A Young Professional Game Plan

Clients often ask me to talk with their young adult children to provide guidance on saving and investing. While everyone’s situation is different, the fundamentals are often the same. Here is what I tell them.

1. Live below your means

The most fundamental money management tip is to simply live below your means. If you spend more than you make it leads to a lifetime of debt and enslavement to the paycheck.  Living below your means allows you to build wealth.  Even a small amount of savings can build into significant wealth over time.

2. Save half your raise until you save 15% of your income

So how much savings is enough? It’s ok to start small - $50 a month can matter. When you are first beginning your career the budget is often tight and that’s ok. But when you are beginning your career you will often receive bigger raises on a percentage basis. When you do, allocate half of it to savings. For example, if you receive a 10% raise, add 5% of the raise to your savings. Keep doing this until you are saving 15% of your income – even if it takes several years to get there.

3. Use your 401k at work if you have one

The best place to save is in your 401k at work since it makes the saving process easy.  Employers will often match your contributions, increasing the benefit of the 401k. If they do match, the contribute enough to get the free matching – it’s free money!  If you don’t have a 401k at work then consider opening a Roth IRA or SEP-IRA.

4. Save in Roth (after-tax) accounts

When you are young your income is typically lower than it will be later in your career.  Take advantage of your lower tax brackets by saving in your Roth (after-tax) 401k or Roth IRA.

5. Be aggressive

When are choosing your investments seek to be mostly in low-cost stock mutual funds or exchange-traded funds (ETF’s), which can be highly volatile – and that’s ok.  When you are saving for the long-term volatility is your friend because more volatile investments typically have higher long-term investment returns.  Target date funds, which are single fund investments that are allocated based on your expected retirement date, can do this for you automatically.

6. Be consistent

Keep adding to your savings even if the stock market is falling or the news is scary.  History says that when others are fearful it is often the best time to buy. Similarly, don’t change your investments even if stocks are falling. One of the biggest mistakes that investors make is selling when times are bad and buying when times are good.  While these actions can feel so right, selling when times are bad often means selling when prices are low. Conversely, buying when times are good often means buying when prices are high, leading to a cycle of buying high and selling low that destroys your investment return. It is better to stay consistent rather than reacting to the daily swings in the market.

7. Notes on buying a home

Saving for retirement and saving for a house are often competing goals. Balancing those competing goals can be difficult, and there are many opinions. Here is mine.  I recommend saving for retirement first until you at least reach 6% of your income and take full advantage of any matching in your company 401k plan.  After you have achieved that saving goal, if you would like to purchase a home then pause on additional retirement savings and put as much as you can into saving for a home.  Keep saving half your raise, keep being consistent. While it may take a few years, eventually you can save enough for a down payment on a home.

8. Pay attention

Dave Ramsey says that the biggest mistake people make with money is simply not paying attention. I think that’s true. Too many people float through life without intention, without goals, without direction. Pay attention to where your money is going, think about where you want to be, and create a plan to get there. That really is half the battle.