After you got out of college, you learned how to pay the bills on time and stay out of financial trouble. But how can ensure your financial success?
If you’re part of GenY, you know debt is a big issue. Two-thirds of college seniors who graduated in 2011 had student loan debt, and once graduates get into the workforce, this debt can cause financial stress.
Credit cards and auto financing cause more serious problems. After graduation, credit card balances can easily balloon as you struggle to get by on skimpy paychecks. Tack on a car loan or lease and you could be looking at big trouble.
With any luck, your post-college financial struggles will ease as you approach 30 and start getting decent salary increases. This is when you should be looking to buy your first home and start seriously saving for retirement.
Strategies for becoming financially fit
To reach your late 20s or early 30s in reasonable shape for your financial goals, you should:
Focus on your career
Your primary source of wealth will most likely be employment compensation. Continue to invest in your ability to earn more money.
Don’t expect to live like your parents
It took them 25 or 30 years in the workforce to achieve their current standard of living. If you’re eating out as often as they do or taking equally extravagant vacations, you’re probably spending too much. (Click here to Tweet this thought.)
Drive a basic, safe and reliable car
The money you’d spend on the high cost of financing, maintaining and insuring a fancy car — whose worth depreciates quickly — should be saved for a down payment on a home.
Handle credit cards with care
Use a debit card, partly because you can get cash back on purchases with some cards. Using a debit card also makes you a more careful spender, because you know the money is coming straight out of your checking account.
If you prefer to use a credit card because you earn frequent-flier miles, every time you use your card, subtract the sum from your checking account balance. That way, when the monthly credit card bill arrives, you know you’ll have enough to pay off the entire bill.
Don’t necessarily rush to pay off student loans
If the interest is low and tax-deductible, your money can work harder elsewhere. Increase the contributions to your employer’s retirement plan to get the full matching contribution and earmark the rest for a down payment on a house
It’s never too early to think retirement
Saving for retirement can be the biggest investment you’ll ever make with your earnings. Start by setting an intermediate-term goal of accumulating retirement savings equal to two times your annual compensation. Once you hit that milestone, the financial wind will be at your back, helping you reach your retirement savings goal.
Here’s an illustration:
Suppose you expect to eventually earn $80,000 a year. Looking ahead to retirement, you estimate that — in addition to Social Security — you’ll need $45,000 a year from your portfolio in today’s dollars. To generate that $45,000, you’ll need a $1 million nest egg, calculated in today’s dollars.
Once you reach a certain level of assets, most of your savings should come from investment returns. The breakthrough occurs at around two times your income. Let’s say your salary has reached $80,000, you’ve amassed $160,000 in savings, you’re saving 15 percent of your pretax income each month and your investments earn seven percent a year.
Over the next 12 months, your $160,000 portfolio would grow by $23,620. Your monthly savings would account for $12,000 of that growth. The other $11,620 would come from investment gains. In other words, you’ll have reached the crossover point where the biggest driver of your portfolio’s growth is now investment earnings, not the actual dollars you save.
But you’re not done yet…
You should keep saving money. That sacrifice will be handsomely rewarded as your portfolio starts to grow. Using the assumptions above, your portfolio would soar from $160,000 to more than $542,000 in 10 years. True, part of this gain would be lost to inflation. But your salary should also rise, allowing you to squirrel away more money.
That still leaves the initial goal of accumulating two times your income, which can take 12 to 15 years. The earlier you start the better. If you’re close to two times your pay by your early 40s, you’re in good shape.
As you strive to amass that sum, your top priority should be funding your employer’s 401(k) plan. In addition to the initial tax deduction and continuing tax deferral, you’ll likely receive a matching employer contribution, which will help speed your portfolio’s progress.
If you can, save outside your employer’s plan by funding a Roth individual retirement account. You won’t get an initial tax deduction, but you will enjoy tax-free growth. A Roth also offers flexibility; you can withdraw your contributions without a tax hit or penalty. Your Roth could double as an emergency reserve or as your house down payment fund.
What are your strategies for staying financially fit?
Mark F. Toledo, CFA is a partner with Chicago Partners Wealth Advisors. Mark has provided investment and wealth management advice to individual and institutional investors for more than 30 years. Mark works with clients to help them define and then achieve their goals through effective wealth management.