It can be difficult to know how to start building a solid financial future. With all the responsibilities of early adulthood you may be tempted to put financial planning on the back burner. However, the sooner you start planning, the better off you’ll be in the long run. The following tips can help you get started.
1. Create a budget.
Identify how much money you spend each month and compare that to your monthly income, considering two types of expenses: fixed and discretionary.
Fixed expenses are those you pay each month, including rent/mortgage, minimum credit card payments, car payments, insurance, utility bills, and cell phone.
Discretionary expenses are costs you choose to take on that may not be essential, including eating out, movie and concert tickets, streaming TV subscriptions, gifts, and vacations.
Once you’ve added up your fixed and discretionary expenses, compare the total to the income you bring in. If you’re spending less than you earn, congratulations! You’re one step closer to a stronger financial foundation. If you find you’re spending more than you’re earning, you may need to trim some discretionary expenses to bring you back to level footing.
Look at the discretionary expenses. Where can you lower your spending? Maybe you can cut back from eating out four times per week to one or two times per week. Perhaps you don’t need all your streaming services. Or maybe you choose to take your next vacation closer to home rather than paying for a plane ticket.
The key is to establish a budget that allows you to pay your fixed expenses and discretionary expenses while living within your means and taking care of obligations.
2. Pay off debt.
Regardless of the type of debt (student loan, credit card, auto loan, etc.), the sooner you pay it off, the sooner you’ll achieve financial security. While there are times when it’s necessary to take on debt, there are other times where outstanding debts can spiral out of control. Two effective strategies for paying off debt include:
• The snowball method — This involves paying off your smallest debt balance as quickly as possible, then moving on to the next-smallest debt. This approach can help you gain a sense of accomplishment as you knock out one loan after another.
• The avalanche method — You begin paying on the loan with the highest interest rate first. Once that is paid off, you move to the loan with the next-highest interest rate. This allows you to pick up speed because each payment saves you more money than the one before.
3. Build an emergency fund.
An emergency savings account can enable you to keep up on your necessary expenses, pay down debt, and continue your lifestyle for a period of time. A rule of thumb is to have three to six months’ worth of living expenses saved. An emergency fund can protect you from taking on additional debts to meet your needs
4. Save for retirement.
The sooner you start saving, the better your chances of achieving or maintaining the lifestyle you want. The easiest way to start is by contributing to your employer-sponsored retirement plan at a rate that maximizes your employer matching contributions while still being sustainable.
Don’t have access to an employer-sponsored plan? Consider an individual retirement account (IRA). There are two main types of IRAs: traditional and Roth.
• Traditional IRA — Contributions are made on a pre-tax basis, which reduces your taxable income in the year you contribute. Money invested in a traditional IRA is free to grow tax-deferred until retirement. Distributions are taxed as ordinary income and may be subject to a 10 percent early withdrawal penalty if taken before reaching age 59½.
• Roth IRA — Contributions are made with after-tax funds, providing no tax benefits during the year in which you contribute. Contributions can be withdrawn after five years with no taxes or penalties (earnings are subject to tax and a potential 10 percent penalty if withdrawn before you reach age 59½).
5. Avoid lifestyle inflation.
As your income increases over time, it may be tempting to increase your spending. This tendency is sometimes referred to as “lifestyle creep,” and if not managed, it can get in the way of your financial goals. When your income increases, consider increasing your savings first.
Gene Gard, CFA, CFP, CFT-I, is a Partner and Private Wealth Manager with Creative Planning. Creative Planning is one of the nation’s largest Registered Investment Advisory firms providing comprehensive wealth management services to ensure all elements of a client’s financial life are working together, including investments, taxes, estate planning, and risk management. For more information or to request a free, no-obligation consultation, visit CreativePlanning.com.
