Building your financial future, one step at a time
By Tanya Ishikawa
The most common financial mistake young adults fall into is spending more than they earn. According to Certified Financial Planner Colleen A. Askew, overspending also happens to be the biggest mistake of the middle-aged, old and very old.
“The wisdom of spending less than you make is so, so obvious, but it is much harder to do in real life, particularly when you are in your early 20s and you are used to the lifestyle of your parents,” says Askew, who is president of Knopinski & Fauver Financial Advisors in Louisville. “If you start with an assumption that you will maintain the same lifestyle and you think somehow the money will be there, then you usually end up in debt. It really is a big transition. It’s hard, but if you can form that habit of spending less than you make, everything else falls into place.”
A financial advisor for 18 years, Askew often works with multiple generations of families to plan for overall family financial health and saving for life transitions, including retirement. The only way to know whether you are spending less or more than you make, she says, is to track income and expenses. She helps clients see that having multiple bank accounts, lines of credit, debit cards and credit cards can make budgeting cumbersome.
“All of a sudden you really don’t know what you have, so sometimes we have to start with structure and get rid of extra accounts,” she says. “You have to set it up so you really do know: This much comes in per month or per year, and this much goes out.”
Young adults usually have a longer list of uses for every dollar than their parents or grandparents, who tend to be more focused on retirement. From paying off student loans to funding grad school or buying a first home, deciding how to plan for each goal can be very confusing, Askew says. Above all, avoiding large, long-term debt appears to be the key to future financial stability. Otherwise, she warns, the debt can become the driver of the rest of your life choices.
When to start saving
After pinpointing your real financial situation, the secondary goal of budgeting is to know how much you can set aside as savings. You’ll need savings to avoid debt on future purchases that don’t fit into the usual budget, and to pay for expenses if your income declines or stops altogether.
Perhaps Gen Y-ers don’t focus on savings because the most commonly advertised savings plans are tailored to retirement and to college funds for children, both of which seem unimaginably distant. However, savings are important in the shorter term to create a cash reserve for emergency expenses when the car breaks down, someone gets sick or injured, or your uninsured computer drowns in a flooded basement apartment. Savings are also the most financially efficient way to pay for planned large expenses like buying a house, starting a business, getting married, having children, going back to school or traveling.
“Most people know that saving earlier is better than saving later,” Askew says, “and most young people are well aware of the effects of compounding. But again, when there are so many places for every dollar, it’s very hard to be able to carve out that piece that will go [to your] retirement.”
Investing money from their savings is also not something that comes naturally to most young people, or something they want to spend time on, the financial advisor observes. For example, knowing the difference between a Roth IRA and a regular IRA can be important when you’re saving for retirement, but matters less when you’re young. “You don’t have to know everything all at once, or you’ll get this overwhelming ‘I can’t learn all of it so I won’t learn any of it’ kind of feeling.” Askew says. “You can get through life without understanding investment terms completely, but you can’t get through life with successful finances unless you start saving for retirement to begin with. When you’re in your 20s and 30s, knowing how to plan for your financial future can be daunting. It’s better to simplify, focus on the basics and just take it one step at a time.
“The one thing you know is that things will change,” she concludes. “Nobody in their early to mid-20s knows exactly how their life is going to go. So they need to have the flexibility in their budget to be able to make decisions as things change.”
Tanya Ishikawa is a 1989 CU journalism graduate who has written mainly about education, government and culture. Her financial writing began with a fellowship to attend the National Press Foundation’s Retirement Issues seminar in Washington, D.C., in 2010.
How to Feather Your Financial Nest
1. Budget. Calculate what you earn and what you spend, and make a plan to keep income and spending balanced. Track it daily, weekly or monthly to ensure you are achieving your goals.
2. Save. Include savings in your budget from the start. You will need to have money readily available for unexpected emergency expenses, as well as money accumulating for large planned expenses like buying a car or retiring. The earlier you start earning interest, even on small amounts, the better off you will be later.
3. Invest. Divide savings into the kinds of investments that give you the flexibility to use them as you intend while accumulating the most interest. Savings for expenses within five or 10 years should go into more-liquid, less-risky investments. Savings for retirement can be in investments that are more volatile but have higher long-term gains.
4. Stay out of debt. Don’t spend more than you make; the interest payments can kill you. When cutting discretionary expenses is not enough to avoid debt, take another job, get a roommate, sell your belongings, or find other ways to increase the income side of your equation.