You know what else isn’t taught in schools to our country’s future leaders? How to be fiscally responsible, how a retirement account works, or how to build credit.
First, let’s discuss saving money and retirement accounts. These are important.
Savings is the easiest thing to explain, so I’ll start with that. At any given time, you should have 3–6 months worth of bills and living expenses saved in your savings account. If you spend $2000 per month, your savings account should have $6000 to $12000 in it. This is to ensure that you are taken care of in the event of a medical emergency, job loss, or any sort of general emergency (for example, your car breaks down and you need it for work).
There are a lot of different ways to approach saving. $12000 is a lot of money, but you have to start somewhere! And every journey starts with a single step.
- One option is to take a specific percentage of your paycheck and put it directly into savings, say 10%. This is a very good way to make sure you are saving money every month.
- Another way is to pay all your bills and expenses out of your checking account and the night before you get paid your next paycheck, put all of the leftovers from your last check into your savings account. Some weeks it may be $50, others it could be $250. This is a less reliable way to save specific amounts, but can be effective.
- Another way is to automatically deposit a specific amount, say $100 per paycheck, into your savings. You can set your bank account online to automatically make this transfer for you, recurring weekly, every 2 weeks, or monthly. This is also a reliable way to save.
All of these are effective ways to save money, and you should be doing one or more of them.
There are two main types of retirement accounts. One is a 401(k), which is through your employer and you can have multiple of them, through each of your past and current employers, or you can roll old 401(k) accounts into your current one. The other is a Roth IRA, a long-term investment account using after-tax dollars, invested in stocks, bonds, and more.
What is a 401(k) and Roth IRA?
A 401(k) uses pre-tax dollars, and you pay income tax when you take the money out of the account at retirement. A Roth IRA is different than a 401(k).
A Roth IRA uses after-tax dollars to give you an even better deal. With a Roth, you put in already taxed income into stocks, bonds, index funds, etc, and you don’t pay taxes on it when you withdraw the money.
Here are the ways to put money into these accounts: You can automatically transfer $100 (or more) per month from your personal bank account into an IRA you opened yourself through Charles Schwab (or Wells Fargo, or many many other options). You yourself are putting your after-tax dollars into the IRA. This money has already been taxed.
For a 401(k), the money is taken out of your paycheck from your employer before you are paid and deposited into the 401(k) account. You are not physically depositing or transferring the money yourself and the money has not yet been taxed. You will pay income tax on it when you withdraw it from the account.
These two accounts work well together, and you should definitely have both. You should start a 401(k) the moment you have a job, and a Roth IRA as soon as possible. These accounts will grow over your lifetime and will be what you use in your retirement as your income.
Many employers will match a certain amount of money in your 401(k). For example, my last employer would match half up to 6%. Which means if I put 6% of my pay into my 401(k), at the end of the fiscal year, my employer would put in an additional 3%, half of what I contributed. This is money not out of my pocket, and serves as an incentive to put money in the 401(k) and save for retirement. Check with your employer to find out if they do matching and what their parameters are, and then take advantage of that.
Roth IRAs are great because you can contribute however much you want to them and can invest it in mutual funds, stocks, bonds, and more. You’re not restricted to what you originally invest in, you are able to buy and sell within the account as much as you want.
The important thing to remember is this: They are both great accounts to save for retirement, you should do it as early as humanly possible in your life, and the biggest differences are that 401(k) is pre-tax dollars that you will be taxed on when you remove the money, and Roth IRAs are after-tax dollars that you do not pay income tax on when you remove the money at retirement age.
There are other types of retirement accounts, and also traditional investment accounts, but these are the two most common and work well in conjunction with one another. Feel free to do more research! Learning about finance stuff can be very fun!
Building Credit: Credit Cards
You need good credit for a lot of things in life. These include buying a car, renting or buying a home, getting a loan, and more.
Basically, you will need good credit for almost any major purchase in life.
Sometimes you don’t have any credit simply because you have been extremely fiscally responsible and have paid for everything you have outright in cash. Sometimes you just haven’t made any major purchase which requires credit. Either way, having a solid credit score is going to be important in life.
The easiest way to start building a good credit score is to get a credit card. Even if you don’t think you need one, get a credit card. Then to actually build the credit, you need to USE the card, not go over the limit, and pay the bill on time every month with at least the minimum payment.
However, the BEST way to use a credit card is to make your regular purchases, like gas, groceries, dinner out, drinks at the bar, things you already spend money on, and then pay off the credit card in full every month. By paying on time every month, you are establishing a solid credit history of on time payments. By paying it off, you are not wasting money on the interest your credit card will charge you if it holds a balance.
Because you are paying your credit card off in full every month, you are basically using it as a debit card: only spending the money you already have.
As you continue to use your credit card responsibly, the bank will often raise your limit, lower your interest rate, and sometimes offer you perks. Because this is money you would usually spend in cash, you’ll be able to pay it off monthly. But instead of the 0.003% interest you earn from the money sitting in your bank account, you can also get perks, points, and rewards from using a good credit card.
Many cards offer cashback, discounts on certain items or categories (like groceries or movie theaters), and air miles towards flights around the world. These are awesome perks that you can build up while using your credit card for things you already have the money for.
Credit cards are also important in case of an emergency situation, like car repairs, dental work, doctor visits, and more. Things you may not have the cash in hand for but need right away.
Other Ways to Build Credit
Other ways to build or grow your credit are very similar. Basically, have bills in your name. Make sure your car and insurance are in your name, and make sure you are paying these bills on time. Anything in your name is helping you build credit. Things like having your apartment lease in your name, the utilities bill, gas bill, etc.
If you’re a parent, you can help to build your child’s credit early. My parents had my car insurance in my name when I was 16, even though they were paying the insurance (I had given up my allowance and gotten a job at 15, and my allowance money I would have gotten covered the car insurance cost). By making timely payments, my credit was already starting to be built when I graduated high school and moved away for college. This was a very helpful jump-start!
Even if you have good credit, you will likely still need a cosigner on student loans, apartment leases, and car financing until you are around 21 years old.
Having bad or no credit will absolutely impact your life. You will have higher interest rates on credit cards and loans, if you can even get one, and you may be barred from loans or even getting an apartment lease based on your credit score!
Once you have started to build your credit, you should also make sure to manage it. Once a year, run your credit report and make sure that everything is correct. If you ever notice something on there that is incorrect or fraud, you need to report it immediately so that your credit is always correct.
If you suspect fraud, talk to your bank and freeze your credit so nothing can be opened in your name until you unfreeze it.
Saving money, having retirement accounts, and building your credit are extremely important, and is what will allow you to be a self-sufficient, independent adult and later, a self-sufficient retiree.
You may not have heard much about these in school, but you are in charge of your money and your destiny. Educate yourself on fiscal responsibility. Even if you think you have plenty of time, start a retirement account ASAP, and build your credit so that you can have nice things in your life. This stuff is so important for your future, and it can be hard to realize it’s importance at 19 or 21 or even 25.
Read more, learn more, get interested! Financial stuff can be exciting. The first time I put money into the stock market, I was nervous and very excited, and learned a lot about how the stock market works.
Get interested! This is your future, and you need to be in control of it!
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