferral contributions are always vested upon contribution.
Not having cash savings for emergencies
While putting money into an employer-sponsored retirement plan or IRA is a great way to set yourself up for your golden years, you should also make sure to keep some cash reserves readily accessible in case an emergency should arise.
The conventional rule of thumb is that you should aim to have three months of living expenses saved up and prepared for an emergency. Getting laid off, taking take time for family, medical leave, or other unforeseen circumstances could mean going without a paycheck in the short-term. Now is the time to assess: am I prepared for a financial emergency?
Not setting aside a portion of windfalls
An unexpected windfall, be it in the form of a raise, a bonus, or a tax refund is a good chance to contribute to savings or retirement funds. While it might be tempting to treat yourself and splurge using your windfall, consider earmarking a portion of it to help grow your investments. That way, you will both enjoy your windfall and gain peace of mind while setting yourself up for success, no matter what the world throws at you.
Not regularly re-assessing financial goals
A very common struggle for young professionals is to not start thinking early about the financial future. The idea of financial planning might seem silly if you’re just starting out and living from paycheck to paycheck, but by having a goal—even a modest one—you will be surprised what you can save over time. Additionally, a tangible goal will offer you motivation when you’re considering another coffee out, rather than putting another five bucks aside today for the future, but remember: those five dollar bills stack up!
By getting into the habit of planning and budgeting now will help you develop essential skills for successful long-term financial planning and investing for your future. We hope these tips will help!
You’re not alone! It’s never too soon to consult with a trusted financial advisor today to start learning how you can plan for a bright future.