The right start
To a degree unseen since early in the last century, young people at the beginning of their working lives today are on their own.
Their employers will provide a paycheck, but other facets of their economic lives — facets once covered by the “fringe benefits” provided to earlier generations of workers — are increasingly in the hands of the workers. For their retirement, for their children’s college and, in a growing number of cases, even their health insurance needs, they are expected to use a combination of their own money, their employer’s money and tax benefits to build up the necessary assets.
That means investing is no longer merely an avocation of the wealthy; it is a necessity for the middle class.
A key element of investment success is time. The best way to build assets is to harness the power of compounding, and that power grows with every year it is allowed to operate.
This is good news for younger workers, who have time in abundance, but it is also a message to them to start now because every year that slips away is time, and money, lost.
Step 1 - banking
The first step toward building an investment portfolio is getting some money together, and careful choice and use of banking services can be surprisingly helpful.
You should have a checking account. Indeed, you may have to have one if your employer wants to deposit your pay electronically rather than handing you a paper check.
But you shouldn’t walk into the first bank you see and sign up. You are lending the bank your money when you make a deposit, so take a look at what it’s willing to pay you.
There are two things to look at: fees and interest rates. If you don’t have a lot of money, no-fee services might be worth more than interest.
Some institutions offer interest-bearing checking accounts, but often they have requirements, such as high balances, that might not suit young workers.
An exception in today’s marketplace seems to be online banks, which operate over the Internet and have few if any branches. Some of these ask only that you sign up for direct deposit of your paycheck. However, getting cash without incurring an ATM fee might be tough, and if you sometimes get paper checks, you might have to deposit them by mail.
Another approach is to find a conventional bank with free online service and then set up savings and checking accounts.
Step 2 – 401(k)s
It might be tough for a twentysomething to focus on retirement, but the brave new world of do-it-yourself retirement plans requires you to.
Many of you will be offered a 401(k) retirement plan at work, and you must, must, sign up. There are tax advantages and maybe free money, so don’t miss out.
The rules for a 401(k) plan are these: Start contributing immediately, contribute at least enough to get your employer’s full matching contribution if there is one, pick an investment option that matches your time horizon, keep contributing all your working life, and leave the money in the plan or an individual retirement account until you retire.
This is easy to say, not so easy to do.
The concept of 401(k)s is simple: When you sign up, you agree to have a certain amount of money taken out of your pay and invested in a mutual fund or other option that you choose from a menu provided by the employer. The money is taken from your pay before your taxable income is calculated — this is called “pre-tax,” and it’s similar to a deduction in that the dollars are not counted in the amount you pay income tax on each year.
The employer typically will also contribute something, usually an amount that matches your contribution up to a certain ceiling. Once in your account, the money and any investment earnings are tax-free until you start drawing on the account in retirement.
Some companies might sign you up automatically and choose an investment for you unless you decide otherwise. Don’t let inertia be your decision-maker. Find out which options your plan offers, and make a conscious choice. And don’t be paralyzed by the choices you have — getting in and getting going is key, even if you don’t pick the best fund.
Don’t be excessively cautious. You are young and have time to ride the ups and down of the stock market; over the long run, stocks have done better than other classes of investments. So at your age, you should consider mutual funds that are predominantly or entirely in stocks.
Step 3 – a budget
The next step is getting a handle on other financial things you might do.
In fact, this is a good time to set up a budget, at least a rough one, so you can measure your fixed expenses, such as rent, food and any loans you are or will be paying, against your take-home pay.
Sad to say, almost every graduate of college or professional school enters the workaday world with student loans, and many also are carrying credit card debt. Young workers in this situation should set themselves two goals: first, to minimize the cost of these debts, and second, to get rid of them entirely.
Student borrowers whose loans are part of various government programs have a number of payment options. One worth considering right now is consolidating your loans to lock in today’s relatively low rate. Rates are expected to jump sharply on July 1, so you should start looking into this issue now. If you’re having trouble figuring all this out, talk to people in your school’s financial aid office and to your lender.
There are also tax benefits for higher-education costs, including a deduction for student loan interest, that you might be eligible for. Don’t miss out on these.
Credit card loans — and that’s what any unpaid balance is — are expensive. Not only are rates high, but the interest is not tax-deductible.
If you’re struggling, here are some things that might help:
•Cut your spending. If you can’t pay for it now, don’t buy it. It’s the first law of holes: When you find yourself in one, stop digging.
•Start paying attention to the solicitations you’re probably getting. Six months interest-free? Move your balance. At the end of six months, do it again. But this is a stopgap tactic and could hurt your credit score if you do it more than once or twice. Use the time it buys you to make payments that reduce the balance.
•Make more than the minimum payment every month. You want to see your balance stop rising and then start to fall. Credit card companies love nothing so much as a debtor who never defaults but never manages to pay off. That’s their idea of a money machine.
Step 4 – medical insurance
The buzzword in medical insurance these days is “consumer-driven,” meaning that workers should be given better incentives to reduce their medical spending.
To do this, some companies are offering the combination of a high-deductible insurance policy and a tax-free “health savings account” (HSA) or “health reimbursement account” (HRA) in which the worker and or the company places funds to pay health-care costs not covered by the insurance. HRAs are entirely company-funded and more restrictive, but HSAs, which can be funded by the employee, the employer or both.