Spending too much money today to fund your lifestyle at the expense of your retirement savings is not unlike living off the money from a jewellery store heist in Grand Theft Auto. Most millennials have participated in at least one heist in this popular video game. But the video game’s characters are continually returning to thieving to pay off debt or replenish funds.
When investment managers warn you that you are living off of your future savings, they are referring to this cycle of spending beyond what you can afford. Ultimately, you may end up using one credit card to pay off another, taking out a second mortgage on your house, or cashing in a retirement savings plan early. Alternatively, if you lower your spending and save more money, the savings will benefit from compound interest and be worth a lot more in your future. $100 saved today could pay for 10 years of vacations in your retirement days.
There’s a better way than stealing from your future – budget, save, invest and retire comfortably. Here’s a four-step millennial guide to personal finance.
- Start With a Budget
Millennials are becoming good savers. A budget can help you sock away even more. A budget is a useful tool for itemizing, evaluating and prioritising your spending. Make a list of your income and expenses. Many apps are available to help you develop a budget, or create one in Excel so you can easily add up the items. An app such as Mint provides helpful features, such as budget templates, alerts, and tips for reducing expenses.
Your budget can be adjusted to meet different goals, including:
– identifying and reduce overspending
– meeting financial goals
– budgeting for new expenses (a gym membership, car lease, university course, or other goal)
– allocating money to unexpected/emergency bills
A major goal of most budgets is savings. You may have heard of the 50/20/30 rule of thumb, which recommends allocating your take home pay as follows:
– up to 50% for essential expenses (housing, utilities, groceries, transportation)
– at least 20% to financial priorities (savings, retirement contributions, debt payments)
– up to 30% for lifestyle expenses (entertainment, smartphone plan, gym, and so on)
An emergency fund should fall under essential expenses. This will provide a financial cushion should you unexpectedly lose your job or have a medical emergency.
- Establish a Credit Rating
Without a credit history, you may be turned down for an unsecured credit card. Your next option is to apply for a secured credit card. Your credit availability will be limited to the amount of funds you place on the card, minus any fees charged. By making regular payments on time, you will be able to establish a credit rating. If you have a credit score, or are not sure, you can request a copy of your credit report.
In Singapore, for example, you would contact the Credit Bureau Singapore. It is not unheard for an incorrect record to be on a credit report. For example, a bill you paid off may have inadvertently been recorded as unpaid. In these cases, you can write to the credit reporting agency and have the incorrect charge removed. Establishing a good credit rating will allow you to borrow funds at a lower interest rate in the future.
- Pay Down Debt
Millennials have more debt than Generation X or baby boomers. Many financial advisors will recommend taking a balanced approach to paying down debt and saving for retirement. The sooner you pay down debt the better. The interest earned on savings accounts is in the low single digits, while the interest paid on debt is often in the double digits. This is an example of stealing from your future.
Let’s say you stop using your credit cards and eliminate interest payments of $200 a year. You place the $200 saved in the first year in a savings account. In 40 years when you plan to retire, that money could grow to be worth more than $20,000.
If you cannot immediately pay off the debt, consider consolidating the debt. The interest rate on a bank loan, for example, will be considerably lower than what you are paying on credit cards. If you do not yet have an emergency fund, then establishing one should be a priority. You may then decide to allocate more money to your debt. For regular bills, automatic direct debit can ensure bills are paid on time, late fees and interest avoided for late payments, and your credit rating is protected.
- Save for Retirement
While millennials are busy travelling and enjoying life, the delay in retirement savings for a few years could amount to a small jewellery heist when you are 65. Consider the time value of money and inflation. The time value of money is the concept that a dollar saved today is worth more than a dollar saved in the future owing to a compound interest rate.
Let’s say you are 20 and decide to start saving for retirement. $100 invested in a savings account today will be worth about $5000 in 20 years. Instead, you decide to enjoy a long holiday each year while you are young and wait 20 years to invest the $100. In 20 years, that same $100 will be worth the face value of $100 minus inflation, which is 3% a year on average. The inflation rate reflects the value of a dollar based on its purchasing power. In the 1950s, $100 was one week’s salary.
Once you have made up your mind to save for retirement today, you will want to understand what investments are right for you.
Understand your risk profile – Markets move up and down. These prices swings are called volatility. What percent of your portfolio can you afford to lose if prices swing down – 10%, 20%? Most financial services firms provide a free online risk assessment tool and many will generate a model investment portfolio for you.
Determine when you will need the money – Your time horizon will help you determine how much money you need to put away each month to meet your retirement savings goals. Owing to the time value of money, this amount will differ if you are retiring in 20 years or 40 years.
Develop your asset allocation – If you are young, you can hold more in stocks than bonds. Popular target-date funds gradually shift the weighting of your portfolio from stocks to bonds as you age. HSBC provides a helpful risk rating of different asset classes. For example, a China equity fund is rated very high risk at 5, whereas a Euro fund has a low risk at 2. An Asian bond fund, rated 3, could give a young investor some extra upside potential with manageable risk through diversification.
Bonds offer a large choice of low risk funds but a number of countries are rated a 5, such as Greece, which has yet to solve its debt crisis. Your portfolio should be a mix of fixed income and equity instruments, cash, and some shorter-dated liquid savings investments.
Start your budget and retirement savings plans today and you will not have to steal from your future. Following the simple steps in this millennial guide to personal finance will help you build personal wealth. You can leave the risky heists to the avatars.
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