It is generally easier to get where you want to go when you have a road map (or GPS!). A financial plan serves this function when making decisions of how to set priorities for your financial future. Each individual has their own timeline, but we have identified some of the key financial decisions people may face in each decade of their life and the considerations that go along with them.
Keys for Your 20’s
1. Get out of debt
A common experience for twenty-somethings is graduating college with significant student loan debt. As of October 2012, the average amount of student loan debt for the Class of 2011 was $26,600 (The Project on Student Debt). Loan payments kick in six months after graduation. Staying organized and knowing your options in terms of repayment is essential to paying off your loans as quickly and cheaply as possible.
To get organized, create a spreadsheet list of all your loans including the name, the loan ID number, the dollar amount of the loan, the interest rate and the date the first payment is due. This process will not only ensure that you are aware of when to make your payments, but will also give you an overall picture of your debt situation. Looking honestly at this breakdown will help you begin planning how you are going to get out of debt.
If you are a low-income earner trying to pay back your loans, consider signing up for an Income-based repayment plan. Income-based repayment plans ensure that your monthly payments never exceed 15% of your disposable income. Furthermore, if you work in the public sector and make 120 on-time payments under this plan, you can have the remaining balance of your loans forgiven.
Another important step is to sign up for auto-debit. Signing up for auto-debit means that your monthly payments will be automatically drawn from your checking account. This measure guarantees all your payments will be made on time. Equally attractive is the fact that education lenders often give borrowers who make their payments by auto-debit a small interest rate reduction, typically 0.25% or 0.50%.
The last important decision you need to make related to your loans is whether or not to consolidate them under one umbrella loan. This can be done for both your government and private loans and can make repayment a much simpler process. However, consolidation prevents you from strategically paying back multiple loans in order to reduce interest payments. Paying of the loan with the highest interest rate first reduces the average interest rate of your loans; whereas consolidation fixes all your loans to one constant rate.
2. Build your credit
You may assume that your credit score is not something to worry about unless you are buried in credit card debt or your house is about to be foreclosed. However, a credit score requires active cultivation, and is another key thing to do on top of paying back loans, looking for work and saving. The good news is that building your credit score does not have to be a painful process and can be achieved through things you may already be doing. Building your credit score early will make it easier for you to take out loans in the future, whether you want to put a down payment on a car or a house, or if you need money to go back to school.
Student loans are a bit of a double-edged sword when it comes to credit. Recent college graduates tend to have low credit scores, because they have significant debt and do not yet have a history of on-time payments. However, making every loan payment on time, starting with the first payment six months after graduation, is a great way to show credit bureaus that you are able to manage debt. Most people who make a late payment due so on the very first payment. You will avoid this fate by following the advice above about organizing your loans and tracking when the first payments are due. If you stay organized and continue to make all your payments on time, your credit score will improve.
Another way you can begin to build your credit through actions you are already taking is by checking out Payment Reporting Builds Credit. Through PRBC, you can self-report payments, such as rent and utility bills. If you are making your rent and utility payments on time, this kind of self- reporting can help win you favor with both credit bureaus and lenders.
Finally, the most common way people build their credit score is by using credit cards. Using a credit card can be an extremely slippery slope; therefore, having a plan for how you will strategically use your credit card is essential. The best thing you can do when using a credit card is use it sparingly and pay on time. If you do make a late payment, you can ask the credit card company for a “good will deletion”, in other words you can ask them to remove the late fee from your record. Credit scorers look at how much credit is available to you versus how much you are not using. Therefore, having two to four credit cards, but only using one can be a great way to build credit. Similarly, you can ask for a small increase in your credit limit every 12 months even though you will not use it. Remember, as of March 2012, 39% of Americans are in credit card debt, and 100% are not happy about it—do not be one of them. A rule of thumb for staying out of credit card debt is to only use 30% of the credit available to you.
3. Open a Roth IRA
Do you want to retire? Even if you are not a white picket fence, two-car garage American Dreamer, chances are you do not see yourself continuing to work full-time into your seventies. Interestingly, in 2011 of those born between 1980 and 2003 found that 60% of the cohort did not think about retirement at all and that more than half had not begun saving.
As long as you meet the criteria, a Roth IRA is the preferred retirement savings account, because the Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply.
Withdrawals prior to age 591/2 may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth ORAs. Their tax treatment may change. As of 2013, persons aged 49 and below can contribute up to $5,500 a year to a Roth IRA account. Hitting this contribution limit each year will pay dividends down the line when you are ready to retire.
4. Cash Reserve
At a time when the average job search lasts 16 weeks, it is more important than ever to have an emergency cash reserve to keep you afloat if your income stream dries up for a period of time. The rule-of-thumb is that you should have at least six months expenses held in savings.
What is the best way to save? Another common rule-of-thumb is that you should save 10% of every paycheck. One place to Put these savings is into a high-yield online savings account. Online savings accounts may be preferable to accounts at physical banks, because they typically offer higher interest rates. Check out Bankrate.com for a constantly updated list of the online savings accounts offering the highest annual percentage yield (APY).
5. Budget
To improve your financial situation, one of the best things you can do is figure out ways to spend less. One of the best ways to accomplish this is simply to track your current spending. Often just the exercise of staying aware of your spending can help you reduce it.
The first step to creating a budget is tracking all of your expenses for a month. Next, you need to sort these expenses into categories that make sense to you, although there should be three general categories of requirements, wants, and financial priorities, such as retirement funds and savings.
One general rule-of-thumb, the 50/20/30 rule, says you should not be paying more than 50% of your income on required expenses, should be devoting at least 20% of your income to financial priorities, and should not spend more than 30% of your income on wants. One of the most difficult parts of budgeting is identifying which expenses are wants. For instance, a car and a cell phone may seem like essentials, but in reality they are not required expenses in the same way that food and shelter are.
For those of you who do decide to keep your smartphone and data plan, there is an app called “Mint” that can help you track your finances. Mint can help you keep track of your student loans, track your debit and credit card purchases, and monitor your savings and investment.