By day, I love my job as wealth coach to grown-ups. On weekends and evenings, for over 12 years when my three children were in grade school, I found it just as rewarding to coach my kids’ sports teams. Baseball, basketball, soccer; I loved it all. One thing I learned as “Coach Mike” was that teaching the mechanics of the sport is easy. The greater challenge was to teach kids how to be responsible athletes and caring teammates and to have some fun along the way.
The same can be said about coaching our young adults about their wealth. Especially if your “baby” is about to graduate from college, you already know how soon he or she will be facing critical and conflicting decisions about their wealth. Life isn’t about sitting on the sidelines. Here are some wealth management ideas to help our young adults get their game on and perhaps for all of us to take to heart.
Youthful Saving: When Time Is on Your Side
One of the first decisions young adults face as they enter the work force is how much to save. “As much as possible,” while well-intended, is terribly easy to brush aside. But saving during one’s youth is also terribly important. There’s nothing like a half-century time horizon for accumulating long-term wealth! Never again will it be so easy to build a life-altering nest egg from relatively modest contributions.
Debt Pay-Off: The Rest of the Balancing Act
Of course there’s also the matter of debt. College education is not getting any cheaper these days. And for better or worse, credit cards seem increasingly easy to obtain. Debt, especially high-interest obligations, can become a life-long drag if not responsibly managed. For example, at $200/month, it takes about 41/2 years and $10,600 to pay off a $10,000 loan at 3 percent interest. But what if the interest rate is 15 percent? Pay-off terms jump to 61/2 years and $15,600 total.
So, how do you balance saving and paying off debt? Here are some good rules of thumb for getting the most bang for your saving-and-loan bucks (in suggested order of priority):
- Save for your Emergency Fund. We recommend at least 3 months of living expenses so you are not set back to far by an unanticipated situations. See our recent article on this topic HERE.
- Save in your 401(k) for maximum employer match. You’re leaving money on the table if you fail to save enough to get the full, essentially “free” bonus from an employer match.
- Pay down credit cards. Or avoid using them to begin with. Generally, credit card debt has those double-digit interest rates that are the most difficult to overcome.
- Pay down other non-deductible loans, such as car loans.
- Save to other tax-deferred accounts, such as IRAs.
- Pay down deductible loans. A student loan is an example of a deductible loan. (It may make sense to wait before paying down a student loan if you might be eligible for a student loan forgiveness program. Teachers often are eligible for such programs.)
- Save to taxable accounts.
Purchasing a Home?
It may be touted as the American Dream, but today more than ever, we advise young adults not to rush that dream. In fact, research has indicated that most people may be best off postponing home ownership until they are in their mid-30s. [1]
It’s both a financial and lifestyle decision. Once you own your home, you’re less mobile, which can dampen career opportunities, curtail new relationships or otherwise tie you prematurely to a particular lifestyle. Also, when you’re younger, with likely fewer financial assets, pouring the bulk of your wealth into a single piece of real estate results in a highly undiversified “portfolio.”
When it is time to purchase, whether building or buying, the best advice is to measure twice and cut once. In other words, be prepared:
- Save for a down payment. You generally need 20 percent down to avoid the costly addition of private mortgage insurance. But saving for home ownership happens within one’s taxable account(s), which is another reason it may make sense to postpone the day, to first build up your retirement savings and pay off high-interest debts, as described above.
- Determine a comfortable loan amount. Don’t be tempted to go for broke, lest you find out exactly what that means. We often counsel young adults to purchase a home for less than they may qualify. Later on, it’s much easier to upgrade a lifestyle than it is to downsize it.
- Familiarize yourself with the different mortgage options. There are many different choices, and the landscape is ever-changing and confusing. When the time comes, let us know; we are happy to put young family members in touch with objective advice.
[1] Rui Yao and Harold H. Zhang, Optimal Life-Cycle Asset Allocation With Housing as Collateral. Working paper, November 2005.
Insurance: When It’s Warranted
Insurance is another wealth decision that is complicated, dependent on specific circumstances and important. As general advice, the highest priority is to insure against applicable catastrophic losses, even those with low probability. For example, actuarial charts indicate that it’s highly unlikely a young adult will die young. But if that individual is a head of household, with a spouse and dependent children, the financial impact would be profound were the worst to occur.
On the other hand, even if your smartphone breaks within a couple of years, you’ll probably figure out a way to replace it and move on. Insurance in the form of extended warranties is typically stacked strongly against you, far more likely to be a moneymaker for the carrier than for you. So there’s an “opportunity” that may be best ignored.
Investing for the Long Haul
Last, but certainly not least, comes the day when a young adult has saved enough to invest. Savings are typically placed in accounts that are “safe,” (insured against loss by the FDIC) and liquid (readily accessible). But they’re also low-yielding, usually not even enough to stay ahead of inflation. Thus, if all you do is save, you’re actually likely to lose ground. A dollar saved in a money market account will no longer be worth a dollar in the future.
Investing is when you place a portion of your wealth into the stock and/or bond market, where expected long-term market growth helps you get ahead of inflation. By investing, you’re able to at least preserve your existing wealth if not build more. On the flip side, market investments are not insured or protected the way savings are. You can lose part or all of your investments. So, while investing is necessary and critical to wealth management, the most important action you can take is to manage for market risk by diversifying, or avoiding concentrated positions in individual securities.
Another key, common-sense investment concept is to minimize the costs involved. Unlike paying more to acquire a higher-performing car, copious academic research has indicated that higher investment costs are not expected to lead to better or faster results. Instead, the more that is sacrificed to trading costs, taxes and other expenses, the less you get to keep for yourself.
Passively managed mutual funds are the least expensive way for investors to own a diversified portfolio. Among mutual funds, index funds or asset class funds are generally preferred in terms of their low costs and high levels of diversification.
Is the terminology a little daunting? Among many other facets, that’s where Cogent Strategic Wealth comes in as the family coach, assisting multiple generations – parents and young adults alike – with both the mechanics of investing as well as with enhancing the spirit of the pursuit.
