Personal Finance: A Smart Start

Courtesy from Personal Finance: A Smart Start
By Emily Schmitt

Common-Sense Advice
It can be hard for young adults to get a handle on their personal finances, and there can be some painful lessons along the way. That's where a little common sense can work wonders. BusinessWeek asked Ramit Sethi, author of I Will Teach You to be Rich, for 10 smart ideas for those setting out on life's financial journey.

1. Consumer Debt

One of the most important things a twentysomething can do is pay off debt as soon as possible. Sethi outlines ways to streamline this process, like asking for a lower APR on your credit cards. Not all card companies will bite, but this step could significantly reduce the amount of money you owe. You may also want to prioritize your cards, making larger payments on higher-interest debt.

2. Bank Smarter

Sethi's advice: Try to avoid monthly fees, and look for accounts with a decent interest rate on deposits. Sethi says all students should have accounts with no fees and no minimums, adding that most big banks offer this for student or direct-deposit accounts. If you find yourself in an account that charges fees, he suggests calling the bank to negotiate out of them.

Sethi is a fan of online accounts, like those featured by ING Direct and Emigrant Direct, because of their higher interest rates.

3. Invest Now

There is no better time than now for twentysomethings to start investing, says Sethi, even if it's just $50. Why? Two reasons. First, most Gen-Y'ers have no dependents, so there's limited downside to losing money. Plus, the stock market remains relatively cheap even after its recent big gains.

In his book, Sethi points out that if you invest just $10 a week at an average of 8% return, you'll have $8,136 in ten years. "Paying off debt isn't enough. You actually have to get ahead by investing aggressively in your twenties," says Sethi.

4. Spend Wisely

The goal isn't to stop spending money but to spend it wisely. Sethi calls this approach conscious spending, and says it's something all twentysomethings should be doing. "I'm not the guy who says don't spend $3.50 on lattes, or $250 on jeans. Spend extravagantly on the things you love, but cut mercilessly on things you don't," says Sethi. He gives the example of his friend who adores shoes but is rarely home. She spends more of her disposable income on shoes but lives in a tiny room. In this way, she's prioritized her money to spend more on what matters to her and less on what doesn't.

5. Saving Strategies

It's important to save, but if you're not doing it wisely you could erase any gains you made. Sethi says a lot of twentysomethings have "should accounts": they know they should be saving so they open an account, but as soon as they want to buy something, they dip into their savings for the purchase. To avoid this, Sethi recommends saving for a near-term goal. This could mean setting up an account for a wedding, a down payment on a house, or a vacation. The point is, if you have a specific reason for saving, you're less likely to touch the money.

6. Student Loans

Sethi says there are two approaches to consider when making your payments. First, there's the technical approach. This works best if you have a very low interest rate on your loans. Because your rate is low, you can afford to pay only the minimum amount on your loans and put the rest of your money toward other, higher-yielding investments.

Then there's what he calls the emotional approach. This is best for those that absolutely hate being in debt. The goal is to pay it off as soon as possible by making more than the minimum payment each month. Once your loans are paid off, you can redirect that extra money to your investments.

7. Retirement

It may seem a long way off, but the sooner you start saving for retirement, the more comfortable your post-work lifestyle will be. Sethi outlines two popular investment vehicles: 401(k) and IRA. If your company offers a 401(k), sign up. If your company offers a 401(k) match, contribute the amount needed to receive it, since you're getting free money. If not, keep the account open but wait to contribute to it until you have your debt paid off, he says. In the meantime, you can set up a Roth IRA to save for retirement.

Sethi prefers Roth IRAs for two reasons: (1) you can invest in anything you want; (2) you contribute after-tax dollars and don't pay taxes on the money you withdraw. This is great for young people who expect their tax levels to rise in the future.

8. Salary Negotiations

For those just entering the work force, Sethi says that the best time to negotiate a salary increase is when you get hired, not after. He says a successful negotiation is more about mindset than tactics. Tell the hiring manager the ways that you can help her company—the value you can add—rather than drone on about your academic accomplishments.

Once you receive a raise, don't be in a hurry to spend the money. Think of the pay hike as a way to boost your savings or pay down debt faster, not a ticket to a fancier lifestyle.

9. DIY Investing

It's easy to buy into the allure of financial advisers, but Sethi says the cost of their services is too much for the pay-off received. He says most twenty-somethings are making such simple investments that paying for expert help is pointless. What's more, he points out that mutual funds are a bad investment because the money earned is eroded by the fees paid. Instead, Sethi recommends lifecycle funds because they are low-cost and rebalance your allocations as you age. "Most people think they'll rebalance their funds, so they may want to buy index funds, but most don't," he says.

10. Financial Check-Ups

Sethi suggests that once you choose your investments, set up systems so that money is automatically redirected to your investment accounts. Make it easy to check up on your various accounts, so that you can ensure that your portfolio reflects your strategy and long-term goals.

Sethi has one more piece of advice. Only sell your investments under three circumstances: (1) you need the money for an emergency; (2) you want to get rid of a bad investment that continues to underperform; or (3) you've reached your investing goal.


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