My oldest son is now 21 and soon finished with uni so we start (with this father – what would you expect?) talking about trading, investing, finance and managing your money. I obviously want him to have a financially comfortable and successful life so here are a few things I believe young people should avoid:
Not putting aside money for emergencies: You need cash ready for an emergency, for when the car breaks down or any other unexpected things happen. If you don’t have the cash (and a lovely father bailing you out) you will have to charge it to your credit card and get stuck with around 20 % interest charges or even worse have to get money from a payday lender at significant fees. As a general rule you should have around six months of living expenses in a savings account as a necessary buffer.
Buying an expensive car: Well, that’s not the problem of my son; he’s just not interested in cars but many young people love the feeling of freedom your own car gives you and often spend a significant amount on a car, sometimes even on credit. Given that (new) cars depreciate by around20 % per year, an expensive car is a high degree of consumption leaving less money for things that are more important in the long run. On the other extreme you shouldn’t buy too cheap a car (a ‘bomb’) either as repair costs will usually be high and annoying breakdowns frequent. Maybe you want to stick with something boring, a reliable, three year old Corolla (and you’ll get the girls because of your character and not because of your fancy car!).
Accumulating credit card debt: At least now banks aren’t allowed to offer you increase of your credit card limit without you authorising them beforehand. But the temptation is there to live today, spend today and worry about how to pay for it later. And hey, you have up to 60 days interest free credit so why not take advantage of an offer too hard to resist? The risk is that you won’t pay back your balance in full in time and ever so slowly your credit card debt increases and fees are pretty high. This leads to a downward spiral as with accrued interest the debt will increase over time. The minimum payment suggested by the credit card issuer is calculated so that paying back your debt takes about 30 years. Imagine that! Great for the banks but not a way to advance in life financially.
Not setting financial goals: If so important to set budgets and stick to it. Not sexy, I know, even boring, but setting a budget and sticking to it and really evaluating all expenses (“Do I really need this stuff? Do I need it now or can it wait?) will set you up for financial freedom in the medium term. It starts with paying yourself first and saving every payday 10 % or so of your net income. Your funds will over time accumulate in a savings account and you’ll be able to learn investing in other financial assets and increase your rate of return. This will lead over time through the power of compounding to an accelerating asset balance.
Not investing for retirement: If you are young you believe that you’ll never get old, that you live forever and that you are bullet proof. All those believes are wrong and it is thus important to start saving for retirement from your first paycheque. Fortunately the government forces us to do just that (against our will). The sooner you start investing, saving for retirement, maybe topping up your employer’s super contribution through salary sacrifice, the higher your retirement nest egg will be at the end. Yes, delayed gratification is sometimes hard, particularly in our current culture that wants everything now, but the rewards are significant and worthwhile some initial pain.
Not talking about finances before getting married: It’s all about sex and money and if as a couple you don’t have a common plan about finance the marriage is doomed to fail. Money can be a touchy subject (polite people don’t mention it) but it’s important that the couple has one common financial goal and talks about finances openly. Talk about it together, make savings plan and agree on how the money is spent.
Spending too much on your wedding: It appears from a recent study that the more you spend on engagement rings and wedding costs the higher is the chance of a divorce. Spending $20,000 on a wedding increases your risk of divorce by 3.5 times against a wedding budget of $ 5,000 to $ 10,000. It’s just hard to start married life with a huge pile of debt. This leads just to unnecessary stress in your relationship.
Buying a bigger house than you need: That’s a hard one as we Australians are wired to believe in bricks and mortar as a sure fire way to get ahead financially. And if you live in Sydney and Melbourne you’re raised to believe that house prices will always go up. But you should really consider the carry charges of a large mortgage due to a McMansion in the suburbs. You’ll have an unnecessary high mortgage, high maintenance cost and you can get really in trouble when interest rates rise (not if) or if you lose your job. Yes, there is a point to be made to own your property at some stage in your live but maybe not at the beginning of your career when you still have to be flexible and move around to follow job opportunities. Consider rental (it’s cheap relatively to owning a house) at the beginning of your career and only buy (once or twice, transaction cost in real estate are really high) a reasonable size. You don’t have to keep up with the Jones. They are probably in financial stress, anyway.