Getting started as a young professional is overwhelming. We all know it. In what feels like seconds, we went from only worrying about how to pay for $1 wells at our local dive bar to having to decide about benefits, paying student loans, building savings, 401(k)s, etc. How are we supposed to understand what to do with the limited resources we have? School never taught us about any of this stuff.
The confusion that comes from making all these “adult” decisions oftentimes leads us to do nothing and push it off till later. Let’s change that. Here are a few steps you can take to set yourself up with a strong financial foundation.
Cash flow management is the key to financial planning and it all starts with budgeting. Many people think of budgeting as a restriction when in reality it’s a way to align your dollars with what matters most. To create a budget, figure out what your after-tax monthly income is and then subtract your fixed expenses from that number. Then build in savings and debt as well. It’s easy to just pay for everything and leave what is left over for savings. Don’t fall into this trap and neglect your savings.
After a few months of learning about your cash flow, you should give reverse budgeting a try. This is where you save, invest, and pay off debt first, then spend what is left. Since you have some idea of what your expenses should be after a few months of tracking it, this tends to work well for people. It allows you to just spend what is left and can help alleviate anxiety around tracking every expenses.
Life throws curveballs at you and typically more than one at a time; think a car accident one week and a job loss the next. No matter how invincible you feel, these things happen. If you aren’t prepared, your only option is to use debt as a crutch to hold you up. Having an emergency fund with a minimum of 3 months of expenses can help you get through these tough times. To best accomplish your emergency fund goal, automate a certain dollar amount to your savings every month so you don’t even have to think about it. Consider using a High Yield Savings Account for your emergency fund.
If you have very high interest debt (think 10%+) then you may want to consider just getting 1 months worth of expenses built up and then attacking the debt. Just don’t skip this step because it can lead to adding more debt if you don’t have some savings built up.
If your employer offers a 401(k) through work, take advantage of it. Try and allocate at least as much as your employer will match, as that is a guaranteed return. Not many other investments have guarantees involved. As a bonus, these dollars lower your taxable income and are tax-sheltered until you use them in the future. Retirement may seem far away, but starting early and taking advantage of compound interest is powerful!
If you are in a low tax bracket now and think you will be in a higher tax bracket in the future, it may make sense to look into doing your Roth 401(k).
Focus on paying off any high-interest credit card debt you may have first, as it grows the quickest. Too many people get caught up in a never-ending tunnel of credit card debt. Do not let this be you!
If you have a high-deductible health insurance plan that qualifies, contribute to an HSA and let it grow. Try to not touch this account for your yearly medical costs if you don’t need to. An HSA is the only triple tax advantaged account (tax deductible, grows tax-free, and can be withdrawn tax-free for medical expenses). The reason to not use this on a yearly basis is because you can invest it and let this account grow overtime and use it in the future. It is a very powerful account!
After doing all of the above, if you still have some additional funds either up your 401(k) contributions or start a Roth IRA. Roth IRAs allow you to contribute post-tax dollars and then never pay taxes on those dollars again for withdrawals. A benefit of starting a Roth IRA is it offers greater liquidity since you can pull out the contributions you put in at any time.
You may have both private and public student loans. Typically, private loans come with higher interest rates, so it only makes sense to prioritize paying them off first. A general rule of thumb is if your interest rate is high you should focus on paying off the debt before adding more investments. Additionally, with the CARES Act there has been a suspension of principal and interest payments on federally held student loans at least through the end of January 2022 so don’t focus as heavily on those now if you have other debt.
If you have any remaining debt like a car loan, federal student loans, etc. work on chipping away at these if everything else above is done. Typically, these loans carry very low interest rates which is why they fall so far down on the list of priorities.
Remember, this isn’t a perfect science. Your goals, how you feel about investing and debt, and your risk tolerance all matter when deciding how to go about handling your finances. But, don’t let time go by and do nothing. Start now and be purposeful with your planning!
Disclaimer: Nothing on this blog should be considered advice, or recommendations. If you have questions pertaining to your individual situation you should consult your financial advisor. For all of the disclaimers, please see my disclaimer page.
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