Your Financial Life
6 minute read time
Having worked for over a decade now in the financial services industry, I sometimes forget how daunting it can be to shape your financial life. Several years ago, I was meeting with some medical residents who had just moved to the Madison area, to speak with them about purchasing a home and how to finance their purchase. During our conversation it became clear that many of the residents did not have a strong understanding of how they should approach this transaction, though no fault of their own. Some of these young doctors were even uncomfortable asking basic questions about financial literacy. It’s never too early to work on your financial priorities – and you have to walk before you can run.
Rather than trying to understand everything all at once, young career professionals should focus first on mastering the basics across several topics. By creating a foundation of financial literacy and understanding these areas like your credit score and what a stock is, you can “graduate” to more advanced behaviors on these same topics later on.
Making a budget can seem overwhelming and scary. Clients will often ask whether they need a spreadsheet or which formulas are best for their budgets. That is almost always way too complicated for the person who is just starting out. If you talk to any physical trainer, rarely is anyone going to bench press above their weight right away. One best practice is to simply write out your total discretionary expenses and fixed expenses and compare that to your take home pay. Evaluate your checking account balance each month – is it rising, falling, or roughly the same? Your first objective once you have a sense for your monthly expenses, is to create an emergency savings account. This account should cover your monthly expenses for between three to six months – it may take some time to build this and that’s OK!
These early budgets don’t need to be accounted for down to the penny. The value is in building the right types of behaviors and routines and growing comfortable with your finances. These are the first steps needed to help you create good savings habits.
It isn’t uncommon for people starting their first job to have debt. Student loan debt, credit card debt and auto loan debts can feel like a lot at the start of your career. One common question younger clients ask is whether they should be saving or paying down debt.
There are different rules of thumb on managing debt. For some people, they get a lot of satisfaction from paying off a loan in a way that motivates them to keep on track. For them it might be more motivating for them to start by paying off their smallest loan first and working their way up to the loan with the highest amount. Conversely, other people prioritize paying off debt in the way that cost the least over time, by paying off the loans with the highest interest rates first. There may be a third route or combination of tools that might involve consolidating debt to help lower your monthly payments. The important thing is that no matter how you approach paying down your debt, you establish a behavior and make a plan.
As you find your footing with a new employer, start familiarizing yourself with investments – what they are, how they function, and what investments you should consider for your retirement and any other savings goals. Learn about the risk and potential return for stocks, bonds, and fund options. Your new job may come with a retirement plan, for example and may offer these investments. As you consider how much to save, it might be a good idea to use a calculator to see how retirement contributions will affect your paycheck. Gaining an understanding of how Roth (after-tax) and traditional (pre-tax) retirement savings differ is also a great base level to work from.
Finally, your employer may offer other benefits that can affect your long-term financial wellness, including, different insurance policies beyond your health care plan, or how you could use a health savings account.
Now that you’ve got a handle on your monthly income and expenses, the following questions for many are: how should I be allocating this cash? How much should I spend on rent, or a mortgage payment? How much should I be saving for shorter term goals or longer-term goals, and where should those savings go?
One starting point is the 50/20/30 rule. This rule suggests that you should spend approximately 50% of your take home pay on necessities (fixed expenses like rent, food, utility bills, transportation). These costs also include minimum credit card or loan payments. 20% of your income should be earmarked for saving and/or debt repayment. That leaves 30% for wants, or discretionary needs.
Once you have a budget that works for you, try accelerating your savings, and increase that 20% figure. Don’t leave behind the 30% component though – living a spartan lifestyle is not usually an effective tool to building good savings behaviors (unless you are a Vulcan). If you are able, leave room to save for a vacation or big purchases like buying a home. You can use everyday money savings tools to put your money to work and achieve your financial goals. Create reminders and checkpoints to reorient you towards your goal, and embrace progress, however small.
This may run counter to many self-help financial experts, but some debt is OK. Student loan debt, for example, is a sign that you have some marketable skills and hopefully may translate into a higher income over time. Mortgage debt can offer tax benefits in some circumstances and is generally essential to owning a home, often an individual’s largest asset. Having said that, credit card debt can quickly spiral out of control and should be managed carefully, especially as you are starting out. A rule of thumb is that your credit card balance should not surpass 33% of your available credit.
As you build savings for a down payment on a home, a mortgage lender will qualify you in part based on a calculation known as your debt-to-income ratio. It’s important to carefully consider the size of the mortgage you are offered and if the monthly payments fit within your budget. Keep in mind the property taxes and insurance you’ll pay as well, in addition to home improvement and care expenses that you may not have as a renter. Additionally, they will want to know your credit score. If you’ve been diligent to manage your debt, that will help keep a robust score.
Once you have taken some time to know what mutual funds are, and the difference between stocks, bonds, cash, and other assets, you are ready to revisit your savings plan and allocate those savings accordingly. Longer term savings (e.g. for retirement) may call for a more risk-oriented approach by using stocks. When reviewing your retirement plan and how much to save, step one is to save anything. When you feel that you can comfortably save more, step two would be to take advantage of the full employer match in your retirement plan (to the extent that they do match your contributions). If your goal is shorter term, more conservative investments with a lower level of volatility may be appropriate. Outside of a retirement plan, you might start to invest in individual stocks or fractional shares of a stock or fractional shares of a mutual fund, or fixed income investments or even a Certificate of Deposit (CD). There are plenty of ways to get involved in investing outside of retirement accounts, and working with a financial advisor can help you clarify those goals and direct cash and choose investments accordingly.
The journey of financial literacy and independence are never over. You may find that, as soon as you have a firm handle on all the above, perhaps something in your life changes, or a law changes. It will be important to periodically revisit your financial priorities and create a financial plan. We recommend revisting your plan once every one to two years initially (commonly called the “accumulation” period), but as your situation changes – if you have a career transition, get married, have a child or any other big life change – make sure to review whether you are on track.
To learn more, contact a Johnson Financial Group Advisor in your area today.
