As we welcome summer, there are more than a few changes in the air. Now is the time when your children and grandchildren will graduate into the next phase of their lives. As young adults bid farewell to their years of schooling, it is important that they understand their new personal finance responsibilities. We recognize that gaining this knowledge can be like drinking out of a fire hose. However, we encourage young adults to take some time to consider their financial lives, so they can confidently enter their next chapter. These three areas are a good starting point…
Cash flow – It is important to get a handle on your day-to-day expenses. Those new to paying bills should consider what their cash flow might look like when these new expenses arise. It is important to prioritize fixed expenses, followed by emergency savings. Having a budget in mind can be extremely helpful. Once young adults start receiving steady income or move out for the first time, a general guideline is for 30% to go to their housing (i.e. rent, utilities, mortgage), 20% for savings, and the remaining 50% for bills, groceries, and any variable expenses. There are also many useful tools available to help track cash flow at no cost.
Career – When young adults start working for the first time, their employer will hand them an official looking tax form and tell them to enter a number 0-5. This is the federal income tax withholding form, officially known as the W-4. When they receive this, most young adults will either call their parents, or ask their friends what they should do. It is important for them to know that for each number closer to 0, their amount of tax due on April 15 will be lower and paychecks will have more tax withheld. Another form they might receive is one for a retirement savings plan. If they can afford to contribute to their 401(k) plans, do it! This will be invaluable – especially if your employer is giving you a match (who would say no to free money).
Investing – Typically, the younger a person is, the more risk they can afford because time is on their side. Over long periods of time, volatile investments, such as stocks, will grow at a faster long-term rate than less volatile investments such as bonds. Reducing risk can be done by diversifying to all areas of the market (International, Small Companies, Large Companies, etc.) and owning an appropriate amount of bonds. As those new to investing choose funds, they should look for investments that have low expense ratios (<0.80%), and whose objectives are aligned with their goals. Note that the earlier one starts to invest, the better!
As young adults transition into the “Adult World”, there are many things to think about and it may be overwhelming. By sharing these three stepping stones with them, you will help to put them on the path to success!