- Start investing with your employer plan now
If your employer offers a 401(k) plan, sign up now and contribute as much as you can. These contributions are made pre-tax, meaning they lower your taxable income for the year. If your company offers a match, be sure to at least save as much as you can to meet the full match, too. That’s literally getting free money! Whether you invest through your employer only or have an individual account on the side, designate a certain amount of money to be automatically deducted from your paycheck and invested each pay period. You won’t miss what you don’t see in the first place.
2. Understand the power of time and compound interest
When it comes to investing, time is one of your greatest allies. When time joins forces with compound interest, your account value grows dramatically. Think of compounding as getting a return on your return.
For example:
• A 25-year-old who wants a $1 million nest egg at age 60 would need to invest $880.21 each month (assuming a constant return of 5%).
• If that 25-year-old waits 10 years to start investing, he would need to invest $1,679.23 each month using the same assumptions.
• Waiting 20 years means that 45-year-old would need to invest $3,741.27 each month to accumulate the same $1 million by age 60.
The only difference between these three scenarios is the impact of compound interest. It can make a huge difference between retiring comfortably and not.
3. Prepare for the unexpected with an emergency fund
Preparation is key for financial wellness. An emergency fund sounds great in theory, but how do you make it happen? Start by gathering your bills and expenses to figure out about how much money you spend each month. A general rule of thumb for an emergency fund is to save enough to cover six months’ worth of expenses. Next, you will want to open an account. An emergency fund should be stored in an accessible account, but somewhere that doesn’t tempt you to make spur-of-the-moment withdrawals. (For example: A high-yield savings account rather than your checking account.) Lastly, start small. If the thought of coming up with thousands of dollars is overwhelming, concentrate on getting that first thousand under your belt by chipping away at smaller but consistent monthly contributions. Treat this fund like a monthly bill. Make “emergency savings” part of your budget and put money into it every month, just like you do your rent, car payment, or credit cards. If you follow the steps, building an emergency fund should become second nature.
4. Use credit responsibly
There are different philosophies on whether or not debt is a good idea. If you do choose to use credit, make sure that you do so responsibly. Certain types of debt can increase your net worth or have future value, such as a mortgage or student loan. Just be sure that with any debt you take on, you are able to pay the monthly bill without it impacting your other financial needs. A good rule of thumb is to pay credit cards off in full each month, rather than allowing purchases to carry over to the next month, which incurs interest. Waiting until you have enough cash to purchase an item is a better strategy than rolling a credit card payment to the next month. Another thing to keep in mind is that a debt-to-income ratio higher than 43% can be a red flag to investors. Determine yours by taking your total monthly debt payments and dividing that by your monthly gross income. Don’t forget to check your credit score frequently. Visit www.annualcreditreport.com to get free reports from the three top credit reporting agencies. Choose a different report every four months to keep an eye on your credit for free throughout the year.
5. Know the time value of your money
Let’s say you earn $20 an hour, and you’re eyeing a $1,000 television. You figure you’ll spend 50 hours at work — more than six days — earning the money to make the purchase, right? Not so fast. What about income taxes? When you earn $20 an hour, you don’t bring home $20 an hour. If you’re in the 25% tax bracket, you would spend about 66 hours — more than eight days — earning the income required to buy the television. The question then becomes: Is the pricey TV still worth it? That’s up to you, but using this calculation helps you make an informed decision based on facts. If you’re considering a large purchase, figuring out how much of your valuable time you’ll be investing in the item can help you add more value to what you buy. It can be motivate you to look for deals and help you decide how much you actually want to spend on an item.
While there can be obstacles on the road to financial prosperity, there are also many rewards. Developing good financial habits early can reap great benefits later.
Investment and insurance products and services are offered through Osaic Institutions, Inc., Member FINRA/ SIPC. Chelsea Groton Financial Services is a trade name of Chelsea Groton Bank. Osaic Institutions and Chelsea Groton Bank are not affiliated. Products and services made available through Osaic Institutions are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value.
