November 25, 2014

10 Financial Pitfalls to Avoid in Your 20s


There's nothing like being in your 20s. You have newfound freedom, you get to make all the decisions, and time is on your side. For sure, the world awaits you.

But with that power over your choices come some big pitfalls that can dramatically impact your financial future. Do any or all of these 10 mistakes and you may be sabotaging yourself.

© Samir Luther (CC BY-SA 2.0) via Flickr

1. Viewing retirement as a thing you’ll think about in 40+ years

The pitfall: Failing to save, even small amounts, towards retirement is a big mistake. Retirement may seem like a lifetime away and a state of being that is just not relevant when there are vacations to take and sporty cars calling your name. Truth is, savings made in the early years benefit the most from compounding returns, and they can significantly reduce the inevitable burden you will have to take on at some point to save more money.

How to avoid it: Participate in your employer’s retirement plan, especially if you’re offered a matching contribution. Otherwise, you’re leaving free money on the table that will add up over the years. Put aside even a small percentage of each paycheck and you’ll be building wealth for that future version of you.

2. Claiming you’ll “gladly pay Tuesday for a hamburger today”

The pitfall: That line might have worked for Popeye’s pal Wimpy, but in the real world, debt is serious and should be dealt with sooner rather than later. Whether it’s student loans or credit cards, paying bills on time goes a long way in keeping and boosting a good credit score.

Without a good credit score, say hello to a life where borrowing will cost you more — if someone will lend to you at all — and your ability to get the job you want may be hampered.

How to avoid it: The sooner you learn the difference between paying interest and earning interest, the better. “The best way to increase wealth is by earning interest on your own money, instead of paying interest to someone else,” says Steve Repak, author of Dollar & Uncommon Sense: Basic Training for Your Money.

3. Winging it, with no map and no plan

The pitfall: While 20-somethings think nothing of jumping in the car and revving up the GPS, many are clueless about their finances because they don’t have a way to navigate their spending. Life without a budget at any age is a bad practice. No budget means there’s no accountability, you spend as you wish and don’t even know where your money goes.

How to avoid it: Continue to skip making a financial map, and you’ll soon drown in debt. However, if budgeting becomes second nature in your 20s and you keep up that good habit, you’ve set yourself up for a healthy financial future.

4. Investing too conservatively

The pitfall: When you’re young, you can afford to take some risks because you have time to make up for any market losses. “If you invest too conservatively, you are giving up a lot of long-term performance, which can hurt your future retirement plan,” says Andreas Scott, a 20-something certified financial planner with Collaborative Legacy Partners.

How to avoid it: This is not to say you should throw all your money toward risky stocks. A diversified portfolio (a mix of investments) is a smart plan at any age. But you may want to allocate more of your funds toward the riskier investments that hopefully provide a higher return over the long term.

One risk you don’t want to take on, however, is ignorance. If you need help deciding where to put your money and how to spread it out, see if your employer-sponsored plan provides free financial advisory services, and always do your research.

5. Relying on one paycheck

The pitfall: In these times, when jobs can be fleeting, it’s smart to have multiple income streams, whether it be an entrepreneurial side hustle or a second, part-time job. Even if your peers laugh at such a thought, it’s actually the cool thing to do.

“There seems to be a stigma to working a second job these days. When I suggest to people to supplement their income with a second job, they’re offended,” says bankruptcy attorney Danielle Callahan of Callahan Law Group. “People in their 20s believe that if they went to college and got a degree, they should be all set for the lifestyle they want to live. ‘Work as a waitress? No way, that’s why I went to college!’ But they need a second job, especially to pay off those student loans.”

How to avoid it: What’s not cool is built-up debt with only a little way to pay it off. Bankruptcies occur from broken dreams. Get ahead of your finances by taking on extra work as you make your way up the corporate ladder.

6. Staying in the comfort zone

The pitfall: So, you finally landed that job you wanted. The years roll by and you stay in your comfort zone. Failing to regularly assess your career progress and opportunities to advance will cost you. “The squeaky wheel gets oiled, and the motivated employee gets promoted or offered positions at external companies,” says Liam Timmons, president of investment advisor Timmons Wealth Management.

How to avoid it: Instead of watching everyone else walk by you toward bigger and better things, be one of them and plan ahead. “By taking the time to plan out your next career move, and steps needed to achieve these goals, you raise the opportunity for lifetime earnings, which will directly impact your financial future,” Timmons says.

Take advantage of any company-sponsored education reimbursement, for example. If your company offers this benefit, consider it free money. Think longer term about where you want to go in your career, and target courses that will help you get there. It will save you a lot of money down the road if you avoid having to pay for graduate degrees entirely on your own.

7. Not having an emergency fund

© Kenny Louie (CC BY 2.0) via Flickr

The pitfall: Even though you are only in your 20s, you’ve probably already learned the lesson that stuff happens. Expect the unexpected. You need to have at least six months of expenses squirreled away in an account you can quickly access if needed. This is a big goal, we know, but that account is more important to have than the latest and greatest smartphone.

Without an emergency fund, you’ll have to tap credit cards and risk having to pay a lot in interest when your car suddenly dies or you have to replace an appliance.

How to avoid it: Start saving even $10-$20 a week and see how it grows. Any amount beats zero.

8. Trying to live up to your parents

The pitfall: The cars, home, and possessions your parents enjoy are the result of many years of working hard, managing their income, and making sacrifices. Perhaps they received an inheritance or maybe they just had good timing for every economic swing.

They are not you, and you are not them. When you leave the nest, it is tempting to try to shift into a comparable lifestyle on your own. Unfortunately, your income isn’t necessarily up to the task. At least not yet. “If you’re not careful, you can spend your way into a hole and create a mess for yourself,” says Joseph Ritter Jr., a certified financial planner with Zacchaeus Financial Consulting.

How to avoid it: “Adopt a lifestyle that matches your income, and then work hard at budgeting, saving, and advancing your career to build up to that level,” Ritter says.

9. Rushing to buy a house

The pitfall: You want the American dream, so you become obsessed with getting a house with a little yard and a little fence. But you also have a big mortgage and taxes weighing you down every month. When you rented, you could go anywhere if you made a career change, but now you’re stuck.

How to avoid it: Just because you qualify for a mortgage doesn’t mean you’re ready. And you don’t need to take on too much either. “Young people feel like they have to buy a house to show they are successful, but frequently they overextend themselves,” says Kirk Chisholm, principal and wealth manager with Innovative Advisory Group.

Renting gives you flexibility as you get to that higher income bracket where you can truly afford your own home. You may feel envious of your peers who spend their weekends at open houses, but you don’t know their true financial situation or whether they can really afford their new home or not.

10. Believing that paying the minimum is OK

© vlastimil_koutecky (CC BY 2.0) via Flickr

The pitfall: When you are in 20s — that decade when you are finally no longer beholden to your parents — you don’t want to be beholden to creditors if you can help it. Paying only the minimum balance every month makes you a slave to your debt for many, many years, long after you enjoyed whatever it is that you bought.

How to avoid it: When you can pay more than the minimum, do so. Pay attention to your credit card statements, and study the part that tells you how long you’ll be paying for your current balance if you only pay the minimum — and understand that that number is only if you do not make any more purchases on the card. The length of time will shock you and so will the amount of interest you’ll have to pay over that time. Always strive to pay your full balance.

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