Your 20s are some of the best years of your life. You have unlimited energy and your life is filled with new experiences and exciting changes. Unfortunately, they are also the most financially challenging years. Dating, going out, and traveling all cost money. With an entry-level salary, you struggle to pay the bills and save money. If you have a student loan, the situation is even more challenging.
The question then becomes “how can I manage my money to make the most out of my 20s?” With a tight income, managing your money wisely becomes critical. Making smarter choices can help you manage expenses and even save money for your future. To help you maximize these amazing years of your life, we compiled some of the best money tips for 20 somethings.
Tip 1: start budgeting
I know. I know. Budgeting is not a sexy topic. In fact, I didn’t start budgeting myself until my late 20s. Yet, when I started, I found many completely avoidable expenses such as forgotten subscriptions and transportation cards. That made me regret not budgeting earlier.
I also realized that budgeting doesn’t have to be boring or restrictive. A good budget allocates money to things you love and help you enjoy life without guilt. For 20 somethings with limited income, budgeting is a great way to take control of your finances and really make every dollar count.
After all, a budget doesn’t take away your hard-earned money. It just helps you spend it a little wiser.
In fact, we have a whole article on how to start budgeting here. Go check it out!
Tip 2: never getting into unnecessary debt, ever
Perhaps the most important takeaway we can offer you is this – unnecessary debt is one of the worst enemies of your finances. Life happens. Sometimes you need money to finance your education, buy a car, or cope with an emergency. In some situations, taking out a loan or a new credit card is necessary.
On the flip side, casual use of debt is a big no-no. Unfortunately, debt has become a part of the American spending habit. According to the Federal Reserve, an average American with an income between 45k to 70k has 4.9k in credit card debt. This debt could take months if not years to pay off. Borrowing money to purchase something you want can be tempting, especially given how easy it is.
Credit cards and loans can satisfy your need to purchase a nice car or go on an instagramable vacation but the consequences are serious.
Buying things on debt is using the money you haven’t earned yet. This means you are essentially pawning your future time and income for money today. An impulsive purchase on debt can haunt you later in life. When you are in debt, you become financially vulnerable to uncertainties. Any change in your job or future income can put your finance underwater. Losing a job can lead to late payments and the interest can soon snowball out of control.
Debt also smothers your potentials to grow your money. Borrowing is the opposite of investing. Instead of earning interest and growing your wealth, you are putting more money into others’ pockets. The hard-earned money used to pay interest could have been invested and make money for you. Having debt can suck up your savings and prevent you from investing. Consequently, you can miss out on meaningful investment opportunities. If you have student loans or debts, try focusing on paying them off as soon as possible. This reduces the interest you have to pay on the debts.
Instead of buying things with debt, you should save and invest for the things you want. If you want a nice sports car or a trip to the Caribbean with your significant other, start saving money each month. Even better, you can invest your savings and let the investment help you reach your goals faster.
Saving and investing protect you from getting into a vicious debt cycle.
Moreover, having a tangible goal can encourage you to work harder and save more. So when you finally earn your dream vacation, the satisfaction doesn’t come with a sense of guilt or the bitter aftertaste of debt.
Tip 3: make your credit cards work for you
The world is officially crazy about credit cards. If you live in a city, your mailbox is likely flooded with credit card promotions. Everywhere you look, there is a new credit card with better rewards and perks. It’s tempting to add one after another into your pocket. Yet, credit cards are double-edged swords with benefits and also dangers.
The benefits of credit cards
Having a credit card can be a good move for 20 somethings. With a credit card, your transactions are protected against frauds and you can earn rewards to help you travel and save money. Additionally, paying off your balances on time can help you build a healthy credit score. Many people in their 20s don’t have a good credit score but our society today runs on credit. A decent credit score shows that you are a responsible and trustworthy person. This can be extremely useful when you want to rent an apartment or apply for a mortgage.
The dangers of credit cards
However, irresponsible use of credit cards also gets many people into trouble. We have all heard horror stories about credit card debt. Perhaps you know someone who is struggling with it.
Credit cards can give people a false sense of wealth. When you can’t afford a new watch, credit cards help you get your hands on it. However, if the balance is not paid off on time, it will start accruing interest on the money you owe. The Annual Percentage Rate (APR) on credit cards is extremely high, ranging from 15% to 30%. The high APR can quickly grow your debts out of control. Your liability can grow even faster when the late fees are added on top of the growing interest. It doesn’t take much to accumulate a debt that can take you years to pay off.
Credit card best practice
While it is unwise to avoid credit cards completely, you can, however, follow some of these best practice tips for using credit cards. These tips will help you make more out of your cards without getting into financial trouble.
Always pay off your balances in full
Most cards allow you to pay only the minimum balance each month, often a fraction of what you owe. While paying the minimum is tempting especially when the bills are piling up, your balances will accumulate interests that you will need to take care of in the future. So, resist, rise above, and always pay off everything in full.
Set up auto payments
Credit cards charge expensive late fees. According to NerdWallet, Americans are paying over $3 billion each year in late fees. That’s a ridiculous amount of money, some of which can be completely avoided by using automatic payments. This feature automatically pays your cards every month so you never need to worry about being late again. So whenever you get a credit card, first set up the auto-payment. After all, a $40 late fee avoided is a nice dinner with friends gained.
Never buy things you can’t afford in cash
The high credit limits on credit cards encourage people to spend more than what they have. The key is to remember that just because you can buy something on a credit card, it doesn’t mean that you can actually afford it. Use credit cards to buy things only if you can also afford them in cash.
Tip 4: yes, you too shall invest!
If you follow the first three tips, you soon can start growing your money through investing. Contrary to popular belief, investing is not an exclusive club open only to middle-aged men in suits. Investing is a good practice at any stage of your life. In fact, the earlier you invest the more growth you can expect from your investment.
The power of compounding
Thanks to the compounding effect, 20 somethings can benefit most from investing. Compounding is perhaps the most powerful financial concept. It refers to the phenomenon where the money you gain from investment can further generate more money for you. For example, if you invest $100 into a portfolio that gives you an 8% annual return. In the first year, you will receive $8 in interest. However, if you reinvest the interest, your return in year two will be $8.64. This is because the $8 from last year can also generate interest for you when invested. So on and so forth, the growth of your investment increases exponentially with time.
To illustrate the power of compounding, let’s use an example. Assume an investor has $10,000 to invest and the return is 8% a year. Their portfolio will grow to be 20 times larger in 40 years! The chart below shows you how their portfolio grows over time. Notice that the growth is fairly slow at the beginning but it accelerates later on. This is why you should start investing as early as possible. The more time you have to invest the more you can enjoy the accelerating growth and create meaningful wealth for yourself.
Making investing a habit
Investing is exciting but it’s not always easy. It takes patience and practice. The market is volatile and sometimes you will lose money. Don’t be discouraged. Even Wall Street professionals lose money on their trades from time to time. It is important to realize that investing is a lifelong commitment and a tool to generate wealth. When you are young, you have time on your side. You can afford to fail and can recover and learn.
Thus, try to make investing a habit. Even a small investment can teach you incredible lessons that can set you up for later success.
Tip 5: retirement is far away but it will come one day
While the subtitle rhymes by accident, planning for your retirement should be an intentional practice. Very few people in their 20s care about saving for their retirement. If you do, you are excellently ahead of your peers. Retirement seems extremely far away and it’s human nature to put off distant worries. However, good retirement takes money, dedicated planning, and disciplined saving. Remember the power of compounding? It is most useful for long-term investment goals such as retirement and an early start can make a difference in your life 30 years from now.
Even just knowing your options and the tools available to you can make a huge difference in preparing for your retirement. Here are some useful tips for you!
Maxing out employer matching contributions
401k is a popular employer-sponsored retirement plan. Many employers also offer matching contributions for 401k plans. With matching contributions, your lovely boss will generously match every dollar you put into the 401k up to a certain limit. For example, if your company matches up to 7% of your compensation, when you contribute 7% your 401k will receive another 7% from your employer. This means you are doubling the money you put into your retirement savings. It is a great idea to max out the matching contribution whenever possible.
If you are not sure if your company matches 401K contributions, check with your HR department. Otherwise, you might be leaving free money on the table.
Considering opening an IRA
Not all companies offer 401k plans. If you are one of the unlucky employees, don’t stress. There are other options available to you. Individual Retirement Arrangements (IRAs) are great tools you can use. IRAs help you save for your retirement with tax benefits. Traditional IRAs allow you to contribute pre-tax income to your retirement account. You will only pay taxes when you withdrawal from the account. The Canadian government offers a similar retirement plan – the Registered Retirement Savings Plan (RRSP).
On the other hand, Roth IRA allows you to contribute with post-tax dollars but you don’t need to pay any more taxes on your incomes and gains when you take money out of the account during retirement.
With IRAs, your money can compound without tax burdens. With the high tax rates nowadays, the tax benefits can be quite sizable. You can invest your IRA savings in stocks, bonds, mutual funds, and ETFs. You can learn more about these retirement accounts in this article.
Make it count!
Your 20s are great! These formative years contain both opportunities and pitfalls. Without a doubt, balancing fun and responsibilities is challenging. So we applaud you for the efforts. Good financial knowledge not only helps you avoid mistakes with lasting impact but also maximize your happiness with smart financial planning.
