Hey everyone, so your twenties can either be your best friend or your worst enemy when
it comes to personal finance.
Depending on how you handle this phase of your life you can either be way ahead of the
game (if not already financially independent) or in debt up to your eyeballs having already
declared bankruptcy once or twice.
Perhaps the biggest determining factor between you ending up way ahead of the game come your
30th birthday and you being well behind where you'd like to be comes down to identifying
and avoiding common money traps that can be a plague to early financial independence.
This is the first video in a two-part video series talking about money traps to avoid
in your twenties.
I had to split the video into two parts because the script just got too long.
So today we’re going to be covering 3 major money traps you’ll want to avoid in your
twenties (or really any age) and next week we’ll be tackling 4 more traps.
Let’s get started.
The first common money trap to avoid in your 20s is excessive debt.
I’ve already done a video on why I consider debt to be the #1 wealth killer, but it’s
still worth mentioning again here.
Having too much debt limits your most powerful wealth-building tool... your income.
You may think that paying off your debt instead of investing would be a bad idea because compound
interest is so powerful.
And compound interest is powerful.
But it can also work against you.
You’ve probably heard the example of how someone could invest $100 a month from age
18 to 25 and then stop investing altogether, but still, end up with more money than someone
who started investing $100 a month at age 26 and kept investing to 65.
That’s a great way to illustrate the power of compound interest working for you, but
with debt, compound interest is actually working against you.
Debt requires minimum payments each month.
That takes away from the money you can put into investments.
It generally forces you to get started investing later because it also increases the amount
of money you need to save in order to have a fully-funded emergency fund.
And, of course, it increases the risk of financial ruin in the event of a job loss or other catastrophe
and costs you in interest as well.
According to articles in Business Insider, CNBC, and Forbes the average American carries
about $9,000 in credit card debt which is often split between several cards.
They have $30,000 in student loan debt.
And (assuming a used vehicle was bought) a little over $21,000 tied to a car loan.
That's around $60,000 in total debt.
If we assume 18% interest on the credit cards and 4.5% interest on the other loans the minimum
payments could be roughly $900 a month.
$900 a month in minimum payments translates to anywhere from $2,700 to $5,400 in additional
savings that must be put into your emergency fund.
If you only had $100 or $200 leftover after expenses and debt payments every month, it
could take you well over a year to get that emergency fund taken care of.
Even assuming your emergency fund is taken care of, your debt could put a damper on your
potential nest egg over time as I detailed in my video on debt being the #1 wealth killer.
So with that being said, how do you avoid this common money trap?
First, if you're lucky enough to not have any debt right now research some ways to ensure
that you keep it that way.
If you're planning to go to college look into ESA or 529 plans.
Look into scholarship opportunities.
Don't be afraid to have a summer job and work during the school year part-time.
Make sure that you always have an emergency fund.
It should contain three to six months worth of expenses so that you never have to take
on debt for those moments when life happens.
Make sure you have insurance for those catastrophes that you wouldn't be able to cover with your
savings.
Catastrophic health emergencies are a good candidate for this.
If you're already in debt, learn about how people have paid off their debts.
Then choose the strategy that will make it most likely for you to get out of debt completely
(and stay out of it).
Three of the most popular strategies are the debt snowball, debt avalanche, and debt tsunami.
I have done videos on all three of those and they will be linked in the description.
Another thing I would recommend looking into is the power of the debt snowflake.
If you haven't heard, the debt snowflake is a strategy where you find ways to free up
money (or just happened to find money) that you can put towards your debt payoff strategy.
The nice thing about it is that it works well with any of the other three strategies I mentioned
even if by itself it isn't game-changing.
A second common money trap that you should avoid in your 20s is harmful external influence.
You might not think this is a money trap, but it is.
In this day and age, there is so much fear and uncertainty being pushed out by the media
and other external sources that it can affect your behavior when it comes to your finances.
One way this could affect your financial future is by causing you to hold off investing for
a better time, which could have negative consequences.
Take John for example.
John has $100 a month left over to invest.
However, he's been listening to the news and has become very nervous about the future of
the stock market.
They're saying that a crash could occur any day now.
John, like most of us, doesn't like the thought of losing any of his money.
Therefore he decides to wait for a better time to invest.
Just to keep things simple let’s say John’s investment was valued at $100 a share, pays
a 2% dividend each year, and mirrors the movements of the market.
Over the course of the first year, the market loses 30% of its value.
John’s investment is now worth $70 a share.
The market continues to drop in year two with John’s investment falling to $50 a share.
At this point, John is happy that he decided not to invest because he would have lost 50%
of his money (at least on paper).
In the third year of this scenario, the market rebounds a bit.
John's investment grows to $60 a share.
That's definitely nice but John listens to the news and they still aren’t sure that
the worst is over.
Therefore John decides to wait a little bit longer before investing.
The market continues to recover the next year with John's investment reaching $75 a share.
At this point, the worst seems to be over so John decides to invest.
We are four years into John's journey and he has $4,800 in his bank account.
He invests it all and buys 64 shares of the fund he’s been following.
He also receives that 2% dividend for the year.
Since the share price was $75 at the time, the dividend will be worth $1.50 per share.
John has 64 shares so he makes $96 in dividends.
He uses that income to purchase even more shares.
In this case, he would've bought 1.28 shares with his dividend income.
Over the course of the fifth year, the market finally recovers.
John's investment is worth $100 a share.
He invests his $100 a month throughout the year and ends with a net worth of $7,728.
That doesn't sound half bad but what if John had just consistently invested instead of
letting the news influence his decision?
As it turns out John would have been better off investing during the crash as opposed
to waiting.
If John had invested his $100 a month over those five years and the market perform the
exact same as it did before his net worth would be a little over $9,300.
This is mainly because he is buying shares when they're on sale (and therefore is able
to buy more with the same amount of money).
In addition, he's also getting income from dividends earlier than before.
Those dividends grow over time and allow him to buy even more shares.
This creates a sort of investment snowball effect that John can ride as the years go
on.
What that translates to is an additional $1,600 in John's nest egg.
Another way this could affect your financial future is by causing you to hold off starting
a business or side hustle.
This could lead to a lower monthly income that could be used to pay off your debts or
invest and start building wealth.
Even if the side hustle is very small it can still be a big difference-maker for your financial
future (among other things as I've covered in previous videos).
If you earn $500 a month from a side hustle and invested that at an 8% rate of return
you would build some serious wealth pretty quickly.
Even if that $500 a month was the only thing you invested, you would have over $1.75 million
to your name 40 years from now.
If you had put that money into a ROTH IRA you could then withdraw it tax-free in retirement.
According to the 4% $1.75 million translates to an annual income of $70,000.
So while there are risks involved with starting a business there's also opportunity costs
with not having some sort of side hustle.
And those opportunity costs are especially large when you're young simply because you
have so much more time for the money you make early on to compound.
If you are concerned with the perceived risks of starting a side hustle consider going with
a lean startup.
That way even if it does end up going in a direction that you didn't desire you could
cut your losses with minimal harm done.
Beyond the fear and uncertainty, hype can also have an effect on your financial future.
In some cases, this can be healthy but in others, it can lead you to make decisions
that you later regret.
One big example of this would be buying a house you weren't prepared for simply because
the market is down but is expected to go up.
If the market rises like expected this may not be the worst thing in the world.
But if it goes down even further then you could end up underwater on a home you already
can’t afford.
You’re not going to be able to avoid external influences entirely.
And you wouldn’t want to as they can sometimes be very helpful.
However, you do want to be able to avoid the ones that won’t be helpful to you in reaching
your goals.
The best way to do this is to have a good financial plan with solid goals to shoot for.
That way any time any of these things come up you can ask yourself, "Does this message
help me achieve my goals better than any other?"
If not, then you can just not follow the message.
This may lead to some situations where you miss out on some opportunities (such as being
an early investor in Bitcoin) but it will also ensure that you don't fall into the trap
(such as those who were late investors in Bitcoin).
And particularly when it comes to investing missing out on a big win is far less damaging
then jumping into a big loss.
This is a simple function of how the math works, assuming this is an investment that
you're not continuously adding to.
If you have $100 in an investment that loses 50% of its value it would be worth $50 right?
However, what kind of return would you need to get in order to get back to your original
$100 value?
It would be 100%, right?
Because that $50 you have left would have to double in value.
However, if you had $100 in investments and it gained 100% of its value it would be worth
$200 right?
But in order for that $200 to fall back to its original $100 value how much would it
have to lose?
It would only have to lose 50% right?
So while there are opportunities that you just can't pass up don't be afraid of taking
it slow and steady.
As our mothers always taught us slow and steady wins the race.
A third common money trap that you should avoid in your 20s is saving, but not investing.
Now don't get me wrong here, saving is important.
It's very important.
Saving gives us some money to use in case of an emergency or when our investments are
down and we need money fast.
It's often better than investing when looking at the short-term simply because the markets
are volatile.
So if you're saving up for a new used car you may be better off saving than investing.
However, it's not the best solution all the time.
Financial independence and your retirement nest egg are great examples of this.
If you're going to simply save for financial independence it's going to take a lot of dough
to make it in any reasonable time frame.
For example, if John and Jane live on $40,000 a year they would need about $1,000,000 to
be considered financially independent according to the 4% rule.
If they invested $500 a month and got an average return of 8% per year on their investments
they would be financially independent in about 34 years.
However, if they were merely saving that $500 a month it would take much longer.
Let's say that they put their money into a high-yield savings account that paid 2.5%
interest.
Under those circumstances, it would take them almost 67 years to become financially independent!
So even if they had started saving at the age of 18 they wouldn't reach financial independence
until they're 85.
If you ask me that's too long.
Even if they managed to save $1,500 a month (or triple what they invested) they still
wouldn't reach financial independence as quickly.
In that case, it would take him 35 years to reach financial independence.
For the record at $1,500 a month and 8% per year in returns, they would be millionaires
in 22 years had they invested instead of saved.
So you can see how it's important to make sure that you're invested and not just saving
especially when it comes to larger and longer-term things such as financial independence.
But some people do have a tough time making the switch from saving to investing.
The solution to this I've found largely comes down to understanding yourself.
And particularly your risk tolerance.
Make sure you have a solid emergency fund that makes you feel comfortable in the event
that an emergency actually occurs.
the general rule of thumb is three to six months worth of expenses but some people do
need more in order to feel secure enough to let themselves make the full switch to investing.
And that's perfectly fine.
If you're living on $3,000 a month but even the higher end six months worth of expenses
(or $18,000) isn't enough to make you feel comfortable in the event of an emergency then
save more.
Take a little extra time and save $20,000 or $25,000 and then begin investing.
You can give yourself a double whammy positive effect by eliminating any debt you have as
that lowers the amount of money you need to spend survive every month (and gives you some
more money left over to invest when you're ready) and as a result, makes you require
less money in your emergency fund.
If that's still not enough perhaps look into some sort of umbrella insurance policies to
give you some extra protection in the event of a major catastrophe.
So those are 3 money traps to avoid in your twenties (or really any age).
Like I said this script ended up going way longer than I wanted it to so there will be
a part 2 coming next week with 4 more money traps to avoid.
If you want to see that be sure to hit the subscribe button and the bell icon so that
you’ll be notified when that video comes out.
With that being said I hope you enjoyed the video.