It’s difficult to think about saving money for emergencies, the future, and retirement when you’re holding a large amount of student debt and living paycheck to paycheck, but that’s no excuse for not saving. Start now. That should be the mantra of all 20somethings when it comes to saving for the future.
Here are eight things you can do while you’re in your twenties so you can be well on your way to financial security in your thirties:
- Build your cash reserves, including an emergency fund. Unexpected expenses happen all the time, but if you have a cushion of savings, these unexpected expenses don’t have to derail you. Instead of draining your long-term savings account or falling into debt, you can simply use your cushion to stay on track, then rebuild your cushion for next time. How much should you set aside? Your cash reserves should cover six months’ worth of expenses. After you have this six-month cushion, you should also set aside a separate emergency fund, enough to cover 24 months’ of expenses, for longer-term situations such as an extended illness. This may sound like a lot of work, but the small spending sacrifices you make as you build your cash reserves will be well worth what you gain in peace of mind.
- Participate in your company 401k or other retirement fund. This is probably the simplest and most tax-efficient way save for retirement, so contribute the maximum allowed, if you can. (You can always fine-tune your contribution amount as you go.) Some employers will even match a percentage of what you contribute to the company 401k — this is basically free money, another great reason to participate.
- Have just a little debt. This may seem counterintuitive, but you do want to carry some debt, rather than none at all. Open a credit card with a modest credit limit and use it regularly, then— and this is key—be sure to make all your monthly credit card payments on time and in full. Doing this will help you build a solid credit history. You’ll need it to qualify for a loan someday, like when the time comes to buy a house.
- Save 10% of your income every year. If you develop the habit of saving 10%, no matter how much you earn, you will always have the confidence of knowing you are living within your means. This step is also what makes many other key steps possible: for example, saving a down payment for a house, setting aside a college fund for the kids, or saving for retirement. Think of saving 10% as the way you ensure that you will be able to make ongoing investments in your financial health, year after year.
- Save your bonus, overtime pay, or promotion pay. It is tempting to treat your year-end bonus or other unusual income as play money. Don’t do it! Instead, sock away these lump sum amounts immediately, then leave them alone. Before you know it, you will discover that you are most of the way to where you need to be for retirement.
- Never borrow from your 401k. Borrowing from your 401k is never a good idea. A loan will be considered an early distribution and subject to income tax and a stiff penalty. These costs will eat away your hard work, even if you plan to repay the loan later. Instead, build your cash reserves and replenish them conscientiously, so that borrowing from your 401k never becomes necessary. If you are truly in a difficult place financially, consider a home equity line of credit or borrowing from a family member. Medical bills and credit card bills can be negotiated as well – consider all your options before you touch your 401k.
- If you’re married or have a child, purchase term life insurance to protect your loved ones in case something happens to you. To calculate the amount of the policy you should put in place, figure out how much support your family needs annually and multiply that by the number of years the support will be needed. It’s a good idea to ensure that the policy term covers children well through college, so a 20- or 30-year policy is usually best.
- Use extra savings that you won’t need in the next five years to start your first investment portfolio (after you’ve maxed out in contributions to your retirement accounts). With one of the high quality, low cost players like Vanguard, Fidelity or T.Rowe Price, low cost index mutual fund or ETF, they can help you choose the right one. You will need a minimum of $3,000-5,000 to start, and should build it up to $25,000 before looking at adding additional funds.