Hey everyone, so as I said last week your twenties can either be your best friend or
your worst enemy when it comes to personal finance.
And perhaps the biggest determining factor between being way ahead of the game come your
30th birthday or well behind where you'd like to be is your ability to identify and avoid
some common money traps.
Last week we covered three of those traps and this week we’re going to be talking
about 4 more.
If you missed last week’s video I’ve left a link to it in the description so you can
check it out either before or after watching this one.
With that out of the way, let’s get started picking up where we left off last week.
A fourth common money trap that you should avoid in your 20s is not getting a jump start
on your retirement savings.
Yeah, I know another one that sounds like it's basically just talking about compound
interest.
But particularly when you're in your twenties, truly understanding compound interest its
effects, and how to get it to work for you and not against you is probably the most important
thing you can do to secure your financial future.
So, yes, I know I'm harping on it in this video but it is really that crucial.
So what do I mean by getting a jump start on your retirement savings?
Live like a college student for a year after getting a job.
Keep your expenses as low as you possibly can while investing every cent you can in
tax-advantaged accounts.
If, after college graduation, you and your spouse's household income is $6,000 a month
and you can live on $15,000 a year for one year (likely we'll need to take advantage
of rent hacking to achieve this) then you could have over $4,000,000 invested in your
nest egg in 45 years when you retire.
That's assuming a 10% return and no further investing after that first year.
That would mean you would have the equivalent of a $44,000 annual income in today's dollars
assuming a 4% safe withdrawal rate.
Again that's based on just one year of investing aggressively.
If you had continued investing $1,000 a month while living on the other $5,000 you would
end up with nearly $13 million by the time you retire.
In that scenario, you would be able to live on $135,000 a year assuming a 4% safe withdrawal
rate was used in retirement.
Even with an 8% rate of return, the numbers are still pretty eye-opening.
With just that one year of aggressive investing, you would end up with over $1.8 million!
If you continued investing after that first year you would end up with almost $6.5 million!
That’s a retirement income of almost $70,000 a year in today’s dollars following the
4% rule.
A fifth common money trap that you should avoid in your 20s is going to college without
a plan.
College is great for some, but it isn't for everybody.
And you can create a very comfortable life for yourself with or without a degree.
According to the Bureau of Labor Statistics, the median income for high school graduates
in 2017 was about $37,300 per year.
For those with bachelor’s degrees, it was about $61,800.
And for those with advanced degrees, it was about $75,400.
There’s certainly a pretty big leap between high school graduates and those who have at
least a bachelor’s degree, but we also have to consider the time it takes to get that
degree and the cost of college itself.
According to ValuePenguin.com the average annual cost of a four-year college for in-state
residents is about $25,000.
That number includes tuition and fees, room and board, books and supplies, transportation,
and other miscellaneous expenses.
Judging by those numbers a four-year degree at such a school would run about $100,000.
That’s quite a chunk of change.
Assuming that you put the full cost of that degree on your student loans with a 4.5% interest
rate and the standard 10-year term you would be paying over $1,000 a month after graduation.
That’s also quite a chunk of change.
In fact, it’s about 20% of the median income for those with bachelor’s degrees.
And that’s just the tip of the iceberg.
If you decide to go to school in some other state it’ll cost even more.
Those same 4-year colleges cost $41,000 per year for out of state residents.
Private colleges can cost $50,000 a year or more.
You can see how these costs can quickly add up even if you finish your degree in the standard
4-years.
But if you go to college without having some idea of what you want to get from it you could
find yourself changing your major a couple of times and spending more years in school.
With that being said, how do you save money for college?
A few things you could do would be going to a community college to get your two year degree
before transferring to a 4-year university to finish your bachelor’s, looking for scholarships
or grants, looking for part-time jobs you can do while at school, and saving early in
things like ESA and 529 plans if you have the time among others.
These strategies can make a pretty big difference in the cost of college and the amount of catch-up
work you’ll have to do after graduation.
For example, according to ValuePenguin’s data, the average annual cost of a community
college is just $4,864.
Heh, and I say just $4,800 as if that’s not also a lot, but it significantly cheaper
than the 4-year university.
If you got your two-year degree from a community college it would run you about $9,700.
You could then transfer to a 4-year university and finish your bachelor’s for an additional
$50,000.
In total it would cost about $60,000 compared to going to the 4-year university from the
beginning and shelling out six figures.
ESAs and 529 Plans are both ways to save for educational expenses.
ESA stands for an education savings account.
The 529 Plan gets its name from the IRS Code number that it’s based on.
Both the ESA and 529 Plan allows for tax-free growth and withdrawals as long as you are
withdrawing the money for qualifying expenses.
While contributions to the ESA are not tax-deductible, they can be withdrawn tax-free for qualifying
primary and secondary expenses as well as college.
You can choose just about any type of investment you want and can contribute $2,000 per child,
per year.
ESAs must have a beneficiary listed and that person must use the money by the age of 30
to avoid any taxes and penalties.
If they aren’t going to use the money before 30 you can transfer it to another beneficiary
as long as they are related to the original beneficiary.
This is really cool because it means that if you’re saving for your kids college and
they end up deciding not to go you can transfer the account to your grandchildren!
However, there are income restrictions with the ESA.
The restrictions begin with incomes between $95,000 and $110,000 for individuals and $190,000
and $220,000 for those who file jointly.
529 Plans are offered by most states and are a little more restrictive with their investing
options than the ESA.
For most states there are a few portfolios that you can choose from when investing your
money and you can reallocate your investments twice a year.
To make up for this the 529 Plans do offer higher contribution limits of $14,000 per
year and the money is still withdrawn tax-free for qualifying expenses.
There is no age limit for those using the money.
So if you’re beneficiary decides they want to go back to school in their forties they’re
free to do so with this money.
Withdrawals can be used for college expenses including tuition, room and board, and textbooks
and supplies.
However, they cannot be used for primary and secondary school expenses like the ESA can.
Unlike the ESA, there are no income restrictions with most 529 Plans.
And finally, just like the ESA, you can transfer from the original beneficiary to someone else
as long as they are related.
With both of these plans, it’s important to consult a financial professional as there
are sometimes some differences in the fine print, but this is generally how the options
look.
But as you can imagine these options can give your son or daughter a massive head-start
when it comes to saving for college.
It’s okay to work while you are in school.
It’s great to be able to work during the summer to earn enough money to pay for school.
If that’s not enough though, there’s no shame in working part-time during the school
year as well.
Your 30-year-old self will thank you for it someday.
Consider if you went to a community college to get your two-year degree.
It costs you approximately $10,000.
If you then went to finish your bachelor’s at a 4-year school you’d be paying about
$50,000.
In total your educational expenses are around $60,000 over the course of 4 years.
If you worked a full-time job in the summer (13 weeks) that pays $12 an hour you would
earn about $6,240.
If you also worked 20 hours per week during the school year (39 weeks) you would earn
an additional $9,360.
In total, you would have an income of $15,600.
After taxes, this would likely be about $14,000 a year in income.
With $15,000 a year in educational expenses that would nearly pay for your entire degree!
Within a few months of graduation, you could be debt-free and off to the races building
your investing portfolio.
A sixth common money trap that you should avoid in your 20s is buying a home before
you’re ready.
Our mid to late twenties is often when we buy our first house.
Many times this is perfectly fine.
However, sometimes people buy houses before they’re ready and that can lead to catastrophe.
So how do you know if you are ready to buy a home?
Generally speaking, there are three rules of thumb when it comes to buying homes.
They are the 28/36 rule, the 30% solution, and the 25% method.
The 28/36 rule states that you should spend no more than 28% of your gross income on your
mortgage payments including the principal, interest, insurance, property taxes, PMI if
you have it, and HOA and other related fees and dues if you have them.
The rule also states that no more than 36% of your gross income should be spent on your
housing and all other debts.
Or in other words, 36% of your gross income should go towards your mortgage principal
(or rent if you're a renter), interest, insurance, property taxes, PMI, HOA fees, and other debt
payments like a car, student loans, or other personal loans.
The 30% solution states that no more than 30% of your gross income should be allocated
towards housing costs which basically includes the same things as before.
Technically the 30% solution also advises that you have no more than 20% of your take-home
pay should be going towards non-housing debts.
However, unlike the 28/36 rule, it doesn't have a second layer for you to adjust your
housing costs if you are in a situation where you're up to your eyeballs in debt.
This could lead to some very tight budgets if you have a fair amount of debt relative
to your income.
The 25% method is the one popularized by Dave Ramsey and it states that you should allocate
no more than 25% of your take-home pay, towards your housing costs.
This is undoubtedly the most conservative of these three rules of thumb and generally
works very well, especially in situations where you need to allocate a large portion
of your income towards other financial goals such as giving, paying off debt, or investing
in your future.
If you are unable to afford a home based on any of these rules you definitely should not
be buying, even if you qualify for a loan.
This may lead to missing out on some real estate appreciation, but that’s a far better
problem to have than being unable to afford to keep a roof over your head.
Ultimately the answer is you need to either earn more, spend less, or some combination
of the two.
I know that isn’t the answer we’d necessarily like to hear, but it is the truth.
Thankfully, there are some things that most of us will be able to do to save money quickly.
For most people, the largest expenses they have are related to shelter.
The combination of housing/apartment costs, maintenance, utilities, and related insurance
premiums quickly add up to a bundle of cash.
In a way, this is fortunate as it gives us a huge opportunity to save money quickly.
Rent hacking is a term that refers to you sharing the costs of housing with others.
Rent hacking takes on many forms depending on the person using it.
Similar to many college students you could share the apartment with some roommates and
split the costs.
You could rent an apartment that allows subletting to other tenants to help cover costs.
Or you could rent out your places on travel sites like Airbnb to earn some extra cash
and offset the costs.
Whichever way you decide to go the end result is your portion of the housing costs goes
down and you are then able to save more money.
In addition to saving money on housing, you could do a zero-sum budget to find out other
areas you may be overspending in.
If you’ve never done this before it can be an eye-opening experience.
Some people find they’re spending significantly more on eating out than they thought.
Others find there are some subscription services that they no longer use and just forgot to
cancel.
Still, others find no glaring oversight in their budgets but many categories that could
use some fine-tuning.
They then research ways to keep utility and other ongoing costs down and save money that
way.
Depending on your situation this could lead to savings of a few dozen dollars a month
to a few hundred.
When paired with rent hacking strategies it can allow you to save some serious cash quickly.
A third way that you could help yourself save money for a down payment is to sell things
that you don’t use anymore.
Depending on the things you have and are willing to sell this could have the effect of a small
initial boost that might cut a month or two off your savings timeline or a big boost that
plays a major role in your overall savings plan.
A fourth way you can save money is by paying off your debts.
This is admittedly more of a long-term strategy, but with those minimum payments gone you’ll
be able to put more of your income toward saving for a down payment and later toward
your mortgage or investments.
This will have a double-effect on your goal to buy a house as it will be much easier to
get a mortgage if your debts are under control.
If you want to see an example of how big of a difference using these strategies can make
on your savings for a down payment you can check out my earlier video on how to save
money for a home at the link in the description.
A seventh common money trap that you should avoid in your 20s is not taking time to become
financially literate.
While the schools are getting better at teaching financial education there's still a long way
to go.
And even if they do manage to get to the level we need to get to it's not going to do much
for those of us who have already finished school.
For those of us in that camp, we're going to have to take matters into our own hands
through self-education.
Expose yourself to new ideas.
Read books, take classes, watch videos or look at blogs related to money just like you
are now.
Any of these going to have very positive the facts on your financial situation both in
the present and future.
They can introduce you to new ideas that you may not have come across on your own.
They can reassure you during uncertain times that the world isn't coming to an end and
this too shall pass.
They can give you encouragement when things are going well and help keep you motivated
to continue working towards your goals.
And perhaps most importantly (especially if you're just starting out and didn't get much
financial education when you were growing up) they can introduce you to so many new
possibilities that get you excited about researching finance.
They can get you thinking about what you can accomplish in your own life with your own
resources.
So if you're watching this right now and you're in your 20s, or even if you're not in your
20s and you're just getting introduced to the concept of financial literacy, make sure
you never neglect it.
I’ve also done a video on how big of a difference this can make to your life and your finances.
If you’re interested in learning more there’s a link in the description.
So those are 4 more money traps to avoid in your twenties (or really any age).
Have you, or anyone you’ve known fallen into one of these traps?
If so, how did they get out of it?
If not, then do you think I missed any traps that we should be avoiding?
Let me know in the comments section below.
Once again, if you didn’t catch the first part of this video series you can find a link
to it in the description below.
Also, I want to make a quick announcement about the channel.
We're coming into the Christmas and New Year's holidays.
I know a lot of you will be spending the time with friends and family and so will I. I never
like to feel like I'm intruding on that time especially since I know how few and far between
these times are for some families.
So just like last year, I will be taking a brief break over the holiday season, but I
will be back Monday, January 13th with some more videos.
So thank you all for taking time out of your schedules every week to support this channel,
I really appreciate it.
And I hope you enjoy the holiday season and have a great start to your new year.
I'll see you in 2020.