This is part three of a four part series on personal finance basics. Parts one and two are linked, but not required to read this post.
The story of a mid-20s millennial burdened with student loan debt, still living at home, is so oft-repeated that it has risen to some level beyond cliche. However, living through the 2008 recession has also left this generation in a more mindful state, conscientious of the risks of investing.
While developing a fancy investment strategy sounds fun to some, it is more important that your 20s are spent focusing on the fundamentals. Setting yourself up for success means paying off debt and learning how to budget. Practicing this delayed gratification will be hard at first, but will become easier as it develops into habit.
Paying Down Debt
There are a number of personal finance coaches who espouse the notion of “good debt” and “bad debt”. Good debt has a low interest rate and was used to buy an asset of value, that could appreciate over time (think of a mortgage for a house). Bad debt has high interest rates and might have been used to buy a depreciating asset (think credit card debt or car loans).
The reality is all debt is a limiting force that inhibits you from seizing new opportunities.
You are working at a medium sized corporation and your friend approaches you with an offer to join her fast-growing startup. You’d take a 50% pay cut, but get significant equity and the chance to take on a lot more responsibility. You’d love the experience, but your large monthly mortgage and car payments mean you’d barely have money for food and gas.
These large immovable payments are known as “golden handcuffs”. Don't let them slip on.
Your 20s are a time to be humble and thrifty. Just as it’s a bit obnoxious to think that you’ll be in the c-suite by 26, you shouldn’t be trying to live a lifestyle of someone who’s made it.
Quite the opposite in fact. The more money you can sink into you student loans and credit card debt, the less interest you’ll end up paying to the lenders you borrowed from.
Paying down the principal of your loans aggressively will afford you the flexibility and options to make real choices as you get promotions and raises.
Start with your highest interest debt and work your way down (don’t ever forget to make minimum payments on everything). As you pay off debts, it will snowball as you have more cash flow to aim at fewer targets.
Restrictions as a Path to Freedom (aka Budgeting)
Most people live like this:
Income - Consumption = Saving & Payments
Budgeting maestros flip the script to something better:
Income - Saving & Payments = Consumption
What does this actually mean?
Most people live their lives feeling guilty because they spend first and save second. Whatever is left over at the end of the month gets pushed into savings, fluctuating significantly month to month.
Along with being inefficient, this is a more mentally taxing system of saving. Each purchase is accompanied by a small (or large) pang of guilt, because you see each dollar spent as savings lost.
When you save first, by automating your monthly savings, you actually release yourself of guilt, knowing that you can spend whatever’s left, because the saving has already been done.
So how can you make this automation a reality?
Through your direct deposit preferences or your bank’s online services; you can select a percentage or fixed dollar amount to be regularly moved into specific accounts.
Allocating a specific amount to savings and debt repayment allows you to enjoy the rest of the money that’s leftover, guilt-free.
Automating your loan repayment means you’ll never miss a payment, and can sometimes get your interest rate reduced slightly.
Mint - One stop shop for budgeting and getting a full picture of your finances
Mr. Money Mustache - Blog with a cult-following where you can get a “personal finance PHD”
Budget Simple - Another, more simplified budgeting tool
This is part three of a four part series on personal finance fundamentals. Check out part one and two if you missed them.
If you want to support this blog, buy your Amazon products through this link.