Where and How to Save?
As a young adult, prioritizing your long-term financial goals can be daunting. The good news is you can navigate through it with some basic planning. Saving for a down payment on a home, contributing to a retirement plan, or paying off debt are all plausible options. Here are some savings strategies, listed in descending order of priority:
Start an Emergency Fund
We are currently living through an unprecedented and scary time. The pandemic has highlighted the necessity for long-term planning and saving. Your number one priority should be to create a stable financial foundation with an adequately funded emergency fund to help you weather unforeseen circumstances. A general rule of thumb is to have at least 6-9 months of funding for essential expenses saved for unexpected events such as losing a job or unforeseen medical expenses. The target savings rate increases to 9-12 months of funding for expenses if you live in a household with only one income stream. While everyone’s financial situation will vary, these guidelines are a good starting point. Having a safety net is especially important so you can avoid high-interest loans/debts in times of emergency. An emergency fund is of utmost importance in helping to ease the monetary strain.
Save for Retirement
It is never too early to invest and save for retirement. If your employer offers a corporate retirement plan, such as a 401k or 403b, you should take advantage of them and maximize your savings to the extent your budget will allow. In 2020, you can contribute up to $19,500, and ideally, you would contribute a minimum of 10-15% of your current compensation. At the very least, contribute as much as needed to receive the full employer matching contribution. Take advantage of the “free money” offered through an employer matching contribution. It provides an immediate return just for saving towards your retirement. If you do not have access to a corporate retirement plan, consider investing in an individual retirement account like a traditional or a Roth IRA (if you qualify). The maximum contribution limit is lower than an employer retirement plan but still allows you to save up to $6,000 for 2020, or $7,000 if you are over the age of 50.
Regardless of the savings vehicle used, the earlier you start saving and investing, the easier it will be to reach your goals. For example, if you want to accumulate $1,000,000 by age 65, assuming an annualized return of 7%, you will need to only contribute $381 a month at age 25, compared to $5,778 a month at age 55. Early savers benefit from compound growth for a more extended period, enabling them to save less and still reach their target. The power of compound interest is real, and it is of the utmost importance. So, start today!
Pay off Debt
Many people struggle to prioritize saving for the future and paying off current debt. Many think they have to tackle debt before they can save for the future. It is essential to allocate a portion of your monthly budget towards paying down debt while also focusing on saving and meeting future goals. Start by creating a monthly budget to understand how much cash is available to use towards these goals. Divide the available funds across your savings and debt goals to work towards them all at the same time. If you have limited funds available, focus on paying off higher-interest consumer debt such as credit cards and short-term loans, before moving on to items such as student loans. Generally, higher interest rate loans should be paid off first, while lower interest rate loans can be paid over a longer period.
Once you have addressed your debt and savings, you can address long-term goals (such a down payment on a home). As a rule of thumb, do not spend more than 28% of your gross income on housing expenses that include mortgage payments. Update your budget periodically to ensure you are not over-extending your finances. Also, consider investing non-emergency funds in the stock market to grow your wealth over time. Following these steps to get started on your financial planning will help provide more financial flexibility while limiting stress and planning for the future.
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