Financial Planning In Your 20s: 3 Important Steps to Take
Key Points:
It is important to start saving as soon as you can, using savings accounts, 401(k) plans, IRAs, and/or HSAs.
Building good credit as early as possible will be important for future financial goals.
Insurance creates an important safety net that mitigates financial risk from unexpected events.
When starting a new journey, the hardest part can sometimes be taking that first step. The same holds true when it comes to your finances. A starting point for many can be in their early twenties, when they are beginning a new career and starting the process of becoming financially independent. Although everyone’s journey to financial wellness may look different, there are a few good habits that can quickly and effectively put you on the right path to success.
Start Savings as Soon as Possible
A crucial first step on the financial wellness journey is saving. Although this may seem obvious, it can be tough to do when launching a new career and balancing basic expenses like rent and student loan payments. But by starting this habit early, however small the amount you save, you will eventually get used to not having those dollars in your wallet or monthly spending budget. Start by setting small monthly savings goals, and try to keep it going (e.g., automatic deposits) once you’ve started. A good first goal is to build an emergency fund, or a safety net of cash you can fall back on when unexpected expenses come up; a typical target is three to six months of expenses.
Company 401(k) Plan
Of course, there are other places to save money in addition to a savings account; arguably the most effective option these days is your company’s 401(k) plan. One of the reasons it is a great way to save is that often, your employer will help you save more by offering a “match” contribution. Check with your human resources department to see if your employer offers a 401(k) match.
Matching programs typically vary by company, but a common example would be that for each dollar you put into your 401(k) account, your company matches fifty cents up to a certain percent (e.g., 3% to 6%) of your annual salary. By not contributing at least that percentage match amount, you would miss out on essentially “free money” that would further benefit from compound interest and growth over time. See Figure 1.
IRAs and HSAs
If saving in a 401(k) plan is not an option for you, or if you’re looking to save more outside of your 401(k) plan, another option is an Individual Retirement Arrangement account (IRA) where contributions can be made up to an annual limit ($5,500 for 2018, increasing to $6,000 in 2019). There are different types of IRAs to choose from and many important things to consider when choosing which type is best for you.
Another type of account to consider is a Health Savings Account (HSA) if offered from your employer or through your individual health insurance plan. Like an IRA, an HSA allows annual contributions up to a certain limit (e.g., $3,500 for individuals in 2019) . HSAs are used as part of a high-deductible health plan and are also tax-advantaged. Withdrawals can also be tax-free if used for qualifying expenses, which can include medical expenses that may not covered by insurance, like eyeglasses.
Build Good Credit
Once you nail down your savings strategy, the next step is to start building your credit. Good credit is important for many things. Even when trying to secure a rental apartment, credit reports are often considered in the application. A high credit score can also enable you obtain a loan for a car or house purchase when you eventually need one in the future. And when obtaining a loan, the interest rate you pay will often be dictated by the score that you have, with those having the highest credit score receiving the lowest interest rate. A good credit score can also help if you are hoping to refinance student loans in the future.
So how do you build good credit? Although this may seem counterintuitive, opening a credit card is one of the best ways to initially build credit. The key, however, is to not overspend and to make timely payments on the balance each month. Over time, there are other factors that will affect your credit, including your income level and how much debt you have compared to that income. When it comes to building credit, it is important to understand how it is measured and how you can increase it over time.
Get the Proper Insurance
Insurance is an additional component that can help put you on the right financial path. If you own a house or condo, then it is essential to have property coverage known as homeowner’s insurance. However, even if you rent, it is equally important to obtain insurance coverage for your apartment. Renter’s insurance will help cover you for many of the same things that homeowner’s insurance would, like damage to your belongings from a fire or theft, or even liability coverage depending on the policy. An event like a burglary in your rental space will make you appreciate the value of a good renter’s policy when it helps to recoup some of that loss.
Besides property insurance, you should also remember health insurance coverage. Medical bills can be a huge financial burden if not covered by insurance. Your company may offer a selection of plans to consider. An “HMO” plan tends to be less expensive, but you will have to choose from “in-network” doctors to be covered. A “PPO” plan typically has a higher premium, but fewer restrictions on out-of-network coverage, so you have more choice of doctors to use.
Another thing to consider when choosing the right health insurance plan is the “deductible” level, or the amount you pay for covered health care services before your insurance plan starts to pay. A “high-deductible” plan typically has lower premiums and higher deductibles. Generally, if you are young and in good health, without any pre-existing conditions, a high-deductible plan could make the most sense.
Our Takeaway
While the above steps do not cover every aspect of your journey to financial wellness, they can serve as a good starting point. Whether it is saving, building credit, or getting insurance coverage, the most important thing is to start taking action sooner rather than later. lang:
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