Get a Financial Life

1. Start saving and investing early to harness the power of compound interest

Suppose you set aside $1,000 a year (about $19 a week) from age 25 to age 65 in a retirement account earning 7% a year—a total of $40,000. By the time you turn 65, you'll have $213,610.

Compound interest is powerful. Starting to save and invest early in life can lead to significantly more wealth over time due to compound interest. Even small, regular contributions can grow into large sums given enough time. For example, saving just $1,000 per year from age 25 to 65 at a 7% annual return would result in over $200,000.

Time is your greatest asset. The earlier you start, the more time your money has to grow. This principle applies to retirement savings, investments, and any long-term financial goals. Even if you can only save small amounts initially, it's crucial to begin as soon as possible. Delaying saving by just 10 years can cut your final balance in half or more.

Automate your savings. Set up automatic transfers from your paycheck or checking account to savings and investment accounts. This "pay yourself first" strategy ensures you're consistently saving before spending on other things. Increase your savings rate whenever possible, such as when you get a raise or pay off a debt.

2. Create and stick to a budget to control spending and build wealth

Where does your money go? If you're like a lot of people, you're not sure.

Track your spending. The first step to financial control is understanding where your money goes. Keep a detailed spending diary for at least one month, recording every expense. Categorize your spending into essentials (housing, food, utilities) and non-essentials (entertainment, dining out). This exercise often reveals surprising spending patterns and opportunities to cut back.

Create a realistic budget. Based on your spending analysis, create a budget that allocates your income across different categories. Use the 50/30/20 rule as a starting point:

• 50% for needs (housing, food, utilities, transportation)
• 30% for wants (entertainment, dining out, hobbies)
• 20% for savings and debt repayment

Regularly review and adjust. Your budget should be a living document. Review it monthly and adjust as needed based on changing circumstances or goals. Look for areas to trim expenses and redirect money towards savings and investments. Remember, small changes in daily spending habits can lead to significant long-term financial improvements.

3. Prioritize paying off high-interest debt while building an emergency fund

One of the smartest financial moves you can make is to take any savings you have (above and beyond money you need for essentials like rent, food, and health insurance) and pay off your high-rate loans.

Target high-interest debt first. Credit card debt and other high-interest loans can quickly derail your financial progress. Prioritize paying off these debts as quickly as possible, starting with the highest interest rate. Consider the debt avalanche method:

1. List all debts by interest rate
2. Make minimum payments on all debts
3. Put extra money towards the highest-rate debt
4. Once paid off, move to the next highest-rate debt

Build an emergency fund simultaneously. While aggressively paying off debt, also work on building an emergency fund. Aim for 3-6 months of living expenses in a readily accessible savings account. This fund provides a financial cushion for unexpected expenses or income loss, preventing you from accumulating new debt in emergencies.

Consider balance transfer options. If you have good credit, look into 0% balance transfer credit card offers to save on interest while paying off debt. Be cautious of transfer fees and have a plan to pay off the balance before the promotional rate expires.

4. Maximize tax-advantaged retirement accounts like 401(k)s and IRAs

If you're fortunate enough to work for a company that offers a retirement savings plan like a 401(k), you should take advantage of it.

Employer 401(k) matching is free money. If your employer offers a 401(k) match, contribute at least enough to get the full match. This is essentially an immediate 50-100% return on your investment. For example, if your company matches 50% of your contributions up to 6% of your salary, contribute at least 6% to get the full benefit.

Consider Roth options. Many employers now offer Roth 401(k) options, and individuals can open Roth IRAs (subject to income limits). Roth accounts are funded with after-tax dollars but grow tax-free, and withdrawals in retirement are tax-free. This can be especially beneficial for young workers who expect to be in a higher tax bracket in the future.

Maximize contributions when possible. As your income grows, aim to max out your retirement account contributions. For 2023, the limits are:

• 401(k): $22,500 ($30,000 if age 50+)
• IRA: $6,500 ($7,500 if age 50+)
  Remember, these accounts offer valuable tax benefits and enforced discipline for long-term savings.

5. Invest in low-cost index funds for long-term growth

Although there are hundreds of different credit cards available, most of us don't need more than two.

Index funds offer broad diversification. Instead of trying to pick individual winning stocks, invest in low-cost index funds that track entire markets. This provides instant diversification across hundreds or thousands of companies, reducing your risk. Popular options include:

• Total US stock market index funds
• S&P 500 index funds
• International stock index funds
• Bond index funds

Keep costs low. The fees you pay for investments can significantly impact your long-term returns. Look for index funds and ETFs with expense ratios below 0.2%. Over decades, even small differences in fees can cost you tens of thousands of dollars.

Maintain a long-term perspective. The stock market is volatile in the short term but has historically provided strong returns over long periods. Don't try to time the market or react to short-term fluctuations. Instead, develop an asset allocation strategy based on your goals and risk tolerance, and rebalance periodically to maintain that allocation.

6. Protect yourself with adequate insurance coverage

Although you may never have heard of disability insurance, it's something you should have even if you live in one of the states mentioned above.

Health insurance is essential. Prioritize obtaining health insurance, even if you're young and healthy. Medical emergencies can lead to financial ruin without proper coverage. Consider high-deductible plans paired with Health Savings Accounts (HSAs) for potential tax benefits.

Don't overlook disability insurance. Your ability to earn income is your most valuable asset. Disability insurance protects your income if you become unable to work due to illness or injury. Many employers offer some coverage, but consider supplementing with an individual policy if needed.

Other key insurance types:

• Renters/Homeowners insurance: Protects your property and liability
• Auto insurance: Required in most states, shop around for the best rates
• Life insurance: Necessary if others depend on your income
• Umbrella liability policy: Extra protection for high-net-worth individuals

Regularly review your coverage to ensure it keeps pace with your changing life circumstances and financial situation.

7. Buy a home only when you're financially ready and it makes sense

At some point in the next few years you may start to feel that it's time to purchase a home of your own.

Renting can be smarter than buying. Don't rush into homeownership just because it seems like the "adult" thing to do. Renting offers flexibility and can be financially advantageous, especially if you:

• Might move in the next few years
• Live in an expensive housing market
• Can't afford a 20% down payment
• Have other financial priorities (like paying off debt)

Be prepared financially. Before buying, ensure you:

• Have a stable income and job security
• Save a 20% down payment (to avoid private mortgage insurance)
• Have an emergency fund separate from your down payment
• Can afford ongoing costs (property taxes, insurance, maintenance)

Consider the full financial picture. While homeownership can build equity and provide tax benefits, it also comes with significant costs and responsibilities. Use online rent vs. buy calculators to compare the long-term financial implications based on your specific situation and local housing market.

8. Understand and actively manage your credit score

You can think of your credit score as the GPA of your financial abilities, a numerical representation of how appealing you are to lenders.

Your credit score impacts many aspects of life. Beyond loan approvals and interest rates, credit scores can affect:

• Rental applications
• Job opportunities
• Insurance premiums
• Utility deposits

Key factors affecting your score:

1. Payment history (35%): Always pay bills on time
2. Credit utilization (30%): Keep balances low relative to credit limits
3. Length of credit history (15%): Maintain long-standing accounts
4. Credit mix (10%): Have a variety of credit types
5. New credit inquiries (10%): Limit new applications

Monitor and improve your score. Get free credit reports annually from AnnualCreditReport.com. Use free credit monitoring services like Credit Karma to track your score. To improve:

• Set up automatic payments
• Pay down credit card balances
• Keep old accounts open
• Limit new credit applications
• Dispute any errors on your credit report

9. Be strategic about student loans and education costs

College graduates who borrowed for school owe about $37,000 on average in student debt.

Explore all funding options. Before taking on student loans, exhaust other options:

• Scholarships and grants
• Work-study programs
• Part-time jobs
• Community college for initial credits

Understand loan types. Federal loans generally offer more favorable terms and repayment options than private loans. Types include:

• Direct Subsidized Loans (need-based, government pays interest while in school)
• Direct Unsubsidized Loans
• PLUS Loans (for graduate students or parents)

Choose repayment plans wisely. Federal loans offer various repayment options:

• Standard 10-year repayment
• Income-driven repayment plans
• Public Service Loan Forgiveness program

Consider your career path and expected income when choosing a repayment strategy. Avoid defaulting on loans at all costs, as it can severely damage your credit and financial future.

10. Make smart choices about cars and transportation

Before you visit a car dealership, shop around to get an idea of current auto loan rates and car pricing information.

Consider total cost of ownership. When buying a car, look beyond the sticker price. Factor in:

• Fuel efficiency
• Insurance costs
• Maintenance and repair expenses
• Depreciation

New vs. used. While new cars offer the latest features and full warranties, they depreciate rapidly. Consider slightly used cars (2-3 years old) for significant savings while still getting modern features and remaining warranty coverage.

Financing tips:

• Shop for auto loans before visiting the dealership
• Aim for a loan term of 4 years or less
• Make a down payment of at least 20% if possible
• Be wary of dealer add-ons and extended warranties

Consider alternatives. Depending on your location and lifestyle, alternatives like public transportation, car-sharing services, or even biking can significantly reduce transportation costs. Calculate the true cost of car ownership versus these alternatives for your situation.

Last updated: October 29, 2024