One of the biggest problems most young professionals face is that they do not start saving from the day they receive their first check. If you've just earned that degree and secured the perfect job with competitive pay, celebrate the achievements with care. It's important to manage your personal finances as a young professional to help prepare yourself for a better life.
Here are four personal finance and money management tips for young professionals:
1. Know Your Net Worth
Net worth refers to the things you own (assets) minus what you owe others (debts). Personal net worth is a useful instrument that measures a person’s economic status and his or her financial progress. Assets include investments, homes, cars, cash land, or any other valuable item you own. Liabilities include what you owe. For example, personal loans, car loans, mortgages or student loans are liabilities. (For more, see: 10 Simple Steps to Financial Security Before 30.)
It is important to know your net worth because it indicates what will be left if you sell all your assets to pay for liabilities.Young professionals need to understand that in every financial move, the target should be increasing their net worth by growing assets and decreasing their liabilities.
Calculating Your Personal Net Worth:
- Calculate the value of your assets: List all assets and assign them an estimated value. For example, list the value of your home, car, business interests, art, jewelry, insurance policies, cash and investment value. Add the totals of all the assets.
- Calculate the value of your liabilities: List all liabilities and their values. These include mortgage, student loans, credit card balances, and any other debt. Add the values of all the liabilities.
- Subtract liabilities from assets: The resulting amount is your personal net worth.
If assets are diminishing and liabilities are growing, that is a sign of financial distress and trouble. If the reverse is true, that indicates good personal financial management.
2. Create a Personal Balance Sheet
Most young professionals just take a look at their credit card and bank statements to see their expenditures. More often than not, they are surprised by their expenditures. A personal cash flow statement or personal financial statement is one of the important items for a professional to own.
Personal financial statements show a person’s financial condition and help in budget planning. Personal cash flow statements show cash inflows and outflows and total cash flow by the end of a certain period.
Preparing a Personal Balance Sheet
- List all your assets and their values: All assets are categorized into three types. Liquid assets include items that can be sold without losing much value. Cash, savings in a saving account, and money market accounts are forms of liquid assets. Personal assets include boats, cars, houses and furniture. Document the market value of these items. Recent market values can offer insight on pricing an asset. Investments fall into the third category and include stocks, bonds, real estate and mutual funds.
- List all of your liabilities: Liabilities include car loans, student loans and credit card balances. As you organize your liabilities, verify the balance and interest rates.
The outcome of this preparation shows your personal balance sheet, a tool a young professional can use to estimate net worth and personal spending.
3. Create a Cash Flow Statement
A statement of cash flow or spending plan, also known as a budget, is a document that determines a person’s cash flow. The document is useful because it aids in planning earnings.
A personal spending plan is similar to the budget - it requires an accurate accounting of every expenditure. A spending plan enables you to control your money. The plan ensures that you know the amount of money coming in versus the money that will be spent. Your plan will illuminate trends in your spending and provide guidance on balancing short-term goals, such as maintaining adequate cash reserves and longer-term goals, such as saving for a down payment or wealth accumulation (retirement).
A spending plan can be designed by listing monthly income and expenses. Expenses are subtracted from income and the remaining money should be set aside to solve problems. The extra savings can help in clearing debts and building an emergency fund that can provide savings for adverse events. It is good to identify expenses that can be reduced to help you gain personal financial freedom.
4. Maintain a Good Credit Score
A credit score is a number that determines your probability of paying back credit. A credit score is established after evaluating your credit history. Financial institutions and other lenders use credit scores to evaluate your creditworthiness. The FICO Score is one of the most common credit score models used to evaluate a person’s creditworthiness. (For more, see: How to Start Building Solid Credit at a Young Age.)
Five Elements Impacting Credit Scores
- Payment history: Payment history indicates your consistency in paying credit. To contribute to a good credit score, your history must show that payments were made on time. Skipped and late payments often extend the payment period, which is not good. Late payments affect your credit history, but this depends on the amount of debt. Foreclosure and bankruptcy negatively affect your credit score and reduce your creditworthiness.
- Credit usage: Credit utilization refers to the ratio between total balance owed and the total credit limit present in your active accounts. Active accounts refer to lines of credit and credit cards. The overall utilization rate is more significant than the utilization rate of a single account. In this case, one must consider all loans, such as personal loans, student loans and mortgage, because credit utilization is calculated after an examination of all of them. A young professional with many accounts with existing balances indicates a risky borrower.
- Length of credit history: The length of your credit history is related to the age of the oldest and newest accounts, average age of all accounts and recent use of any of them. Haphazard opening of new accounts reduces the average age of your accounts and affects the score negatively. Increasing your total credit limit, reducing the utilization rate, and ensuring payments are made on time enhance your credit score. Closed accounts can stay on the credit report for a period of 10 years and increase the average age of your account. When the closed account is removed from the credit report, the average age of all your accounts drops and has a negative impact on your credit score.
- Credit mix: Your credit health can be improved by having experience in types of credit such as student loans and revolving credit card accounts. Credit mix experience is vital because it helps young professionals know that one cannot take a loan to pay another because of increased interest rates.
- Recent credit: Soft inquiries about recent credit do not have a negative impact on credit scores. Hard inquiries may affect scores because it may reveal details such as negative remarks on the credit report. In most cases, lenders use both hard and soft inquiries to learn more about your credit history. Hard inquiries have a bigger impact for someone who has no credit.
Credit Report Bureaus
Credit report companies have current information about your credit report. These credit bureaus get information from companies that have done business with you and the information is updated every month.
The three main companies are:
- Equifax: This credit reporting agency has information on more than 800 million individual consumers and more than 90 million businesses worldwide. It also offers data protection to its clients.
- Experian: This agency has information on more than 250 million individual consumers and 25 million businesses. It uses FICO to evaluate your credit score. It also offers identity protection for its clients.
- TransUnion: This agency offers credit information and training for its clients. The agency has information on more than a billion individual consumers and more than a million businesses. It offers credit protection, scores, and alerts to its clients.
Federal law allows consumers to obtain a free copy of their credit report annually from each credit reporting bureau. It is important to ensure all of the information on all of your reports is accurate and current. Annualcreditreport.com is the only source authorized by federal law for consumers to obtain a free copy of their credit report.
Importance of Credit Scores
A good credit score will help you when you need to borrow money and it also ensures you can get good interest rates, helping you save more. Your credit score impacts your insurance premiums. A lower credit score means you will pay more money per monthly installment. When your credit score is high, you have an increased chance of obtaining discounts for property and casualty insurance and more favorable terms when borrowing money (lower interest rates and 0% interest for 18 months, instead of six months). A good credit score is one factor that will enable you to obtain a position that requires security clearance or that much-needed promotion.
Young professionals have a lot to manage financially once they are on their own and supporting themselves. It's important to properly manage your finances when you are young so you can establish a solid foundation for your future and learn how to be wise with your finances throughout your whole life. (For more, see: Retirement Savings Tips for Young People.)