Your guide to financial decisions: the 20's edition

Congratulations! You’ve made it out of your teen years, and, by this age, maybe even out of your parents’ house. ;) That means you’re making your own money from your first “real” job, with the power to make some of your first significant purchases, like a car or a really nice vacation.

But it can also mean a heap of student loan debt which can come with it the temptation to live beyond your means and charge your life away with credit cards. That is not at all uncommon, especially since so many people finish college saddled with enormous debt, yet they don’t make big salaries just yet. How do you pay for it all? And, making it even harder: this decade of your life is one of the most important for your financial future! The smart choices you make now can keep you on track to reach your goals while poor choices could derail you for years to come.

But before you get depressed, take a deep breath and don't worry - because you CAN take steps right now to help set you up for a bright financial future. (Life goes by fast, the future will be here before you know it.) And if you’ve made some mistakes already, well, that’s ok. Fixing them is fairly straightforward.

Here are some tips to consider on your path to financial readiness.

Don’t buy the shoes. (Unless they’re from a thrift store and you buy them with cash). You know where we’re going with this, right? Basically, just don’t rack up a bunch of high interest credit card debt. While credit cards are a great way to build good credit history that sets you up for lower rates on loans, including a mortgage (one day you’ll get there!), not using cards responsibly can almost immediately put you in a financial crisis. Credit card debt can really catch up to you - like wildfire. Consider for example, that a recent survey found that the average American household has about $16,000 in credit card debt.

Yikes.

So, for your first credit card, a good idea is to get one with a lower credit limit, maybe as little as $500. That way, you can build good habits that increase your credit score. The best way to do this is to pay off your balance every single month. Use your card like it’s cash and pay it right back. Also, make sure you only use it sparingly. Don't use more than 20% of your available credit (as tempting as it is).

If you take one piece of advice from this article, let it be this:

A credit card in your 20s should be used ONLY as a tool to build credit - NOT to buy things.

And don’t be fooled by minimum payments – they’re a trap! Pay the entire balance off, every month, no matter what. It’ll raise your credit score and you won’t be paying 25% interest on a salad you ate six months ago. (Way too much money for a salad).

Say no to dessert. (You don’t need to be weighed down with credit you don't need). When you’re ready for a higher limit credit card, it's easy to get overwhelmed by all the choices and enticed by all the great benefits - like cash bonuses, free airline miles and teaser introductory rates (especially if you are transferring a balance).

It's really important to match the offers you get with how you’re actually going to use the card. Make sure you really read the fine print to avoid common credit card “gotchas” like introductory teaser rates that expire, spending tiers that require you to spend a certain amount to attain advertised benefits, and missed payment penalties.

Several online credit card comparison tools exist to help you choose, including this one from Consumer Reports.

Know your credit score inside and out. We can stress enough the importance of not just knowing your credit score but monitoring how your credit use is affecting your score.

You can get your free credit score and report right now!
It's good to know where you stand and keep track of it on a regular basis (every month is a good idea) to make sure no mistakes or incidents of fraud are dragging down your credit score. 1 in 3 people have errors in their reports so you should definitely check yours often.

Budgets may be boring but being broke is more boring.
Budgets aren’t necessarily that foreign to many twenty-somethings – it may have started in college when you were forced to make a lump sum of money last for an entire semester. That’s really the goal of any budget – not running out of money!

But keeping a budget is also a good way to be smart about money without relying on credit cards or getting too close to zero in your checking account. To start thinking about a budget, try tracking your spending for at least a couple months. That length of time will minimize expenses that may not have repeated every month.

Once you see where your money is going, you might find that a lot of your spending is on nonessential items. Then comes decision-making time: How many of your “wants” can you live without so that your fixed expenses like rent and utilities are paid? In other words, living with a budget doesn’t mean you can’t spend money on fun stuff. It just means taking care of your mandatory expenses, then seeing what’s left.

Remember that money equals freedom. Saving money is pretty basic but it can be hard to do if you’re not used to doing it. The bottom line is that saving money is simply the most important thing you can do to avoid messing up your financial life. It’s really that simple. You can’t attack your current debt or invest in your future without it.

So how much should you save? As much as you can. The rule of thumb is to try for 10 to 20 percent of your gross income. One economic expert suggests saving 25% of your income in your 20s with the goal of having saved 1X of your year’s salary by the time you’re 30. And 4X your salary by the time you’re 40. That might sound ambitious but if you’re capable of saving that much, by all means, DO IT. You won’t regret it. If you can’t do that, just do what you can. If you can save even 10 percent of your paycheck, you’ll have more than a month’s salary set aside the first year.

Expect the unexpected. Your first goal should be setting up an emergency savings fund – the money you have for when a significant expense that is absolutely necessary pops up. And it always does – this includes things like an unforeseen medical emergency, a needed car repair or losing your job. Try to save as much as three months of your living expenses (housing costs, utilities, groceries).

Once you’ve established an emergency fund, the most important savings decision you can probably make is putting away money for retirement.

A great future takes planning. For retirement savings, the simplest rule applies: the earlier, the better. If you start saving in your 20s, you’ll be in a much better position to maintain your lifestyle when you stop receiving a paycheck. It only gets harder after that – wait until your 40s and you may have to save as much as one-third of your paycheck to catch up.

For many people, an employee-sponsored 401(k) plan is one of the most common retirement plans you can access. It allows you to put aside a percentage of your pre-tax salary, and sometimes your employer will make a contribution as well. Often, your employer will match what you put aside, typically up to 3%-6% of your income. That brings up one of the cardinal rules of 401(k)s: Always contribute enough to earn the highest possible employer matching amount – it really is free money.

Since funds in a 401(k) accumulate tax-free until you start withdrawing the funds at retirement, do everything you can to avoid tapping into this money early – you’ll not only be subject to taxes but also a 10% penalty.
For those without access to a 401(k) plan, similar tax-advantaged plans, like IRAs, exist for most consumers.

Be empowered. As they say, with great power comes great responsibility. For twenty-somethings newly out in the world, making sound financial decisions from the outset - like living within your means, avoiding crippling debt and saving for unexpected costs as well as retirement - can set you up to minimize life’s financial stresses and prepare you for whatever life throws your way later on.

Before you know it, you'll be 30, then 40, etc. Ten years ago you were just a kid. When you think about it that way, it becomes easier to envision why it's so important to start making the best financial choices you can - right now.