We are putting together a five-part series on what financial decisions you should be thinking about as you approach each decade of your adult life from a young adult into your 70’s. The years involved are when individuals generally earn the majority of their lifetime income from work.
Part 1: Approaching 30 years old — How am I doing financially and what can I do to stabilize my financial future?
Part 1 of this series discusses what financial decisions individuals should be considering as they approach the decade when they are aged 30-39. As you approach 30, there are some measurements that can help you determine if you are on the right track financially. In addition, there are actions that you should be taking to stabilize your financial life as you are approaching a time when you are starting a family, your employment situation is likely more established, and there are conflicting financial strains on your budget.
A few strategies and actions that will help you measure how you are doing financially include the following:
- Workable budget. If you do not already have a written budget, you should prepare one and review it at least annually. You may be surprised where your money is going. Ensure that your monthly budget is realistic, include amounts due on a periodic basis such as vehicle insurance due every 6 months, higher utility expenses during certain months (or use budget payments with your utility company), annual homeowners’ association dues etc.)
- Eliminate credit card and personal loan debt. This is the debt that financial planners and others refer to as “bad debt” because the debt is not secured by an asset and most likely the money was spent on purchases that you could not truly afford. If this debt is not zero, then you should focus on paying it off before you do anything else except funding your short-term emergency fund. No unsecured debt is acceptable for securing your financial future. You should set up a methodical plan to make automatic payments and consider consolidating multiple accounts into one that has a lower interest rate. The interest rate that you pay is based on your credit score, payment history, and market rates.
- Emergency funds. My philosophy is for everyone to have two emergency funds, one for short-term needs and one for long-term needs. The short-term emergency fund should be set up at your local main bank. It should be at least enough to cover insurance deductibles for all of your vehicles, medical expenses, and home maintenance expenses. For example. if your deductible for each vehicle is $1,000 then ensure you have at least enough in savings to cover at least one accident per vehicle owned. You can build this up over time, but a good starting point is to have at least $1,000 and then increase it by at least $100 per month until you have a sufficient amount accumulated. If you have two cars, one home, and health insurance deductibles are 80% covered then you would need $2,000 for the car deductibles, $1,000 for the home deductible, and $1,000 for medical deductibles at a minimum. The long-term emergency fund is related to more catastrophic situations such as loss of job, unusually high medical expenses, or unforeseen emergencies such as a sick relative and you have to travel to see them quickly which will be more expensive. You could accumulate these funds over time, but you should start with a base amount of $1,000.
- Maximize Credit Score. You need to ensure that you are maximizing your personal credit score because your financial options will be significantly hampered by a poor credit score. Unfortunately, you have to play the game even if you want to use cash to pay for everything which is an admirable goal. However, everything from insurance rates, renting an apartment, interest rates on financing of purchases, and reducing existing debt are affected by your credit score. A few important actions that you can take is to establish credit by applying for a small credit limit credit card that you use for monthly expenses and then pay off the full balance each month. (Note: Do not use credit to pay your monthly expenses unless you have enough discipline and resources to pay the full balance off each month.) Another action that you must do is to pay all of your expenses such as utilities, insurance, and debt servicing on time, so using automatic withdrawals from your bank account is a good way to ensure you do not have any late payments. Late payments will decrease your credit score and affect your financial reputation. You need to make sure that your bank account is managed effectively to avoid any NSF fees for insufficient funds when a payment hits your account before your paycheck is deposited. Also, set up direct deposit of your income from employment and other sources to avoid having a low balance.
- Retirement savings. As a young adult, starting to accumulate retirement savings is critical because time is on your side and you will not have to contribute as much now compared to what you will have to contribute if you start at a later time. Also, the future of Social Security and Medicare for a young adult is bleak, so you have to save for your own needs and not rely on the government programs such as Medicare and Social Security. You should set up automatic contributions to a tax deferred 401(k) up to at least the employer match if you are eligible for one. You should contribute to a Roth 401(k) account because of the time you have to accumulate tax free earnings and the expectation that income tax rates will be higher in your future. If a Roth 401(k) is not available from your employer, then contribute enough to your Traditional tax deferred 401(k) to secure the full employer match and contribute the maximum annual amount to a Roth IRA account at a low fee brokerage such as Vanguard, or Fidelity. If you have additional available funds for retirement then contribute more to your tax deferred 401(k).
- Term Life Insurance. The rule of thumb used to be five times your annual expenses for the death benefit, but new thinking is for a higher death benefit. The thought behind a higher death benefit for your beneficiaries is because of the cost of health insurance for survivors, future education expenses etc. You should secure the maximum term allowed which is usually 30 years to keep total premium costs down over time. The earlier age that you purchase the insurance, then the lower the annual premium for the full term that you can lock in. The death benefit should be calculated by adding your annual salary (times the number of years that you want to replace income usually at least 5 years) + your mortgage balance + your other debts + future needs such as college and funeral costs. If you’re a stay-at-home parent, include the cost to replace the services that you provide, such as child care. From that amount subtract your liquid assets such as savings, life insurance you already have in place, and education savings. If the cost of the life insurance is not within your current budget, then at least start with a minimum death benefit of five years of your annual income. The next steps should be to add life insurance that will provide an additional death benefit before age 35 for a 30-year term and another amount of life insurance before turning age 40 for a 25-year term. I can help you in determining your life insurance needs and fitting the premium into your budget, so feel free to reach out.
- Saving for long-term purchase goals. You should save money in a separate account for long-term purchases. For example, buying or remodeling a house, purchasing a newer vehicle, a vacation, or new furniture. Set up a money market fund with your local bank or brokerage firm earmarked for accumulating this savings. Do not use this account for anything except long-term savings for future purchases and make automatic transfers from your main account to this account. You can start with the minimum amount allowed to open an account and plan out your goals to determine how much to contribute each month. Some internet banks pay around 2.5% currently in interest.
- Education savings. Start at birth, even if only $25 per month, into a 529 plan that is invested in a stock mutual fund. The accounts are transferable to other relatives if the child that you originally set up the account for does not need the money for their education. The eligible education expenses that 529 plan funds can be used for has expanded substantially over time. Qualified higher-education expenses include tuition, fees, textbooks, supplies and equipment required for enrollment, special needs services and, in some cases, room and board costs. Qualified education expenses also now include up to $10,000 of private elementary and secondary school tuition.
The next blog will be on how to plan as you approach your 40’s.
To promote the concepts in this blog, the first two young adults (under 30) that email me, or fill out the website contact form will receive a free (skype, zoom, in person) financial planning session from Lydford Financial PLLC.