Originally published 7/27/2010 at the Financial Planning Association's All Things Financial Planning blog
Robert Schmansky, CFP(r)
This is the second of a three part blog on the early stages of the Financial Life Cycle. In my last blog post, I introduced the concept of the Financial Life Cycle. This week’s blog is all about the strategies and pitfalls in the first adult stage, and next week I will look at strategies and pitfalls for those who have navigated the first stage successfully.
The first adult stage of our financial life is all about self-sufficiency. Sure, you’ve got stuff (e.g., car, computer, nice clothes), but what you don’t have are the things that provide safety over the long-term. Your net worth is less than your annual income, or it may even be negative.
If you’re just starting out or starting over, this is right where you are supposed to be. But, for many, it is easy to become a little too comfortable and linger in this stage. If you are one in that category, you would have to admit a disaster would set you back substantially, and you aren’t quite sure how you would cope. For now, though, it’s not an issue.
This is an interesting stage for many, because while you have ample time to make up for any losses and mistakes, you may be tempted to take risks. Why not splurge a little?
The problem comes when people do just that every time they appear to be getting ahead and accumulate some money.
To move forward from here, below are some prerequisites to advance in your financial maturity:
Save. Some people say it’s not critical to save, that the opportunity to spend while you are young is worth more than saving for a goal decades away. But at this stage you probably couldn’t handle multiple setbacks like having to replace your car, losing your job, or a health emergency. Your short-term goal for saving at this stage should be at least 10% of your pay. Once you’ve achieved that, I suggest an additional 1 to 2% per year.
Pay off consumer debt. For more information on saving and debt, see my blog on the topic. Debt can drag down your best efforts to get ahead, making your life less enjoyable and unnecessarily stressful.
Track income and expenses. Start by writing down all of your expenses as they come up for at least three months, rounding to the nearest dollar. Get up close and personal to your spending and raise your awareness of where your money goes. After a few months, consider dropping the pencil and paper for software like Mint.com or Quicken, but however your do the tracking, continue to monitor changes in your expenses each month.
Develop your worth in the marketplace. Diversify your skills. Take courses that give you an edge in your career. For example, does your job involve work with spreadsheets? Take a class and become the expert in your office. Find a niche where you can add value, whether it enhances your income or makes you more employable.
Buy adequate protection. Your insurance may have gaps, such as not enough disability coverage. Or you may not want to pay for renters’ insurance, but likely it’s too risky to go without it. I recommend higher deductibles both to get the correct amount of coverage and to discourage claims that can cost you your coverage.
All the items I’ve just listed aren’t easy to contemplate or act on when life seems trouble free. However, like trying to get into physical shape (or stay that way), establishing good financial habits only gets harder over time.
In the next financial life stage, you will begin to have some discretionary income and learn how to put your money to work for you. Our litmus test to discern if clients are on their way is to monitor their net worth and make sure it approaches an amount equal to their annual income. In my next blog I’ll cover more strategies and pitfalls at the first stages of accumulation.