Many young adults tell us that they are entering the workforce with little financial training. Basic budgeting and portfolio construction were not classes offered in school. They understand the need to “save for a rainy day” or “save for retirement,” but they are not sure how to get started. Bragg now offers the Bragg Financial “Boot Camp” each year to help young adults prepare for their financial future. Our hope is to give our students both the high-level rules for financial success as well as a deeper exposure to the nuts and bolts of day to day financial decision making.
As for the high level rules for success, I’ve reprinted seven nuggets excerpted from an article Benton Bragg wrote two years ago.
Start Early (Form Habits Early)
In our business we’ve learned over time that on average, people spend what they make. Someone making $75,000 per year will spend $75,000 per year. Someone making $350,000 per year will spend $350,000 per year. Call it consumption creep or whatever you will, it is just reality. Therefore it is critical that a healthy pattern of saving and investing starts at a young age before “alternative habits” are formed. I remember my first paycheck from my first job at NCNB after college in 1990 (for young readers, NCNB was the predecessor to Bank of America). My salary was $21,500 and my first bi-monthly paycheck (gross) was almost $900—a ridiculously large sum of money for me at the time! I remember sitting there just staring at that figure. Wow! Looking back, this was obviously a great opportunity to form good habits and to avoid the temptation to adopt a standard of living requiring a paycheck of that size.
Start Early II (Take Advantage of Compounding)
Suzie Saver saves $5,000 per year starting at age 22. She increases her annual savings by 3% per year. She invests the money and earns an annualized return of 6.5%. At age 65 Suzie has $1.9 million. Sam Spender does the same thing EXCEPT he waits until age 32 to begin. At age 65 Sam has $879,000.
Save a Lot
Here are three responses we often hear when we ask the question, “Do you contribute to the retirement plan offered by your employer?” 1) “I’m planning to start once I pay off my credit cards and save up for a new car.” 2) “I only put in what they will match.” and 3) “I always contribute the maximum allowed.” Of course I realize that not everyone can contribute the maximum but obviously, the more you save, the sooner you’ll reach your goal.
Do Your Own Math
Quoting my brother Phillips from an article he wrote twenty years ago, “It’s your paycheck; do your own math and make the numbers work for you. Don’t get caught up in what your neighbor spends or has. For all you know, your neighbor inherited a fortune or is drowning in debt.” Basing your decisions on the actions of others is not a plan that will work.
Over long periods of time, owning a diversified portfolio of stocks has been a far better investment than alternatives like bonds or cash equivalents. Specifically, since 1926, large company US stocks have enjoyed an annualized return of about 10% while bonds have averaged approximately 5%. Cash equivalents have barely kept pace with inflation which has averaged just under 3% for the same period. These are historical returns and there is no guarantee that we’ll see these returns in the future. In fact, when planning for the future, we think it is prudent to assume that future returns will be lower than historical averages. Yes, lower future returns will require saving a lot in order to reach your financial goals.
Pay attention to how your money is invested. Consider that over a 40-year period, a lump sum of $10,000 invested at 4% grows to $48,010 while the same amount invested at 7% grows to $149,745. You don’t have to be Warren Buffet to get this right. Whether you do it yourself or pay someone to help you, give your portfolio some attention each year. As demonstrated, it’s worth it!
Be Humble and Never Bet the Farm
You can’t see the future and neither can anyone else. Don’t try to time the market and never make big bets with money you can’t afford to lose. Maintain an investment allocation that is appropriate given your need for liquidity and your need for return. Avoid any investment that sounds too good to be true. The only exception to this last rule is compound interest. While it appears to be too good to be true, it’s not, and you should embrace it! As Albert Einstein is reported to have said (but probably didn’t), “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”
Click here for Benton’s complete article about kids making good decisions—”Car Wash”
As for a deeper exposure to the nuts and bolts of financial decision making, our Boot Camp delves into the following topics:
Understand Your Paycheck
Review your paycheck. Make sure you understand all the deductions. Ask questions of your human resources department if needed. Remember that Federal, State, Social Security and Medicare taxes will be deducted. Take note that your take-home pay is significantly less than your gross pay. Build your budget around your net pay.
Track Your Expenses
Track your expenses for 3-6 months. Use Excel or an application like Mint. Categorize your expenses so you know where your money is going. What percentage of your take-home pay is spent on rent? How much is spent on dining out, your phone, transportation or entertainment? How much is being spent to help you further your career or to help you accomplish your financial goals? How much is spent on your lifestyle? Use the expenses you tracked to guide you in the next step.
Set Up a Budget
Determine your take-home pay and then create a budget. The key to your budget is that your take-home pay must cover all of your savings and your expenses. This includes the expenses you charge on a credit card. Compare your budget to your actual spending. Set savings goals and implement a plan to achieve your goals.
Initially set a goal to save $1,000 in your emergency savings. Your ultimate goal is 3-6 months of expenses.
Employer-Sponsored Savings Plan
If your employer offers an employer-sponsored savings plan like a 401k or 403b, you should plan to participate! We encourage you to contribute 10-15% of your pay; at the very minimum, you should participate up to the amount your employer will match. An example of a match is an employer who will contribute 50 cents for every dollar you contribute to the plan. If you contribute $1,000, your employer will contribute $500. Most employers will cap their match at a certain percentage of your income. With most plans, to become vested (to own the funds) in the portion contributed by your employer, you will need to work for that employer for a minimum period of years (minimum of 3 and maximum of 7). Be sure to consider vesting before changing employers.
Good Debt vs. Bad Debt
Should we use debt to buy stocks? Or to buy a home, a second home, a car or to pay for college? Let’s reframe this question. Instead of asking whether debt is appropriate for a specific investment or purchase, we think it makes sense to step back and consider the structure or makeup of your overall balance sheet. Answer the question, “How much debt should I have on my balance sheet?” Forget about whether or not to finance the new car and instead focus on the amount, structure and cost of all of the debt you have. There is a great article on our website about good debt and bad debt.
File and pay your taxes in a timely manner. If your financial situation is not overly complex, doing your own taxes can be a very useful exercise as you’ll learn a lot about the ins and outs of our tax system in the US. This knowledge can be quite useful as you make financial decisions. There are a number of online tax services that walk you through the necessary steps to file your return. For more complex situations including multiple returns, K-1s from partnerships, self-employment income and trusts, we normally recommend that you hire a professional.
Understand Your Credit Score Your credit score impacts many aspects of your life. It will influence lenders and determine if you get a higher- or lower-than-average interest rate on a loan. It may be viewed by your landlord and employer. Your credit report and your credit score inform others about your history of making payments and whether or not you are a good credit risk. To increase your credit score, pay your bills on time, own 1-2 credit cards and only spend 30% of your credit limit, and pay off your entire credit card bill on time, every month.
Only Insure What You Can’t Self-Insure
Prior to having children, we suggest young adults consider insuring their health, home (or contents of a rental unit), auto and risk of disability. Insurance on your sunglasses, a television or a new computer are risks you can cover without insurance.
As you continue to build your financial knowledge, please remember that the most important part of being successful financially is your behavior. Understand where and how you are spending your money and make sure that your money is working for you and not the other way around. We wish you the best of luck.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.