Start right now. The younger you are, the more time your money has to grow.
A class titled “Finance for Young Adults” usually isn’t part of a high school curriculum—an unfortunate oversight that leaves many young people clueless about how to manage their money, apply for credit, and stay out of debt. Although some progress has been made—23 U.S. states required a personal finance course and 25 required an economics course for high school graduation in 2022—there are still large knowledge gaps in this age group.
Basic economic and financial education in high schools should help at least a segment of the next generation, but young adults in the crucial post-high school years also need to master core lessons about money. Let’s take a look at eight of the most important rules to get your finances on the best possible track. Never forget that the younger you are, the more time your savings and investments have to grow—so the sooner, the better.
- Taking the time to learn a few basic financial rules can help you build a healthy financial future.
- Learning to prepare your annual tax return yourself could save you money.
- Start an emergency fund and pay into it every month, even if it is a small amount.
- Saving for retirement is an integral part of any financial plan, and starting young gives you the maximum time to grow your nest egg.
8 Essential Financial Rules for Young Adults
1. Practice Self-Control: Pay With Cash, Not Credit
If you’re lucky, your parents taught you self-control when you were a kid. If not, keep in mind that the sooner you learn the essential life skill of delaying gratification, the sooner you’ll keep your personal finances in order as a matter of habit.
One of the most important ways to exercise self-control with your finances is also very simple. If you wait until you’ve saved the money for whatever it is you need, then you can put all everyday purchases on a debit card instead of a credit card. A debit card deducts the money from your checking account immediately (with no additional fees), but a credit card—unless you can afford to pay off the balance in full every month—is actually a high-interest loan. If you get into the dangerous habit of putting all your purchases on credit cards, then not only will you be paying interest on a pair of jeans or a box of cereal, but you could also still be paying for those items in 10 years.
Credit cards are certainly useful; some offer great rewards; paying them off on time helps you build a good credit score. However, it is essential to use them to your advantage—not to the advantage of the lender who profits from your bad habit of racking up interest-bearing balances. Keep credit cards for emergencies only—and always pay your balance in full when the bill arrives. Also, don’t apply for every credit offer you receive—and never carry more cards than you can keep track of.
2. Beware of Bad Advice: Educate Yourself
If you don’t learn to manage your money, then other people will find ways to mismanage it for you. Some of these people could have bad intentions, like unscrupulous financial planners. Others may be well-meaning, but not fully informed about your circumstances, like relatives who make blanket recommendations about the importance of owning your own house—even though the only way you could afford to buy right now would be taking on a risky adjustable-rate mortgage.
Instead of relying on random advice from unqualified people, take charge of your own financial future and read a few basic books on personal finance. Once you’re armed with knowledge, don’t let anyone get you off track—whether it’s a significant other who siphons off your bank account or friends who want you to go out and blow tons of money with them every weekend.
3. Learn to Budget: Know Where Your Money Goes
Once you’ve read a few personal finance books, you will understand the importance of two rules that every personal finance advisor keeps repeating. Never let your expenses exceed your income, and always keep your eye on where your money goes. The best way to do this is by budgeting and creating a personal spending plan to track the money you have coming in and the money you have going out.
Once you actually start tracking how you spend your money, it can be a valuable wake-up call to realize how the cost of buying coffee from a barista every morning adds up over the course of a month. Unlike a salary increase, which is in the hands of your boss to a large extent, small changes in your everyday expenses, like making coffee at home, are completely under your control—and they can have as big an impact on your financial situation as getting a raise.
Keeping your larger monthly expenses—like rent—as low as possible can save you even more money over time. Even if you can swing an amenity-packed apartment right now, choosing a simpler place—and banking the cash you save—could put you in a position to own a condominium or a house much sooner than your friends who are paying high rent.
Tip: Understanding how money works is the first step toward making your money work for you.
4. Pay Yourself First: Start an Emergency Fund
One of the most-repeated mantras in personal finance is “pay yourself first,” which means saving money for emergencies and for your future. This simple practice not only keeps you out of trouble financially, but it can also help you sleep better at night. Even on the tightest budget—no matter how much you owe in student loans or credit card debt, no matter how low your salary is—there are ways to put at least some of your money into an emergency fund every month.
An added benefit is that, if you get into the habit of socking away money into savings automatically, then you will stop treating savings as optional—and start treating it as a required monthly expense. Before long, you’ll have more than just emergency money saved up—you’ll have retirement money, vacation money, or even money for a down payment on a home.
If you put your cash into a standard savings account, it will be secure and available whenever you need it. However, that kind of account will earn almost no interest—which means that inflation will erode the value of your savings over time. Instead, you can put your fund in a high-yield savings account, short-term certificate of deposit (CD), or money market account. Just make sure the rules of your savings vehicle permit you to get to your money quickly in an emergency.
5. Start Saving for Retirement Now
Just as your parents sent you off to kindergarten to prepare you for success in a world that seemed eons away, you need to plan for your retirement well in advance—that is, right now.
An excellent way to get started on the right path is to educate yourself about the power (some say magic) of compound interest. Once you do, the wisdom of starting your retirement fund as soon as possible will be undeniable. The simplest way to think of compound interest is as “interest on interest,” which means that you will earn interest not only on the principal (the money you put in), but also on the interest (the money the bank pays you for holding your principal). By making your money grow at a much faster rate than simple interest, which is calculated only on the principal, compound interest super-charges your savings—especially over time.
Why start saving for your retirement in your 20s? Again, because of the way compound interest works, the sooner you start saving, the less principal you have to invest to end up with the amount that you need to retire. Here’s an example: You start investing in the market at $100 a month, averaging a positive return of 1% a month (which is 12% a year), compounded monthly over 40 years. Your friend, who is the same age, doesn’t begin investing until 30 years later and invests $1,000 a month for 10 years, also averaging 1% a month (12% a year), compounded monthly. After 10 years, your friend will have saved around $230,000. Your retirement account will be a bit over $1.17 million.
Company-sponsored retirement plans are a particularly great choice. Not only do you get to put in pretax dollars (which lowers the income tax you pay), but many companies will also match part of your contribution, which is like getting free money. Contribution limits tend to be higher for 401(k)s than for individual retirement accounts (IRAs), but any employer-sponsored plan that you’re fortunate enough to be offered is a step closer to financial health.
If you don’t have access to a company plan, don’t despair. Those who are self-employed have a range of options for setting up retirement plans. Others can open their own IRAs, allowing for a set amount of money each month to be withdrawn from their savings account and contributed directly into their IRA. Even if it’s only a small sum, it will eventually add up to something substantial.
6. Get a Grip on Taxes
Before you even get your first paycheck, it’s important to understand how income tax works. When a company offers you a starting salary, you need to calculate whether that salary will give you enough money after taxes to meet your financial obligations—and, with smart planning, meet your savings and retirement goals as well.
Fortunately, there are plenty of online calculators that take the grunt work out of determining what your after-tax salary will be, such as PaycheckCity.com.
These calculators will chart your gross pay (total earnings), how much goes to taxes, and your net pay (earnings after taxes and other deductions, also known as take-home pay). For example, in 2022, an annual salary of $35,000 in New York City would leave you with around $28,270 after federal and state taxes (without exemptions)—about $2,356 a month. (Then you need to consider city taxes as well.)
In another scenario, perhaps you’re considering leaving one job for another to get a salary increase. Before you do this, you’ll need to understand how your marginal tax rate—the tax rate you pay on additional income—will affect your raise. In the U.S., low-income earners are taxed at a lower rate than higher-income earners—the higher your salary, the higher the tax rate. For example, a salary increase from $35,000 a year to $41,000 a year looks like an extra $6,000 per year ($500 per month)—but the tax rate will be higher, so it will only give you an extra $4,227 (around $352 per month). (The amount will vary depending on taxes in your state of residence.) If you’re considering a move, keep that in mind.
Finally, take the time to learn to do your own taxes. Unless you have a complicated financial situation, it’s not that hard to do, and you won’t have to pay a tax professional. Tax software has made doing your own taxes much easier than it used to be—and software also ensures that you can file online.
7. Guard Your Health
If paying monthly health insurance premiums seems impossible, what will you do if you have to go to the emergency room—where a single visit for a minor injury like a broken bone can cost thousands of dollars? If you’re uninsured, don’t wait another day to apply for health insurance. It’s easier than you think to wind up in a car accident or trip and fall down a flight of stairs.
If you’re employed, then your employer may offer health insurance, including high-deductible health plans that save on premiums and qualify you for a Health Savings Account (HSA). If you need to buy insurance on your own, investigate the federal and state plans offered by the Health Insurance Marketplace of the Affordable Care Act (ACA). Look at quotes from different insurance providers to find the lowest rates. Research all your options to see if you qualify for a subsidy based on your income. If you have health issues, know that a more expensive plan could be the most cost-effective in the end.
If you’re under age 26, then your best choice may be to stay on your parents’ health insurance—an option that has been allowed since the 2010 passage of the ACA. If you can manage it, offer to reimburse your parents for the cost of keeping you on their plan.
It also makes excellent financial sense to build staying healthy into your daily routine as soon as possible. Common-sense health maintenance is very straightforward, and you’ve heard it all before. Eat fruits and vegetables, maintain a healthy weight, exercise, don’t smoke, avoid excessive alcohol consumption, and drive defensively. Not only will you feel better physically right now, but these behaviors can also save you on medical bills down the road.
Important: Since the 2020 COVID-19 pandemic exposed critical gaps in U.S. health care and health insurance, the U.S government has been leveraging the American Rescue Plan (ARP), a $1.9-trillion stimulus package signed into law in March 2021, to expand health care coverage and reduce costs. The plan also includes incentives for states that have not participated in the Affordable Care Act (ACA) expansion to do so, potentially extending healthcare coverage to over 3 million uninsured people.
8. Protect Your Wealth
To ensure that your hard-earned money doesn’t vanish in an emergency, you should take steps right now to protect it. Here are some smart moves to think about, even if you can’t afford them all right away:
If you rent, get renter’s insurance to protect the contents of your home from loss due to burglary or fire. Read the policy carefully to see what’s covered and what isn’t.
Disability insurance protects your greatest financial asset—the ability to earn an income—by providing you with a steady income if you ever become unable to work for an extended period of time due to illness or injury.
If you want help managing your money, find a fee-only financial planner to provide unbiased advice. Unlike a commission-based financial advisor, who earns money when you sign up with the investments that their company backs, a fee-only planner has no personal incentive to give you financial advice that might not be in your best interest. (Even if a commission-based advisor gives you solid advice, they still always have a divided loyalty—to their company’s bottom line and to you.)
You should also protect your money from taxes—which is easy to do with a retirement account—and from inflation—which you can do by making sure that your money is earning interest. As you decide how to protect your savings, learn everything you can about relevant investment vehicles, because they all bring both different degrees of risk and different potential for growth. For example, high-interest savings accounts, money market funds, and CDs are relatively free of risk; your money is safe, but it will grow slowly. On the other hand, stocks, bonds, and mutual funds are much riskier; the value of your portfolio could fall, but the potential for growth is much greater as well.
How Do I Choose a Financial Advisor?
An excellent choice for a young adult is a fee-only financial planner. Unlike a commission-based advisor, who earns a commission if they sign you up with their company’s investment plans, a fee-only planner has no personal incentive beyond your best interest, so they have no reason not to give you unbiased advice.
Why Is Compound Interest So Powerful?
Compound interest is one of the most powerful forces in finance because it grows your money exponentially, which means it can super-charge your savings, especially over time. The magic of compound interest for your retirement account is that it is interest on interest—literally. You earn interest not only on the principal (the money you put in), but also on the interest (the money the bank pays you for holding your principal).
Why Did My Paycheck Shrink After My Raise?
The higher your salary, the higher your tax rate. If you just got a raise or took a new job at a higher salary, the change in the marginal tax rate on the additional income will definitely affect your paycheck. For example, if a salary increase of $6,000 per year bumps you up into a higher tax bracket, the percentage of your income that goes to taxes bumps up as well—which will make your paycheck smaller than expected. If you’re considering a move to a more expensive area to accept a higher salary, keep that in mind.
The Bottom Line
Remember, you don’t need an MBA in finance or even specialized training to become an expert at managing your finances. Following these eight basic rules can put you on the path to financial security, which is the foundation that will allow you to build the rest of your dreams.
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