You’re on the right path. You’ve graduated from college and started a career in your ideal profession. You’re working hard and being recognized for it. At this pace, you’ll be able realize all your aspirations.
However, there are ten financial pitfalls that that could derail you or stop you entirely. Let’s consider five of these financial mistakes and how you can navigate around them.
1 | No Budget
Do you have a budget? Do you know what you’re spending each month? If you don’t, you’re not alone. Even though younger people tend to budget more than older folks, many young professionals don’t have a budget.
You can quickly and easily build a budget using online tools from Intuit Mint, Nerdwallet, NFCC, and BudgetTracker. You can also build your own budget using desktop-based programs like Microsoft Excel or Apple Numbers.
You’re probably receiving a salary from your employer. Your pay statement will indicate your gross salary, withholding for retirement plan contributions, taxes withheld and deductions for company-sponsored insurance. But let’s focus on what you’re doing with your net take-home pay.
You should start the budgeting process by identifying all your spending. You can do this by reviewing your bank and credit card statements. You should identify broad categories of spending such as housing (your rent or mortgage), utilities (including internet service), food, clothing, insurance, travel, entertainment, and so on. You should distinguish between core, or fixed, expenses that don’t vary much from month to month, and discretionary, or variable, expenses. In general, core expenses are essential and variable expenses are optional.
2 | No Emergency Fund
What will you do if you need to repair your car, have emergency dental work done or replace one of your home appliances? The Federal Reserve’s Survey of Household Economics and Decision Making found that 40% of Americans aren’t able to pay for an unforeseen $400 expense.
Most people don’t have an emergency fund. But everyone needs one. Why? Because emergencies happen, and you need to have the ability to cover the costs when they do.
How much should you have in your emergency fund? Well, you need to be able pay for the biggest emergency you could face. What is that? Almost certainly, losing your job. Without a job, you’ll have no income. How long could that last? To be conservative, let’s say six months. So, if your core living expenses are $5,000 a month, then you need to have $30,000 (6 x $5,000) in your emergency fund.
What qualifies as an emergency fund? An emergency fund needs to be safe, liquid and easy to access. So, you could put your emergency dollars in a bank checking or savings account. You could also use cash value life insurance as an emergency fund. Depending on your circumstances, you might also be able to use a Roth IRA.
If you don’t have a fully-funded emergency fund, start working toward that. If you make $120,000 a year, you could save 10% a month ($1,000) and get to $30,000 in a few years.
3 | Carrying Consumer Debt
Far too many Americans are addicted to consumer debt. We’ve been programmed to buy whatever advertisers tell us will make us feel better. Houses, cars, electronics, vacations, gadgets. If we can’t afford to pay for something, we’re offered easy financing.
Experian reports that Americans carry an average of $6,194 in credit card debt. The average auto loan is over $32,000. It’s now possible to buy a growing array of products with payment terms offered by tech companies like Affirm, Viabill, Financeit and Klarna. These companies allow you pay installments, just like Sears did 75 years ago.
Don’t fall for the enticements and don’t borrow money unless you’re buying a home or getting 0% interest (or close to it) to buy a car. It’s totally acceptable to use credit cards. But you should pay off the balance every month.
If you currently have credit card debt, come up with a plan to pay off the debt as soon as possible. Let’s say you have $12,000 in revolving credit card debt. Let’s again assume you’re earning $120,000 in salary. You should be able to allocate $1,000 per month to pay off the credit card balance in a little over a year, depending on the interest rate on the card.
4 | No Disability Insurance
If your best friend asked you what your most valuable asset is, what would you say? Your house? Your car? Your investments? Your stamp collection?
As a young, successful professional, your most valuable asset is your ability to earn an income. If you earn $120,000 per year and you receive regular salary increases only for inflation (assume 2%), you’ll earn nearly $5 million over your 30-year working career.
Have you protected your ability to earn an income? What happens if you become sick or hurt, or suffer some other impairment that affects your ability to work?
You may have disability benefits through your employer. Typically, employer-sponsored long-term disability (LTD) insurance will pay 60-70% of your base salary, and often the benefits are integrated with Social Security. There is usually a maximum monthly benefit (e.g. $5,000 per month). Portland-area companies like Intel, Nike, OHSU, and Columbia Sportswear all provide employer-sponsored disability insurance.
The problem with group LTD insurance is that it’s often difficult to qualify for the benefit, because the definition of disability is restrictive. This is even more so the case with Social Security. The latter defines disability as “the inability to engage in any substantial gainful activity (SGA) by reason of any medically determinable physical or mental impairment(s) which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months.”
So, you should buy individual disability insurance to protect your income. Good quality disability insurance isn’t inexpensive and hopefully you’ll never use it.
5 | Inadequate Property and Liability Insurance
As a successful, young professional, you’re beginning to accumulate assets. Perhaps you own a home. But whether you own it or rent, it surely contains lots of valuables. You might own jewelry, art, collectibles, and so on. Your valuables should be insured against damage or loss from weather-related events, vandalism and theft. For example, as a young professional living in Portland, Oregon or Santa Cruz, California, fires, earthquakes and, possibly, floods are risks you should insure against. Many young professionals don’t have the right kinds of insurance in the right amounts.
There are several types of insurance that you should own. If you own a home, you should have homeowners’ insurance, while if you own a condo or co-op, you should own condo/co-op insurance. If you rent your home, you should have renters’ insurance. If you live in a flood-prone area, you should own flood insurance. If you live an earthquake zone, you should have earthquake insurance.
If you own a car or drive a car, you should have auto insurance. Personal property is typically covered by your homeowners’ or renters’ insurance. But, if you have valuable or unique possessions, you may need a so-called rider on your existing policy to cover them.
Property insurance provides coverage for replacement cost, actual cash value or extended replacement cost. Property insurance also provides liability coverage if someone is injured while on your property and sues you. However, this liability coverage is often inadequate, and you should consider adding supplemental or “umbrella” liability insurance.
Don’t buy property insurance without fully understanding your needs and researching the vast array of products available. If you’re concerned that you need guidance with this, seriously consider working with a property and casualty agent or broker. The former works for an insurance company (e.g., State Farm or Allstate), while the latter represents you to the insurance company.
Do you have questions about building a robust plan for your financial future? Contact us today to see how our team at Springwater Wealth can help you.
We’ve covered five of the ten biggest financial mistakes young professionals make and how to avoid them. Look for Part 2 of this article, which covers the next five mistakes, on the Springwater Wealth Management website soon.