Aside from starting your career, the most important thing you can do in your 20s is to develop good financial habits. That’s because the decisions you make now can set the stage for the rest of your life. Below are five things you should do now to establish a firm foundation for your finances.
Start saving now. Consider saving 10% to 15% of your pre-tax income for retirement. While that may sound like a lot right now, especially on an entry-level salary, the beauty of starting early is that the percentages should remain steady throughout your working years as long as you save consistently. (By contrast, if you wait until age 45 to begin saving, you’d have to put aside 40% of your pre-tax income to reach the same place by retirement age.)
Starting early is a huge advantage because you reap the benefits of compounding. Even small amounts can add up significantly. For instance, if you invested $100 per month starting at age 18, assuming a 6% return, you’d have about $307,000 at age 65. If you waited until age 40 to begin saving the same amount, you’d have roughly $70,000.
Compounding makes a lifelong difference
Accumulated earnings at age 65
Source: Schwab Center for Financial Research. This example is for illustrative purposes only and does not indicate or guarantee future performance. Assumes for 6% average annual growth and does not account for any fees, costs, or taxes. The actual annual rate of return and value will fluctuate with market conditions.
Build a rainy-day fund. Set aside at least three to six months’ worth of living expenses for emergencies like a job loss. Consider augmenting your savings account with relatively liquid investments that earn a slightly better return, such as certificates of deposit or short-term U.S. Treasury securities.
Pay down debt. If you graduated from college with student loan debt, you may be paying between 3% and 11% in interest, and interest on credit card debt can be 20% or more. Not only is this debt expensive, but missing payments can hurt your credit score and make it more difficult to borrow money in the future. Sending more than the minimum payment amount each month will shrink the balance faster and reduce the total interest you’ll pay. Also, consider setting up automatic withdrawals from your checking account so you don’t miss payments.
Don’t leave “free money” on the table. Become familiar with your benefits package. Many companies will match a portion of your 401(k) contributions to a tax-deferred account. For example, if you earn $60,000 per year and your employer match is 50% for up to 5% of your annual compensation, a $3,000 pre-tax contribution will result in $4,500 deposited into your 401(k). This additional 50% can add up significantly over time. If your employer offers a match, sign up and contribute at least enough to qualify for the max.
Some employers also make annual contributions to employees’ tax-advantaged health savings accounts (HSAs), or offer employees the option to buy company stock at a discount. Either option is worth considering, if it’s available.
Invest for growth. Generally, you can handle the greatest amount of risk when you’re young because you’ve got time to recover from a down market. Consider a growth strategy, concentrating on stocks with strong growth potential, rather than on conservative investments like money market funds or blue-chip stocks. Sure, your portfolio should be diversified, but at this stage your asset allocation is normally tilted decidedly toward growth.
Don’t forget about your 401(k) when you change jobs. Workers ages 25-34 keep their jobs for a median of 2.8 years, according to the U.S. Bureau of Labor Statistics.1 While job hopping is often the best way to move up, you may accumulate a string of 401(k) accounts as you go. When you switch jobs, you can: leave your money where it is, roll it over into your new employer’s 401(k) plan, roll it over into an individual retirement account (IRA), or cash it out. Consolidating those accounts may simplify your financial planning, but consider all your options first, as there are a variety of factors that may influence your decision, including fees, taxes, and investment options.
1 Source: U.S. Bureau of Labor Statistics, “Employee Tenure 2006-16,” Sept. 2016.
What You Can Do Next
Whether you’re a first-time investor, or simply want to take better charge of your finances, the good news is that time is on your side.
- Schwab Intelligent Portfolios® can help you open separate portfolios for a variety of goals—including buying a house or saving for retirement. Complete a simple questionnaire to build a diversified portfolio of low-cost exchange-traded funds (ETFs). It’s automatically monitored and rebalanced when needed.
If you prefer personalized guidance, consider Schwab Intelligent Advisory™. A Certified Financial PlannerTM professional can help you establish a sound plan for all your future goals.