If you had to give a young adult one piece of financial advice, what would it be?
I am 22 years old and have developed a vast interest in personal finance and the economy. What would be the most critical piece of advice you would give to someone my age who has just entered his first career? I have lofty expectations for myself and my future, therefore, I want maximize my income and value as much as possible.
1) Start saving NOW! Utilize your company's 401(k) if applicable; if not, contribute to an IRA. Time is your friend, and the time value of money shows that the earlier you start, the better. Save at least 10% of your income, give away 10%, and live off of the rest. Invest in a diversified portfolio of domestic and international equities.
2) As part of the above, don't forget to also build up a stockpile of emergency money, this amount doesn't necessarily need to be some % of your income, but an amount that helps you sleep well at night, whatever that means to you. But it should at least be enough to cover the cost of new tires or some other potential unexpected expense.
3) Stay out of debt. Regarding home ownership, there can be benefits from buying a house, but there are a lot of expenses as well. And mortgage interest isn't necessarily deductible depending on your itemized expenses. You are given a standard deduction of $6,350 (double that if you are married), so don't buy into the "get a mortgage; it's deductible" hype that lenders (and real estate agents) like to say. Once you are a little older and more settled, then consider a house. Regarding other debt, looking rich by buying expensive cars and technology doesn't make you rich. It's not what you spend, but what you DON'T spend that makes you wealthy.
I will give you three pieces of advice. First, pay yourself first. Before you spend any money on food, clothing, housing, entertainment, vacations, whatever you can think of, be sure you have put aside something for yourself. It is best if you set up an automatic transfer that corresponds to your paycheck deposit. Even if the amount is small, get into the habit of saving regularly and consistently at the beginning of your career. This habit will reap huge dividends for you in the future.
Second, invest your savings prudently. As your savings balance grows, many individuals will come to you with ideas of how to invest your money for the future. Be sure to take a critical eye to all of these proposals. Ask as many questions as you can. Decipher how the person you are speaking with is paid. Ask them to explain their underlying assumptions, go beyond the materials presented to you and dig into the details. Ask if they invest their own money in this way, and if the answer is no, ask why. Many individuals are highly experienced in personal finance and have the tools and the knowledge to guide you on the right path. It is your responsibility make sure that the person you are working with is one of these individuals.
Third, appreciate your greatest asset, time. Right now, the most powerful force you have going for you is time. The dollars you invest today will work and grow for you for the rest of your life. Those dollars will earn more dollars, which will, in turn, earn more and more. This phenomenon, known as compound growth, is extremely powerful, but it takes time. Know that this is a lengthy process, do not get discouraged, and enjoy the ride.
This is truly a great question, especially at your age. In an attempt to answer your question, and I've been doing planning on a fee-only basis for 35+ years, the key is not living to the level of your income. Always avoid having to compare what you have versus your friends and neighbors. It's irrelevant and you can help yourself and your family directly if you begin to save early and often. As an example, see if you can set aside 15% or 20% of your income now and use this as a guideline for the future. Take advantage of any 401(k) plan, 403(b) plan, or any other form of retirement planning, including Roth IRAs, and begin saving today, not tomorrow. Obviously your level of income is critical in making these decisions. As an example, if your income is not sufficient to cover your basic needs, then saving is extremely difficult. However, it can still be done if you can be frugal enough to deal with yourself honestly and make a distinction between what you need and what you want. Never, and I repeat, never miss an opportunity to save and don't assume you'll ever have an inheritance or any form of windfall because it may never happen. If it does, all the better, but depending on one of these forms is simply dangerous. If you can get into a 401(k) or similar plan with a company match, do so as quickly as possible at least to the level of the match. If cash flow is short, make it a point to put one half of every year's raise into the 401(k) plan until you can get to the maximum over a period of years. Make savings a fixed expense, not a discretionary expense and you will never regret it. Your long-term goal should be to plan to retire (financially) at age 55 and not at the normal 65 or 66. Whether you actually retire at 55 is irrelevant, but if you can afford to do so, you can write your own ticket to the future. Again, my thanks for such a great question and I wish you much success.
Begin investing as much and as early as possible to maximize your compounding effect over time. And every time the markets take a dip, try to add as much as possible. One other thing, the biggest mistake I see investors make is that they are so worried about a tax deduction, they put everything into a 401(k) or a regular IRA. Then they have no flexibility on the outside to invest in alternative investments like real estate or precious metals.
A Roth is a great alternative when young because your tax rate is likely not that high yet so the tax deduction is therefore less important. And you can access and take out any contributions anytime penalty and tax free, but it grows tax deferred (and tax free if done correctly). For instance, the max per year you can put in is $5,500. So, you could take out any $5,500 contributions over the years without penalties for emergencies.
Hope this helps, and you are asking the right questions. Congratulations. Dan Stewart CFA®