I received a lot of positive feedback on my recent post, “6 Key Pieces of Financial Advice for Your Young Adult Child,” so this article expands on that topic. One of my readers said it would be helpful if I would discuss what her adult daughter should focus on, financially, as she progresses through her first 10 – 15 years as an adult—a sort of “financial road map,” if you will. She wanted me to outline what steps her daughter might take to obtain a solid financial footing and begin to accumulate assets and achieve financial security. So, the following is what I recommend.
Late Teens/Early Twenties: Begin Developing Good Financial Habits and a Credit History
As a young adult, whether or not you decide to go to college, the focus of your financial life should be the same: begin developing sound financial habits and a favorable credit history. The first and most critical habit is to always pay your bills on time. This is the most fundamental way to keep your financial life in order and develop good credit. Another basic way of beginning to build a favorable credit history is by obtaining a credit card and using it in a disciplined way. If you don’t yet qualify for a regular credit card, then you can start to “practice” good financial habits by using a prepaid credit card. With a prepaid credit card, you or your parents deposit a small sum of money with the card company, say $200, and then the card can be used for purchases up to that amount. A prepaid credit card will not develop a credit history, but it can be useful in helping you learn good credit habits.
Mid-to-Late Twenties: Don’t “Dig a Hole,” Continue Building Credit, and Start Saving
My first point here is critical: do not dig yourself into a huge financial hole, as so many twenty-somethings do. Or, as the saying goes, if you have dug yourself into a hole, the first order of business is to stop digging!
There are many ways a young adult, or anyone for that matter, can dig themselves into a financial hole by accumulating debt (also referred to as “liabilities”) and developing a bad credit rating. The most common problem is simply buying things you cannot afford, or “overextending” yourself financially. What often happens if you spend beyond your means is that you begin falling behind on monthly payments such as your rent, car payment, phone bill, utilities, etc. Another mistake is to rack up large unpaid debt on credit cards, often for purchases you don’t really need. Yet another misstep is to purchase a car with a long loan life, such as 6 – 7 years, and then have the car repossessed or be forced to sell it when the value of the car has depreciated to a point where it is less than the outstanding loan amount (referred to as being “under water”). All of these actions create financial liabilities, rather than assets and wealth, and a bad credit history. This just puts you behind, and in a position where you will need to get back to “zero” before you can begin building wealth and financial security.
Rather than making these mistakes, you should strive to continue to pay all of your bills on time and use small amounts of credit (such as a credit card and maybe a small auto loan) to build a favorable credit history.
This is also a great time to begin a saving program. Depending on your job and level of income, you might be able to save a little or a lot, but start saving something. I recommend you prioritize your initial savings efforts in the following way:
1st If your employer offers a company match in its 401k (or other retirement) plan, contribute at least enough to get the full match. This is basically “free money,” and should be taken advantage of if at all possible.
2nd Put at least $1,000 aside in a savings account for unexpected emergencies such as a car repair or unforeseen medical expense.
3rd Start saving for a down payment on a house or condo.
4th Purchase a home if you: a.) have accumulated enough money for a down payment, b.) qualify for a mortgage, c.) can afford the monthly expenses, d.) have a secure employment situation, and e.) don’t plan to relocate anytime soon.
5th Increase your contributions to your 401k, since it is tax-deferred savings.
Thirties: Buy a Home (if you haven’t already) and Increase Your Savings Rate
If you haven’t yet bought a home by this point, which many of you won’t have, then this is when you get the big payoff for all of your earlier hard work during your twenties, by finally owning your own home! Hopefully you have saved enough money for a down payment, and your credit history impresses the mortgage company so much that they will actually lend you hundreds of thousands of dollars.
After you make this significant financial step and actually buy a home, your next order of business is to make all of your home-related payments on time every month: mortgage, property taxes, insurance, condo fees (if any), and utilities. This will help you continue to build improved credit, but more importantly, it will also keep you in your home so the bank doesn’t decide to take it back!
Once you have proven over a period of 6 – 12 months that you can handle the additional expenses associated with owning a home, any additional money you can afford to save (often as a result of raises or promotions at work) should go first toward increasing your emergency fund so that it is large enough to pay for a full 3 months’ living expenses in case you lose your job for any reason. Then, after that fund is built, any extra money should go to your 401k.
In conclusion, these are all just general guidelines for the various stages of your young adulthood. The principles I discuss are sound, but the path your life will take, including your financial life, will certainly be unique, winding, and not follow any one prescription. Your career, whom and when you decide to marry, and if and when you start a family, will all have a tremendous impact on your life and your financial decisions. Make good decisions and build the life you always dreamt of!