When you first enter the real world, it can be scary. For all you learned in high school or college, many of us are left feeling unprepared for the responsibilities that come with setting out on your own. This can be particularly true when it comes to managing your finances.
Learning personal finance
as an adult doesn't have to
be scary–in fact, it can be
liberating. When you learn
how to manage your money,
you tend to feel more in
control of your life.
The fact is, very few Americans get the financial education they need in school, so many are left to figure it out on their own. In 2002, just four states required that personal finance education be offered to high school students, according to data collected by the Council on Economic Education, a non-profit group that has promoted children's financial education for more than two decades.
Since then, the numbers have improved. In 2007, the number of states requiring high school-level personal finance education increased to nine, and in 2016, it was up to 22. However, that doesn't help those who were out of high school before a personal finance education was implemented, or who were in a state that didn't have a program at all.
Learning personal finance as an adult doesn't have to be scary—in fact, it can be liberating. When you learn how to manage your money, you tend to feel more in control of your life.
If you are just getting started on your journey as an adult (or even if you are a few years in and need to level-set), here are five things I wish I knew about managing my finances when I first embarked in the real world.
Understand Compound Interest
The most important thing to understand as an adult is something called compound interest. Compound interest can either be your best friend when it is working in your favor (think retirement savings accounts) or your worst enemy if it is working against you (think credit card debt).
You either can earn interest in savings accounts or on other investments or you can owe interest on any sort of debt you carry. That interest becomes compound interest when it is added to your balance and included in future interest calculations.
An easy example of compound interest working in your favor is when you have a savings account at a bank that earns interest. Say you have $1,000 in a savings account earning 5 percent interest annually (hard to find these days, we know, although rates have begun to rise again). In month one, you would earn $4.17 in interest on the $1,000 in the account. But in month two, you would earn interest on $1,004.17, so the next month you would earn $4.18 in interest.
That may not seem like a big difference, but over time, it can really add up. If you didn't touch that account for 10 years—you didn't deposit any additional money or take any money out—and the interest rate stayed constant, you would end up with $1,647 without lifting a finger! Even if your account paid 1 percent interest annually (closer to today's national average), you would have $1,105, and with 2 percent, $1,121.
Unfortunately, the same principle applies to most of your debt like student loans, mortgages and unpaid credit card balances. The balance you don't pay off each month will accrue interest and increase your balance, so you pay interest on this higher balance each time. To make matters worse, credit cards generally have significantly higher interest rates than savings accounts. In fact, in June 2018, the national average annual percentage rate (APR) hit a record high of 16.75 percent. That means unpaid credit card balances can quickly spiral out of control.
To learn more about how you can use compound interest to your advantage, check out The Time Is Now: The True Value of Time for Young Investors.
Take Inventory—and Set Goals
What are you making (after taxes)? What are your expenses? Is there anything unnecessary in those expenses? How do your expenses compare to how much money you have coming in every month? You need to ask yourself these questions—and more—to truly get started on the road to managing your money like an adult.
Use this information to set up a realistic spending plan. But don't stop there. Set goals. Setting goals helps you to stay focused on saving and gives meaning to the dollars you put away (or to the luxuries you skip) to make your goal a reality.
Some goals will take longer to achieve than others, which is why it is good to set some short-term goals. If you are only focusing on saving for events far in the future, like retirement, your long-term goals can begin to feel overwhelming. Your short-term goals can help you stay on track toward achieving those goals that are further down the road.
What are some good short-term goals? If you have high interest debt like credit card debt, make paying that down a priority (see the bit about compounding interest above).
Set Up Your 401(k) or IRA
When you start your first full-time job, there are plenty of outlays vying for a piece of your new paycheck. You might have student loans to pay, an emergency fund to save for and new furniture to buy for your new apartment. You might think it's impossible, or unnecessary, to set some money aside for retirement now. Let's be honest, it's decades away and you are just getting started.
But that's no excuse. Wrong. You need those decades to build up a retirement income you can actually live on, and the earlier you start, the better off you will be. Many employers offer a 401(k) and it is a great way to get started without having to do too much heavy lifting. A rough real-world estimate of how much you should put aside—at last 10 percent.
Many employers also match an employee's 401(k) contributions up to a certain percent of salary. If you contribute at or beyond that threshold, you take full advantage of the benefit. But if you contribute less than your employer is willing to match, you may be passing up free money. Unfortunately, many people do miss out. Americans leave billions of dollars in 401(k) company matches on the table each year.
But investing in a 401(k) can have other benefits as well, including tax advantages that are worth a second look. Check out Retirement Isn't Free—But Your 401(k) Match Is for more information.
Don't Ignore An Emergency Fund
When I first graduated, I set up my 401(k) and contributed enough to get the full match, but then I was putting everything I could into my student loan payments. It wasn't until I had a meltdown after receiving a larger-than-expected medical bill that I came to appreciate the importance of an emergency fund.
There will always be large, unexpected expenses in life, whether it is a medical bill, a flat tire, a family emergency that requires a flight home or something else unexpected. An emergency fund prepares you for that inevitability and allows you to tackle the challenge without resorting to your credit card (see above about how quickly compound interest can come to hurt with credit card debt).
Ideally, an emergency fund should be big enough to cover three to six months' worth of expenses, but you can start small—even a few hundred dollars can help give you a buffer as you get started.
Related: Start Your Financial Road Trip With an Emergency Fund
Consider Other Investments
Let's get one thing straight: You don't need to make a lot of money to invest. It's a common misconception that investing is for rich people, but it isn't—it's for everyone. In fact, investing early could help you become one of those rich people for whom you thought investing was reserved!
When you have paid off high-interest debt and have an emergency fund set up, it's a good idea to consider opening a non-retirement investment account, such as a brokerage account, to save money and invest toward future goals. That's because the goal of investing is to grow your money faster than you typically could in a bank account.
Investing with a small amount of money is easier than ever with new apps that will let you start investing with just a few dollars, basically allowing you to buy fractions of stocks or funds that invest in a wide range of companies. Before you get started with any of these platforms, however, be sure to check out these tips on automated investment tools.