The Five Financial Mistakes of Young Adults

Student loans. Rising healthcare costs. New house expenses. Entry-level salaries. Put these all together, and you begin to understand why nearly two out of three young adults are struggling for financial independence.

But that’s not the whole story. Substantial numbers of 20- and 30-somethings make financial mistakes that are largely avoidable—threatening their long-term financial health. Here are five of their biggest financial mistakes:

Mistake #1: Keeping Up With the Joneses

If you’re just getting started, you may find yourself frustrated, maybe even confused, about money. While you may find yourself stuck living paycheck to paycheck and weighed down by massive student loans, other young families seem to be driving new cars, living in trendy loft apartments and taking fabulous vacations. With luxury and consumption at every turn, there is a perpetual temptation to join in on the fun.

One of the biggest mistakes young adults can make is to spend too much too quickly, digging themselves into an early financial hole. If you’re already teetering on the edge, now is the time to stop. To get on more stable ground, you might consider taking a temporary second job to earn additional income. Rather than buy a new car, consider a used one—or keep the one you’ve got a year longer. Better still, consider using public transportation and put your savings toward paying off your debts faster.

Mistake #2: Postponing Saving for Retirement

When you’re 25, it can be very difficult to look 45 years into the future and imagine your retirement. Understandably, people in their 20s and 30s would rather concentrate on their short-term financial obligations, rather than consider the standard of living they want to enjoy far into the future.

Still, it’s smarter to start saving now—especially if your employer offers a 401(k) program and will match a portion of your contribution. That’s free money. Besides, the earlier you start saving, the better off you’ll be later. If you save $1,000 when you’re 20, and it grows at 10 percent per year, it will yield you almost $73,000 when you’re 65. Put that same $1,000 into savings when you’re 50, it will grow to only $4,200 by age 65.

That leads to another reason why it’s smart to start saving when you’re young. If you begin saving in your 20s, you may only need to sock away 10 percent of your income to meet your longterm financial needs. Wait until you’re middle-aged, and you’ll need to put away closer to 15 or 20 percent or more.

Mistake #3: Putting Your Eggs in One Financial Basket.

It’s not just enough to save. You also need to invest those savings wisely. Young people in their 20s and 30s can usually afford to invest more aggressively than persons closer to retirement age. For many, that means stocks are the answer. Over long periods, a diversified stock portfolio greatly outperforms bonds, cash and real estate.

Also, be cautious if you’re part of a corporate stock purchase plan. If the company’s stock has done well, it may make up a big part—sometimes more than half—of your retirement savings. That, says many financial planners, is too much. Most experts agree that company stock, or any other single stock, should comprise no more than 10 percent of your portfolio. You don’t want your retirement savings to depend on the health of any one company.

Mistake #4: Cashing Out Your 401(K) When You Switch Jobs

When young adults leave one job for another, their retirement funds often suffer. That’s because a significant number of 20- and 30-somethings cash out their 401(k)s rather than leaving them intact. As tempting as this may be, it’s generally a bad idea. You’ll almost always owe a 10 percent penalty—in addition to having to pay income taxes on the withdrawal. You’ll be much better off in the long run if you roll over the 401(k) into an IRA, which you can then invest any way you want.

Another mistake young adults often make is leaving a job too soon. Most employers require you to work for a period of time—usually about five years—before you are eligible for full benefits. With a 401(k), for example, you might get 20 percent of an employer’s contributions after a year, 40 percent after two years, and so on. If you’re nearing a vesting milestone, it might be worth your while to put off a job change.

Mistake #5: Not Saving Automatically

Many young adults claim, “I’d like to save more, but there’s no money left at the end of the month.” That mindset, many financial experts say, is half the problem. Saving shouldn’t be the last thing you do every month, but the first.

The best way to save, in fact, is to make it happen automatically. Whether you funnel your money into a savings account, mutual funds or an IRA, a systematic bank draft allows your savings to grow in the background, without requiring any further effort from you. Years from now, the result may be the best gift you’ll ever give yourself. TPW