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Credit Karma Guide to Saving in Your 20s


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Building a solid financial foundation starts in your 20s. In this guide, we’ll provide actionable advice for how to spend less, how to save more money and how to stay debt-free. These moves will help you meet your money goals, as well as prepare you for financial surprises life may throw your way.


In your 20s, you may be entering the workforce for the first time. You’re finally earning a paycheck, but now you’ve got questions. How much should you save? How much are other people your age saving?

Or maybe you’re well on your way to establishing your career and wondering how to save money while you hit other financial milestones, such as buying a home, saving for retirement, taking a much-needed vacation or starting a family.

Your 20s are the perfect time to start laying the foundation for your financial future, and that all begins with having the right attitude about money. Many people make money mistakes when they’re young — from running up huge credit card bills to spending every dollar they make and then some. Prioritizing your financial goals and making a plan to save can help you avoid mistakes and put you on the right track.

The good news is that you’ve likely got a lot of earning years ahead of you. So whether you want to learn how to avoid mistakes or need a little help recovering from them, the simple and actionable advice in this guide will help you build good saving habits on an entry-level budget.


Establish a budget and be deliberate with your spending

Some people think “budget” is a four-letter word. That attitude is often the byproduct of a budget that is overcomplicated and difficult to maintain, so they quit updating it. But without a budget, you risk overspending on discretionary items and under-saving for big-ticket purchases and unexpected events.

Before you begin budgeting, take a few moments to think about what is important to you. What’s on your list? Is it financial independence, freedom and security? When you follow a budget based on what is truly important to you, it’s easier to remove yourself from the never-ending competition to have the best stuff and keep up with the Joneses.

Budgeting doesn’t have to involve pricey software packages or complicated spreadsheets — although if you enjoy those tools, there are some great options out there. You can create a basic budget using a pen and paper, or download one of the many templates available online.

When you start putting together your budget, make sure you’re not using an inordinate number of categories. The main reason people fail to follow a budget is because they’re often overly complicated and require tracking numerous categories. But you don’t need to count every penny if that type of budget is not going to work for you.

All you really need to do is differentiate between needs, wants and dreams.

All you really need to do is differentiate between needs, wants and dreams.Your needs include daily expenses — such as transportation and food — and recurring monthly payments such as rent, utilities, debt payments and insurance. Your wants are discretionary spending such as dining out, leisure activities and hobbies.

Your dreams are where you want to go with your life, whether that’s traveling the world, starting your own business or retiring early. After paying for your needs, set a goal to allocate a certain percentage of your income to your dreams, then check in consistently to make sure you’re staying the course. Whatever is left over can be used for your wants.

If you find that your spending habits start slipping over time, you can regroup and work on cutting costs. For example, you may be spending a considerable amount going out with friends.

Brainstorm ways you can trim your dining and entertainment budget, such as splitting meals with friends at a restaurant or hosting potluck get-togethers at one another’s homes instead of going out.

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How can I save money on groceries?

Cooking meals at home is typically cheaper than going out to eat at restaurants, but preparing seven days’ worth of meals at home can be costly too. To avoid blowing your budget on food, here are three tried-and-true methods for saving at the grocery store:

1. Plan meals based on what’s on sale at your grocery store. Many stores send a weekly mailer, or you can probably check online if it’s a bigger chain.

2. Compare price using price per ounce or pound, not just sticker price. Most stores post this information on the shelf label. Sometimes buying the larger size will get you a lower cost per ounce — which is a good deal as long as you’ll use it all up by the expiration date.

3. Take advantage of digital coupons. Couponing no longer requires scissors and envelopes. Many stores have an app that will allow you to download coupons right to your store loyalty card.

Michelle Waymire, a financial advisor and coach as well as the founder of Young + Scrappy, a specialty practice geared toward millennial and generation X clients, recommends the 50/30/20 rule of budgeting.

This simple rule says that 50% of your after-tax income should go toward needs such as housing, utilities, health insurance, gas and groceries. As much as 30% of your after-tax income should go toward wants such as shopping, trips to the salon and travel. The remaining 20% should be put to work saving for the future.

Of course, in your 20s you may be living off an entry-level salary, so in your entry-level budget, saving 20% of your after-tax income may not feel feasible. In that case, Waymire recommends starting with saving a smaller amount. You can always increase the amount later on.

No matter the amount, Waymire recommends setting up automatic transfers to a savings account as soon as your paycheck hits your account. If you’re like most savers, you won’t miss what you don’t see.

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How can I automate savings?

It’s easy to set up automatic transfers from your checking account to your savings account. To get started on your emergency savings account, log in to your bank account online and look for the “Transfers” tool. From there, you should be able to schedule automatic transfers of a set amount from checking to savings on a specified day each week or month.

Remember, the latest iPhone release and the Nordstrom fall sale don’t qualify as emergencies. If you have trouble resisting the temptation to tap your savings for non-emergency purchases, stash your money somewhere it’s just a little harder to reach — for example, you could open a savings account at another bank separate from the bank with your checking account.

 

Build an emergency fund

Saving money is essential, but where should you save it? Invest it in stocks or mutual funds? Put it in a retirement account? Before you start investing or locking your money up in a retirement account, it’s a good idea to build up an emergency fund.

An emergency fund is money set aside to cover any surprises that life may throw your way — things like unexpected medical expenses, home or car repairs, or a job loss. Without an emergency fund, such events could cause you to go into debt or force you to tap retirement assets.

Where to keep your emergency fund

Most experts recommend that your emergency fund be liquid, which means that it’s easily turned into cash.

Investments tend to be a bad option for an emergency fund. If you need the money when the market is down, you may have to sell your investment at a loss. Plus, the process of selling your securities and then transferring the cash from your brokerage account to your bank may take a few days.

Many people balk at the idea of stashing their money in a traditional savings account where they’ll earn just a fraction of a percentage point in interest. If you want to boost the returns on your safety net while still having the option of accessing the money when you need it, consider a high-yield online savings account or a money market fund.

Online banks are able to offer higher interest rates for savings accounts than traditional bricks-and-mortar banks because they have lower overhead expenses. A money market fund is a type of savings account that usually offers a higher rate of interest than a basic savings account. Keep in mind, though, that the required minimum balance may be higher.

Shop around for a high-yield savings or money market fund offering higher rates and low or no fees. In a low-interest environment, you won’t earn a ton of interest on the account. But remember, the point of an emergency fund isn’t to make money; it’s to have money available in case of an emergency.

How much to save for emergencies

Most experts recommend keeping enough money in your emergency fund to cover three to six months’ worth of living expenses. Keep in mind, that’s expenses, not income.

What does that look like?

Let’s look at a sample budget for Amanda, a 24-year old public relations assistant whose take-home pay is $2,500 per month. Her monthly living expenses are as follows.

Rent and utilities $600
Transportation $250
Food $200
Insurance $200
Student loan payments $250
Clothing, entertainment, travel & other discretionary spending $500
Saving $500
Total $2,500

 

That’s the total of her needs (rent and utilities, transportation, food, insurance and student loan payments) multiplied by three months.

Amanda doesn’t have to factor what she spends on entertainment, shopping, vacations or savings into her emergency fund because that spending would probably be cut from her budget if she lost her job or faced another financial emergency.

Saving $500 per month, it would take Amanda nine months to save three months of expenses. Once she reaches her initial goal, she can set a new goal to have six months of expenses ($9,000) saved.

While three to six months of expenses is a good starting point, Timothy Wiedman, retired associate professor of management and human resources at Doane University, says for some people, three months is simply not enough protection for something like an unexpected job loss or long-term layoff.

“Estimate how long it would likely be before a new job is found and paychecks resume,” Wiedman says. “Consider the demand for your job skills in the immediate area, the local unemployment rate, whether relocation is a realistic option and how long it took to find your last job.”

When you consider all of those factors, you may find that a job search could easily last five or six months. Unemployment benefits may help cover some expenses, but they’ll likely fall short of covering all of your recurring costs, so you’ll want to save accordingly.

Ultimately, how much you save in your emergency fund depends on your expenses, income, whether you have dependents, your insurance coverage and your ability to find work if you get laid off. The more responsibility and the more uncertainty in your situation, the more you’ll probably want to save.

Pay off debt and stay debt-free

If you’re like many Americans, you have debt. As of the third quarter of 2017, the U.S. had nearly $1.49 trillion in total outstanding student loan debt and $977 billion in revolving credit accounts, which includes credit cards and lines of credit. Once you’ve established an emergency fund, it’s time to pay down debt.

Why not pay off debt first? Because paying off debt without having an emergency fund in place is an invitation for trouble.

To illustrate, let’s go back to Amanda’s budget that we outlined above. Let’s say Amanda has outstanding student loans totaling $10,000 with an interest rate of 4%. The following table illustrates how much Amanda could save by redirecting the $500 per month she’s putting into her emergency savings and putting it toward her student loans.

Original With $500 Additional Payment Savings
Monthly payment $250/month $750/month N/A
Interest paid $750 $246 $504
Time to repayment ~3.6 years ~1.2 years ~2.4 years

 

As you can see, redirecting that $500 per month from savings to paying off student loans would help Amanda save $504 in interest and pay off her loans more than two years sooner. That’s great, right? Not if Amanda encounters a financial crisis.

If Amanda has no emergency savings and suddenly needs $1,500 to repair her car, where would that $1,500 come from? She may be able to pay less toward her student loan that month and cut out her discretionary spending, but it’s likely that Amanda would have to use a credit card to cover at least part of the repair bill.

The average APR on a credit card is much higher than Amanda’s student loan interest rate of 4%. So rather than making progress toward getting out of debt, Amanda is running the risk of getting deeper into debt. And that’s just a car repair — if Amanda lost her job with no emergency fund, not only would she be unable to pay her living expenses, but she may even default on her student loans.

Once you have an emergency fund in place, prioritize paying off debt. Although debt from car loans, student loans and credit cards is a fact of life for many young adults, letting debt accumulate can set you back for years to come in the form of higher interest payments and lower credit scores.

Tips for paying off debt

If you’ve made some missteps with debt in the past, you may be wondering where you start in getting it paid off. Here are a few tips to consider for paying off debt faster.

  • Pay more than the minimum balance. Each credit card or loan statement you receive likely includes a minimum payment amount. If you pay only the minimum each month, it could take years (and a whole lot of interest) to pay off your debt. Commit to paying more than the minimum balance. Even just a few dollars more a month can make a big difference.
  • Pay off high-interest debts first. Make a list of everything you owe, ranked from highest interest to lowest. Then make extra payments toward the debt with the highest interest rate while continuing to make at least the minimum payment on the rest of your debts. Once the first debt on your list is paid off, tackle the next one on the list.
  • Put “found money” toward your debt. If you struggle to come up with enough money to pay more than the minimum payments on your debt, commit to putting “found money” toward it. That unexpected holiday bonus at work, birthday check from Grandma or rebate check in the mail could be frittered away. Instead, put them toward getting out of debt.

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Finding a balance between paying off debt and saving is a challenge, but it can be done. Establish an emergency fund and contribute enough to your retirement plan at work to take advantage of any employer match. Then prioritize getting out of debt. You can work on increasing your savings as your debt is paid off.

Save for retirement

In your 20s, retirement seems a long way off, but it’s important to start saving early. “The earning power of compound interest is based on time,” Wiedman says, “so an initial delay can have severe consequences.”

To illustrate, here’s an example of a 23-year-old who puts $3,000 per year into a retirement account that earns a 7.8% average annual return versus waiting 20 years to begin saving, then contributing the maximum to an IRA.

23-year-old 43-year-old
Annual contribution $3,000 $5,500
Number of Years 44 24
Total contributed $132,000 $132,000
Rate of return 7.8% 7.8%
Value at retirement $1,009,275 $357,164

 

As you can see from the chart above, both the 23-year-old and the 43-year-old contribute a total of $132,000, but the power of compound interest works in the 23-year-old’s favor in a major way. The delayed start costs more than $652,000.

If you are eligible to contribute to an employer-sponsored plan such as a 401(k), 403(b) or 457(b) in which your employer provides a matching contribution, Wiedman recommends signing up immediately and contributing enough to get the maximum annual employer match.

“The employer matching contribution is essentially free money,” Wiedman says, “so not joining an available employer retirement plan, under those circumstances, is like volunteering for a pay cut!”

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How much can I contribute to my retirement accounts per year?

Knowing how much you can contribute to different retirement accounts can help you make the most of their tax advantages. Here’s a look at the limits for different types of accounts.

  • 401(k), 403(b), or 457 plans: $18,500 for 2018, up from $18,000 in 2017.
  • Traditional IRA: $5,500, but if you or your spouse are covered by a retirement plan at work, your tax deduction may be limited.
  • Roth IRA: $5,500, but you may be ineligible for Roth contributions if you make too much money. For 2018, Roth IRA contributions start to reduce for single people with income starting at $120,000 and married couples filing jointly with income starting at $189,000 per year.
  • Catch-up contributions: People age 50 and older can contribute an additional $1,000 per year to traditional or Roth IRAs, subject to the income limitations mentioned above. They can contribute up to $6,000 extra to a 401(k), 403(b) or 457(b) in 2018.
  • IRA caveat: You can contribute a total of $5,500 ($6,500 if you’re age 50 or older) to all of your IRA accounts. So if you have two accounts, one Roth and one traditional, you can still save only $5,500 between them, not $11,000.

What’s next

Your 20s are probably a time of many firsts: first “real” job, first apartment, maybe even first home, wedding and child. That’s why it’s important to make good decisions in this first decade of handling your own finances.

Make saving a priority in your 20s, even if you’re not yet able to hit the benchmarks that the experts recommend. It’s a time to build the habit of spending responsibly and saving, day in and day out. It may sound like a lot of work, but establishing good financial habits now will set you up for success later in life.

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