Financial Moves to Make in Your 20s
Your twenties are known to be some of the best years of your life. You’ll experience many different things through this decade. You might graduate college, get married, purchase your first home, or start your career. While there’s no denying that this is an exciting time in life, this is also your first opportunity to get ahead financially. While your friends might be buying new cars or traveling the world, this is your chance to prepare for your next goal in life, financial freedom.
Financial freedom can be interpreted differently by different people. Some people may see this as simply not having to worry about money. Some people might see this as not having to work. There is no right or wrong answer to what financial freedom is.
Buy a Home
Purchasing your first home is considered an expense for many. You pay a monthly mortgage payment that is routed to the housing portion of your budget. But we don’t consider that true. Your home is an investment. It should appreciate over time as well as provide housing for you and your family. Like investing, it’s always important to make good investments, and that’s no different when purchasing a home. You might be tempted to purchase a newly remodeled home with granite countertops, updated floors, and new stainless steel appliances. Oftentimes this can be a mistake. Because the home is already remodeled, it will be more difficult to increase its value and therefore obtain a positive return on your investment.
Typically when buying your first home, you will have to finance the purchase, and for most people, they will opt for a 30-year fixed-rate mortgage. Some people highly advise against a 30-year mortgage. Because of the way mortgages are structured, 90% of your first payments will go towards the interest of the loan and not the principal balance. While this is true, those interest payments are tax-deductible. To combat this, some of our advice is:
- Keep your mortgage payment under 20% of your household income
- Don’t agree to a mortgage with above 7% interest rate (under 4% is ideal)
- Pay off your mortgage early! Try to make at least one extra mortgage payment per year.
The average return on your investment in the stock market is 7% per year. Taking a few hundred extra dollars per month and investing them can add up with the concept of compounding interest. In the simplest terms, compounding interest is interest on your interest. For example, if you invest $100 and receive a 10% return on your investment, you would have $110 after the first year, $10 of interest plus your $100 investment. Assuming you earned another 10% return the second year, you would have a total of $121, $21 of total interest plus your $100 original investment. Notice how you earned an extra $1 of interest for this year. That is because you were paid interest on the $10 of interest you earned the first year. This example explains the power of compounding interest. A rule of thumb says that you will double your money with compound interest in 9 years. Want to know the exact numbers? Check out this compound interest calculator! Compounding interest is the largest wealth-building tool you can take advantage of, so it’s better to start early rather than wait.
Explore Retirement Options
Does your company offer a 401k match? Perfect, this is free money you need to take advantage of! If not, it’s still a great idea to contribute to a tax free 401k account. With years ahead of you, you can maximize the concept of compounding interest to develop a portfolio that will provide lifelong income.
The most common retirement accounts are a 401k and a Roth IRA. Both of these accounts offer several benefits but also come with some restrictions outlined below.
A 401k allows you to invest pre-tax income up to the amount of $19,000 annually (increases to $25,000 if you are older than 50) tax-free. If you need to withdraw this money, there is a penalty that comes with it. If you withdraw before the age of 59 1/2 you will have to pay a 10% penalty, plus the income tax on the amount. For example, if you are in the 24% taxi bracket, and withdraw $5,000 it will cost you a total of $1,700 in taxes and penalties, leaving you will $3,300.
This is probably the second-best options for those looking to invest in their retirement. You are capped at investing $6,000 annually (increases to $7,000 if you are older than 50) that will grow tax-free. Unfortunately, this money is contributed after-tax, which is one of the major differences between a 401k and Roth IRA. Another major difference between the two is that you can withdraw your Roth IRA contributions without penalties, and tax-free before the age of 59 1/2. NOTE: This is only your contributions. Any earnings cannot be withdrawn penalty-free.
Ultimately you want to aim to invest up to the $19,000 limit in your 401k first (taking advantage of an employer match if possible), then invest any additional savings you may have into a Roth IRA to lower your total tax payments.
Trim Unnecessary Expenses
Everyone has unnecessary expenses. Whether we chose to admit them or not, is between us. Some of the largest monthly expenses are cell phone bills, cable, and car payments. While it’s arguable that a cell phone bill is a necessity, do you really need that unlimited data? Probably not. Trimming these expense can help you to invest more of your money and take advantage of compounding interest. You can read our full guide to lowering monthly expenses here!
During your 20s you will probably run into a few financial windfalls. Tax returns, bonuses at work, or an unexpected raise. During these times, it may be tempting to go on that lavish vacation or upgrade your television. It’s during these time to think about your future. Instead, putting that money into your investment portfolio or your savings account is a better option. In addition, learning not to splurge can boost your morale and create strong financial habits in the future.
Create Multiple Income Streams
Having multiple income streams is extremely beneficial to lifelong wealth. Earning a consistent income, separate from your primary income not only increases your overall income, but it also serves as an emergency blanket in case something were to happen to your primary income stream. Starting a side gig like mowing grass or writing blog posts are two great ways to boost your income enabling you to save, invest, and live a life free from financial worries. You could also consider renting your space on VRBO or using apps to make real money to increase your income.
Read our article on how to start a side hustle to learn everything you need to know before you start.
By using these six tips, you’ll be on your way to financial freedom in your 30s and beyond. Don’t forget to follow us on Facebook and Twitter and subscribe to our email list to get the latest news straight to your inbox!