By Rachael Everly
We all know that old saying: “Being poor is having too much month at the end of your money.” How is it that some people always have the money to meet their financial obligations (and then some!), while some of us are always struggling to get through those last two weeks of the month?
You might think it has to do with the size of one’s paycheck, but the truth is, good cash flow has a lot more to do with effective financial management and planning than with earning a lot. Not that earning in spades doesn’t help—of course it does. But almost all of us can conquer instability in our personal finances if we know how to go about it.
Whether you’re in your mid-twenties or early thirties, if you haven’t begun to plan your personal finances, you’re going to have a hard time managing your financial affairs in the coming years. Here are five things about personal finance that all of us should be aware of:
1. It’s important to keep careful records
You might think record-keeping is for big-name companies and medium enterprises. However, the first step to effective financial management for anyone is to have a documented account of earnings vs. spending. Make sure you know how much you earn and what your expenses and debts are.
If you’re graduating with a student loan or have just graduated, you will likely have a 6-month grace period before your repayment schedule kicks in. This is the point when most students call their financial intermediary and ask how much they owe—don’t be that person! Whether you want to restructure your student loan or decide how much to set aside for that vacation next year, understand what your essential expenditures and foreseeable debts will be in the next 1-, 2-, and 5-year periods. Document them, whether in a notebook or with software like Excel; you might be tempted to think you can remember all that detail, but that’s a lot easier said than done. Check out Investopedia’s recommendations for the best budgeting software for 2020.
Once you understand your personal financial situation, you will have far more clarity on what next steps you need to take.
2. Don’t underestimate the time value of money
Perhaps the most fundamental concept of the modern financial system, “time value” is not just a concept for investment bankers and finance gurus. Essentially, time value means that ever $1 you have today is worth more than $1 you will have in the future.
Why is that? Because any amount of money you have today can be invested to earn interest or profit; the longer this amount contributes to an investment, the more money it will earn. Understanding the time value of money will allow you to maximize your income in the long run. At a 10% rate of interest, if you save $100 today, you will have $259 in the next 10 years.
3. It’s important to start saving early
Going from $100 to $259 in 10 years does not seem that great a difference, and indeed, with small numbers and small time periods, the time value of money is not all that impressive. But the larger both the amount and the time period, the larger the amount you’ll earn without lifting a finger.
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This is especially important for those people in their twenties and thirties—the earlier you start saving, the greater the payoffs of your sacrifice. Consider this: Assuming a 10% fixed interest rate, $1,000 invested today will be worth $6,727 in 20 years, $17,449 in 30 years, and $45,259 in 40 years. That’s over a $38,000 difference between the first and last amounts! Bottom line? Don’t think short-term; the long run is where the money’s at.
4. Take advantage of a good retirement plan
Saving early sounds like a great plan, but once you get down to it, what are your options? One great option is to see whether your employer offers a tax-advantaged retirement plan. Most employers offer a 401(k), which is a tax-qualified plan based on the matching principle. Your employer will match the amount you save, putting in a dollar for each dollar you save through the account.
However, even if you don’t have access to a 401(k), you can still leverage products such as the Roth Individual Retirement Agreement (Roth IRA), a retirement plan that provides you a tax break on the money you withdraw.
5. Don’t shy away from the stock market
A 2018 Gallup poll found that only 37% of adults under 35 invest in the stock market. This means that over 60% of adults between 18 and 35 are missing out on the benefits of having a long-term stock investment horizon—including earning interest on interest and being able to weather economic downturns.
While stocks can go up and down like crazy in the short run, in the long term, speculation and volatility tend to cancel out to zero. What does this mean in layman terms? If you start saving early, your average return on the stock market will be positive. In the long run, you’ll make a lot more than you’ll lose.
One question that boggles most potential savers is, Where to start? Not everyone has enough will or time to learn about which stocks to purchase, or to follow the financial progress of the companies they’ve invested in.
One solution to this problem is to invest in an index fund. An index fund is a mutual fund constructed to match or track a market index, such as Standard & Poor’s 500. Essentially, an index fund purchases all sorts of stocks on the market in fixed ratios, resulting in a performance that is reflective of the market as a whole. Added benefits? Because index funds have no active management, the fees they charge are also low, so you get to keep more of your earnings than you would with an actively managed mutual fund.
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