This is a guest post from Pauline of InvestmentZen.com
As a young adult, figuring out your finances can be overwhelming. You’re just out in the world, living on your own for the first time, and even if you are not making millions, your first paycheck is probably bigger than that of any summer jobs you’ve ever had. So here are a few tips to help you start your financial life on the right foot.
In order to prepare for a solid financial future, you must start saving now. Time and compound interest are on your side, and waiting too long before you start investing could have dramatic consequences on your retirement. Mopping the floor of a fast food in your 70s to make ends meet kind of dramatic. Since it is just you for now, it will be much easier to find extra money in your budget to save and invest, compared to your 40s, when you are a parent with many financial commitments.
One of the best thing I did when I graduated college was to keep living like a student for a few more years. I was used to a simple lifestyle, and had learned to be very resourceful. I would pack my lunch to work, look for deals on anything I bought, and try to get free stuff here and there. When my friends wanted to go out, I would suggest a picnic in the park or a potluck dinner at one of our places. I didn’t buy a car until I was 29. Growing up in Paris, where public transportation is excellent, helped a lot, but it saved me thousands in my 20s. Then I moved abroad to take a job, and found a place that was 10 minutes from the office, cycling. On summer days I walked to work and got my 40 minutes of exercise each way. No need for a gym membership.
If you challenge every expense, you will realize you don’t need as much as you think. A lot of our consumerism is ingrained by advertisers and our peers. But here is a scary figure: if you want to generate $40,000 in income when you retire, you need to save $1,000,000. And with inflation, your million won’t buy as much as it does today. Furthermore, we are talking about income generating assets, you will have to pay for your house on top of that. $40,000 per year is just over $3,300 per month, and if you still need to support your kids in college, or have to get medical care, it won’t buy you a lot.
Whereas now, you are young, healthy and productive. So let’s get started on that million by slowing down on lifestyle inflation a little bit. Here are the main pitfalls when people graduate:
- Moving into a place that is much more expensive. Paying over 25% of your salary on rent.
- Not taking into account taxes and having to borrow to pay them back.
- Buying tons of clothes and gadgets “because I deserve it”.
- Going out every night because you work hard and YOLO.
- Using your new paycheck to get into consumer debt. Just because a bank is willing to lend you money doesn’t mean it is a good idea.
- Buying a car that costs almost as much as rent every month.
Let’s look at a financial example. The S&P500 has returned over 8% for the past 30 years. If you are 25 and plan on retiring by 60, here is what your nest egg would grow by instead of:
- Paying $100 more than you should on rent: $230,917
- Having a $300 car payment: $692,752
- Spending $50 on drinks just once a month: $115,458
Total: $1,039,127. There is the million we needed to retire comfortably! You didn’t notice it was gone, because honestly, who cares about $100 worth of rent? Well, time and compound interest just gave you the answer. Growing your net worth from an early age is the best gift you can give to your future self. Well, that and sunscreen, and a healthy diet, so you actually live long enough to enjoy your retirement.