Remember all those times when you were younger and you couldn’t wait to be an adult? Now reality is sinking in with student loan payments, rent and car payments. And maybe you’re thinking it wasn’t so bad being a kid and free of responsibility.
This really is an exciting time in your life as you start to map out your journey. It’s also a great time to lay down a firm financial foundation.
It doesn’t have to be difficult. Time and compound interest are your best friends. Compound interest is earning interest, or money, on previous interest you’ve earned.
For example, a one-time deposit of $10,000 will grow to more than $46,000 over 30 years with a hypothetical average return of 7% for someone who is in the 25% tax bracket. That’s the advantage of compounding interest.
Here are 5 actions you should do in priority order to start your financial future:
Learn to Budget
Live within your means. Make sure your expenses don’t exceed your income. This is a key component to saving. You need to understand all your bills and where your money goes.
Track your expenses and see how much money you spend on discretionary items like happy hour drinks, morning lattes or a cute pair of shoes. Even cutting $12.50 a week from your spending can give you $50 a month to put toward savings.
Establish Good Credit:
A good credit rating is important. Future loans and credit card interest is dependent on your credit score. Insurance companies often look at it to determine your car insurance rates. Even employers use it as a way to determine if you are responsible.
You’ve already started establishing good credit by paying back your student loans. A credit card with a small limit is another way to establish it. Make sure you pay your bills on time.
Create An Emergency Fund:
Emergencies happen. The car needs repairs. You get hurt. Or you lose your job. Create a fund with at least three months of living expenses to give you a financial cushion.
Contribute to your 401K:
If your employer offers a 401K, contribute to it as soon as you can. If they match up to a certain percentage, make sure you contribute that much into the account.
This is part of your compensation package. Take full advantage of it. The money they contribute is free to you. The money you put in isn’t taxed and the account grows tax-deferred.
Start an IRA:
An Individual Retirement Account, IRA, allows that compounding interest to grow tax-deferred or tax-free. This is a major deal. What type of IRA is right for you depends on your earnings.
A Traditional IRA allows you to deduct your contributions from your taxes, but you will pay income tax on all the money you made over the years when you take it out at retirement. Put in $10,000 and it grows to that hypothetical example of $46,000 and you pay taxes on the $46,000 when you use it.
Under current tax laws, a Roth IRA uses money that’s already been taxed and the growth is then tax-free. Pay taxes on $10,000 and as it grows to a hypothetical $46,000, you never pay taxes on it again. Also you can always take out your contributions at anytime without a penalty if you have an emergency so it provides flexibility.
Remember that $50 a month? If you put that in your IRA for the next 30 years, you saved $18,000. But with it growing a long-term average of a hypothetical 7% a year, you would have more than $58,000.