One of my readers asked me what financial advice I would give to a young adult. She was concerned that her recently college-graduated daughter might begin making money mistakes, such as overspending on credit cards, which would jeopardize her finances. She said if I did a post on this topic she would pass it along to her daughter as a starting point for a discussion about money management.
First, what a thoughtful and caring mom!
Also, this mom’s concern is quite valid, since our educational system does a poor job of teaching our children even the most basic concepts of personal finance, which is a shame.
In response, then, here are the 6 most important pieces of financial advice I would share with a young adult:
- Manage credit cards carefully and wisely. Credit cards can either be an excellent tool for managing your finances or a financial disaster, depending how you use them. First, let’s explore how not to use credit cards. Do not purchase anything with a credit card that you cannot pay off in full when the next credit card bill comes due. If you maintain an ongoing balance on your credit card, the interest rate you pay for this “loan” will result in you eventually paying multiples of the cost of your original purchase. Do you want to end up paying $300 for that $80 pair of shoes? If you instead pay your credit card balance off in full every month, you will be wisely using your card to your financial advantage, by developing strong credit, paying no interest charges or penalties, and earning rewards points to use for free flights, hotel stays, or cash back. If you find you simply cannot use credit cards in a disciplined way, then cut them up and pay for everything in cash.
- Create an emergency fund. As they say, sh** happens. Your car breaks down, you have a medical problem, or your pet needs its stomach pumped. You need to have at least a few hundred dollars set aside for such unforeseen emergencies. You can start by doing something as simple as having just $25 per pay period automatically transferred to a savings account so you can accumulate some emergency money. Ideally, you should eventually strive to have 3 month’s salary set aside to protect you in the event of a major financial setback, such as losing your job or incurring a major medical expense.
- Purchase cars economically. The most expensive way to buy an automobile is through a lease. Leases appear attractive because they have relatively low monthly payments. However, if you continually lease cars, you will never be without a car payment, and will have to pay high upfront costs at the start of every new lease. The most economical way to buy cars is to purchase ones that are 1 – 3 years old (to avoid the high depreciation they experience in their first few years), finance them over a period of 4 years or less (to reduce interest costs), and drive them until well after your payments have ended.
- Own a home or condo instead of renting. When you rent, your rent payment provides a roof over your head, but no other financial benefit. When you own, 100% of your mortgage and property tax payments produce wealth for you. The part of your mortgage payment that goes toward paying down your loan builds “equity,” which is defined as the net value of what you own in the home. As an example, if you purchase a $100,000 condo and take out a $90,000 mortgage, you initially have $10,000 in equity ($100,000 value of condo, less $90,000 in debt). When the mortgage is paid down to, say, $80,000, you will have increased your equity to $20,000 ($100,000 – 80,000). You have built wealth. Also, the portion of your mortgage payment that goes to pay interest on your loan, as well as your property tax payments, are tax deductible, which thereby increase your tax refund at the end of the year. This also helps you build wealth. Owning a home can be a useful way to steadily grow financial assets over time.
- Contribute to your 401k at work. Yes, I know, retirement is much too far away to worry about yet, so you don’t see the need to participate in your employer’s 401k. However, there are several reasons to start saving in your 401k now, even if you only contribute a small amount. First, if your employer offers matching funds, then this is basically “free money” you can obtain by participating. Also, if you start saving early in your career, you will be taking advantage of how money builds as interest on your money compounds over the years. Over 30 or 40 years, saving just a few hundred dollars per month can develop into a million dollar nest egg. Lastly, many people don’t realize that retirement savings can be used, without penalty, for such purposes as an initial home purchase, education expenses for a child, and medical emergencies. While I wouldn’t recommend using retirement funds in this way if you can avoid it, having 401k savings provides you with these options.
- Live within your means. This is perhaps the most important advice I can give. If you are continually chasing a lifestyle that is above your income level, you will forever be worried about and unhappy with your money situation. I don’t want to burst your bubble (well, maybe I do!), but there will always be people who make more than you and have more than you, so get over it. Buy only what you need and can afford and you won’t be so stressed about money your entire life.
In sum, I think we all want our children to avoid common mistakes, including money mistakes, so they can be happy and secure.
Oh, and we also probably wouldn’t mind if they hit us up for a “loan” a little less often, right?