Personal finance for young adults: Savings basics and the power of compounding
Author: Halsey Schreier
Are you just out of school and beginning a new career? Do you want to save money to buy a new car or home, or get married and eventually start a family? Or perhaps you just want to have a financial buffer for emergencies or know when and how you can start saving for retirement?
Saving money can be challenging, especially if you’re just getting started in your career. If you are like a lot of young professionals, you may discover that there’s not much left over from your paycheck once the rent and bills have been paid, and it is easy to neglect saving for the future. But if you can start saving now while you’re young, no matter how small the amount, it could be one of the best financial decisions you make. Forming saving habits early could have a significant impact on your ability to weather unexpected expenses, make large purchases and achieve major life goals.
Below are five things you can do early in your career to jump-start your savings.
1. Plan for the future
Setting goals is essential to achieving financial success. Yes, saving is important, but before you start putting money aside, you’ll want to have an idea of what it is you are saving for and why.
Goals could include buying a house or car, going back to school, getting married, starting a family, or saving up enough money so you can quit your job and travel to faraway and exotic places. If you know what your goals are, you will have a better idea of how much you need to save and can create a plan that will help turn those dreams into a reality.
2. Establish a budget
A budget is one of the most effective tools for saving money. Creating and sticking to a budget doesn’t mean sacrificing fun. Rather, a budget can help make having fun possible.
With a budget, you track your expenses to get a clear picture of where your money is going each month. A well-designed budget will help you prioritize your spending and saving. You’ll know how much you need to set aside each month for basic living expenses and savings, and how much you have left over to spend on lifestyle expenditures such as dining out in restaurants and entertainment. Otherwise, if you’re living paycheck-to-paycheck and are not careful with managing your money, it can be easy to lose track of discretionary spending. You could wind up in debt or be unable to afford important big-ticket purchases.
A simple way to integrate saving into your monthly budget is to automate it. If your employer allows direct deposit, you may be able to have a portion of each paycheck deposited into your savings account. This way, what is out of sight is out of mind, and you avoid the temptation to spend money that you could be saving.
3. Open a savings account
A great place to start saving is with an interest-bearing savings account, which can keep your money safe while your money grows with interest.
The amount of interest you earn generally depends on the interest rate, how long you keep the money in your account, and how the bank pays the interest. Almost all banks compound interest, which means you earn interest not just on the principal, but also on the interest you earn. The main benefit of a savings account is fast and convenient access to cash when you need it.
4. Start an emergency fund
Building up an emergency fund should be a top priority. Unexpected expenses, such as a huge car repair bill or a medical emergency, can easily wipe out a budget. However, an emergency fund that can cover at least three to six months of basic living expenses in an interest-bearing savings account can ensure that an unexpected emergency won’t totally derail your financial plans. Having an emergency fund means you won’t have to rely on credit card debt to pay for emergencies and other unexpected expenses.
5. Start saving for retirement
While retirement may not be a top-of-mind concern right now, it is important to start saving for retirement early.
When saving for retirement, it’s not just the amount you have to invest that matters, but also the length of time you have to invest. If you start saving early when you’re young, you may be able to grow your savings at a much faster rate than those who wait—because of the power of compounding.
To illustrate the effect of compounding, consider a 25-year-old who puts aside $250 every month for retirement and earns an 8% annual return on her investment. By the time she reaches age 65, her savings will have grown to more than $878,000. But if that same person waits until she is age 35 to begin saving, and puts aside the same monthly amount and earns the same rate of return on her investment, her savings will have grown to just $375,000 by the time she reaches age 65. By waiting 10 years to start saving, she sacrifices more than $500,000 in potential returns.