Millennials, also known as Generation Y, are individuals born between the early 1980s and the early 2000s, and range between ages 18 to 34. In the media, we often hear about the challenges this generation is facing, such as high unemployment rates, widespread underemployment and overwhelming student loan debt. Due to these challenges, many millennials are delaying rites of passage, such as homeownership and marriage, and are sometimes forced to move back into their parents’ houses.
The news isn’t all bad, however. Recent surveys show that millennials are saving more than almost every other generation and are increasingly financially literate.1 Do you find yourself at the opposite end of the financial spectrum? Don’t worry! There are some simple steps you can take to improve your situation and help get on track to financial success.
Make a realistic budget
Making a budget is an important first step toward creating a financial plan. There are many different rules of thumb for creating a budget. While it helps to take those rules into consideration, it’s also important to make sure your budget is realistic and achievable.
One rule of thumb to consider is the 50/20/30 formula, which divides your after-tax income into three buckets:
- The 50 percent bucket goes toward expenses necessary for daily living, or non-discretionary spending. This includes food, clothing, shelter, utilities and transportation.
- The 20 percent bucket goes toward long-term savings goals like retirement, as well as any additional debt repayment above and beyond the minimum payment.
- The 30 percent bucket goes toward expenses you could live without, or discretionary spending.
This may include entertainment, eating out, vacations and hobbies.
While this is a good rule of thumb to follow, the 50/20/30 strategy may not work for everyone. Instead, it might help to look at your budget from the angle of what you spend versus what you save. Online budgeting tools can also help you track your spending and make budgeting more convenient. A simple rule to remember is to put at least 10 percent of your after-tax income toward your long-term goals. This includes 401(k) salary deferrals and additional funds invested in taxable investment accounts. Any savings above 10 percent are great, but it’s also important to make sure those excess savings are not preventing you from affording everyday living expenses.
Come up with a manageable plan for paying off debt
Before setting aside funds for emergencies (we’ll get to that a little later), tackling high-interest debt should be a priority. High-interest debt usually refers to credit card debt, which can carry an interest rate of 20 percent, 30 percent or even higher. There is no cap on the interest rates credit card companies can charge, so it is important that you fully understand the rate you’re paying.
This type of debt can grow quickly and become unmanageable if you only make the minimum payment. Generally, if the interest rate on your debt is higher than what you could earn if you invested in the market, it makes sense for you to pay down the debt aggressively rather than investing in the market. It’s usually wise to pay off all credit card debt before you start investing.
However, you may consider only paying the minimum amount for debt with lower interest rates, which typically include student loans and mortgage debt. For this type of debt, it makes sense for you to invest excess income rather than paying it down, because the interest rate on the debt is generally lower than what you could earn if you invested in the market.
For example, let’s say that your student loans have an interest rate of four percent.
If you could invest those funds and earn a six-percent average annual return, why not invest your excess income instead? A financial advisor can help you develop a plan for resolving the debt in a way that works best for your situation.
Set aside funds for emergencies
Unexpected expenses can wreak havoc on a financial plan; that’s why an emergency fund is essential. Perhaps your Monday morning commute is worse than usual and results in a fender bender, causing $2,000 in damage to your car. Where will you get the money to pay for the repairs? Dipping into your investment accounts can generate capital gains and lead to taxable income. And withdrawing from your retirement account can generate ordinary income, which is taxed at a higher rate than capital gains. You could also be subject to early withdrawal penalties for accessing your retirement account before age 59 ½.
Setting aside cash for emergencies is the best way to avoid using your existing investments to pay for the unexpected. Your emergency fund should cover three to six months’ worth of non-discretionary expenses, such as your mortgage or rent, bills, food and transportation.
An emergency fund can also help you prepare for potential life changes. For instance, if you are anticipating a job change or a move, you should build up your fund to cover your expenses for up to six months or more in the event that you do not have an income.
Saving six months’ worth of cash in an emergency fund may seem like a burden. While it’s impossible to save the entire amount overnight, making an effort to save a little bit at a time will help you reach your goal. A simple way to establish (or replenish) your emergency fund is to save windfalls. Did you get a tax refund? Put it toward your emergency fund. Did you receive a bonus? Congratulations! Treat yourself to a reward, but consider saving the majority of that money for emergencies. Before you know it, you will have three to six months’ worth of expenses saved.
Make sure you’re properly insured
Besides the insurance coverage you are required to have — health, auto and homeowners — there are several types of insurance that are often overlooked:
- Umbrella insurance: It may be beneficial to have an umbrella liability policy in place above your auto and homeowners insurance policies. This coverage can help protect against liability in case you face a lawsuit, and can also pay for expenses over and above what your auto and homeowners policies cover.
- Disability insurance: This type of coverage is particularly important if you’re just starting out in your career. Over time, there is a greater chance that you may become disabled than pass away unexpectedly, so it’s important to plan for a potential loss of income if you are unable to work.
- Life insurance: If you have children or you’re providing for a family member, life insurance is recommended. It is also necessary if you are single and have any type of debt. Life insurance can cover your remaining expenses or your family’s expenses if you pass away. The coverage should be enough to ensure that your family members can continue to pay all of their expenses without difficulty following your death.
Many employers offer disability insurance and life insurance as employee benefits.
If you’re eligible to receive coverage through your employer, be sure to reach out to your human resources department or representative to ensure you understand your options and how much coverage you can receive.
Don’t live beyond your means
It’s normal to feel pressured to keep pace with your peers, especially when your newsfeed is filled with photos of new cars and exotic trips. However, it is important to tune out what everyone else is doing and focus on what is best for your own financial situation. If your goal is to buy a new car, you should make sure that a monthly car payment fits into your budget. If not, then you should consider purchasing a less expensive car or putting down a larger down payment. Staying focused and sticking to a savings plan will help you keep your long-term goals in perspective.
Click here to check out Part II of Financial Tips for Millennials and discover more ways to build your financial well-being.