When we’re in our 20s it’s easy to make these big investment mistakes, but it’s the perfect time to fix them.
By Qiana Chavaia, Wall St. Cheat Sheet
Young people often suffer delusions of immortality, and one day realize they’re under prepared for the realities of age. Naivety and ignorance make them squander time and resources. They tend to ignore personal finances, even though poor financial decisions in your 20s can have a significant impact on the quality of your life, and require sacrifices down the road.
Rising debt among America’s young adult population has become a burgeoning issue. Some speculate it will have a negative impact on the future U.S. economy, and several studies have linked mental and physical illness in young adults to surmounting debt. Young adults with student loans have been said to feel like they are “drowning in debt.”
According to Senior Research Associate Laura Choi of the Federal Reserve Bank of San Francisco, through her research that examines the effects of the recession on individual health in a report entitled Financial Stress and Its Physical Effects On Individuals and Communities, it can be concluded that the correlation between debt and health related concerns is real.
It’s never too early to start taking your finances seriously. Start by avoiding the top five investment mistakes people make in their 20s.
1. Spending All You Earn
As a general rule of thumb, your income should be divided into a pool of baskets with 65-70 percent allocated to living expenses, 15 percent to retirement savings, and 15 percent leisure.
2. Not Taking Advantage of 401(k) Matching
Most employers offer an employer-sponsored 401(k) plan. Contributions are made pre-tax, which can lower your income tax bracket and many employers will match 100 percent of your contributions up to 6 percent of your salary. If you earn $42,000 a year and take full advantage of its benefits, your annual contribution of $2,520 will double to $5,040 after your employer’s contribution.
3. Failing To Open a Roth IRA
In addition to an employer-sponsored 401(k) plan, you can open a Roth IRA. The current annual contribution limit is $5,500. IRAs are tax advantageous because after the age of 59½, distributions can be made tax-free. This is a great place to stash your savings from income if you know you will not need the money within the next five years. Distributions before the five-year wait period are subject to penalty unless it is for a qualifying life event, such as using $10,000 for a first-time purchase or to pay individual medical expenses.
4. Using Credit Card Debt
Using credit card debt to finance purchases just does not make sense. It will cost you more. As long as a balance remains on your account, interest will be assessed and accrue until it is paid off—forcing you further you into debt, which brings us to the importance of setting up a rainy day fund.
5. Failing to Set Up a Rainy Day Fund
Start building your rainy day fund or emergency fund for unforeseen expenses or in the event you lose your job or suffer a disability. You want to have enough savings to cover at least 3-6 months of living expenses. Try to set aside as many months as you can, and these funds should remain liquid. A safe place to keep them would be in a low-volatility money market account.