Financial Management and Planning for Millennials

According to Schwab’s 2018 Modern Wealth Index, millennials have their financial act together more than the average person might suspect.  The study revealed that 31% of millennials (defined as people born between 1981 and 1996) have determined their financial goals and have a written plan.

Before you scoff at what might appear to be such a low percentage, consider that the study also revealed that just 20 percent of generation X (born 1965-1980) and 22 percent of baby boomers (1946-1964) said they had accomplished both of those goals.

Another interesting tidbit revealed that 36% of millennials have specific savings goals compared to 25% of generation X and 17% percent of baby boomers.

Despite this encouraging news (at least for millennials), still, only about one in five millennials work with a financial planner to achieve their long-range goals.

What is a financial plan, and why do millennials need one?

As of 2017, millennials became the largest segment of the U.S. workforce, with 56 million members either working or actively looking for work.  That outpaced 53 million gen X’ers and 41 million boomers.

With this much economic impact and as a growing force in the economy, the need for millennials to take care of their hard-earned money is more important than ever before.  Many can expect significant upswings in their careers and their disposable incomes in the coming 20 to 30 years.

Many millennials are on the road to becoming more financially savvy.  They are opting to self-educate and make decisions on their own.  But as millennials grow older, the stakes are raised as their salaries grow and the time they have left in the workforce declines.

Millennials need a financial plan if for no other reason than to deal with their debt issues.  Approximately 25% are carrying more than $30,000 of debt and 11% with a staggering $100,000+ of debt.  Paying off student loans was cited by a third of survey respondents as having a significant impact on their ability to save money for the future.

Debt is also putting off other major life milestones like buying a home or getting married.

The same Schwab study also revealed that debt isn’t the only thing that’s causing millennials to delay their long-term savings goals.  It comes as no surprise that millennials are squarely focused on short-term spending on things like vacations, entertainment, and life experiences, even if it delays retirement that is still decades away.

Other research supports this.  Millennials eat out more often than other generations, and 87% say they’re willing to splurge on a nice meal, even when money is tight.

LendEdu surveyed 1,000 millennials in 2018 and found that more than 25% spend more on coffee each month than on retirement savings.  Also, about one-third spend more on clothes than on retirement, while almost half spend more on dining out than on retirement.

To change spending habits like these, pay down debt, and begin saving for the future, its essential for millennials to create a financial plan and then approach it with discipline.

The one advantage millennials have over other generations is time.  Here’s an example of how time can work in a young person’s favor.

If you’re 18 and want to build a million-dollar nest egg by the time you’re 70, investing just $71 per month at a 9 percent average annual return should do it. But, if you wait until you’re 28, it’ll take $176 per month, and if you wait until you’re 38, it’ll take $448.

While millennials have the advantage of time, the amount of changes they tend to go through in their 20s and 30s is more significant than people who are in their 40s and 50s.  Older demographics have settled into their personal and professional lives for the most part. They can concentrate more on saving for retirement, especially if their income levels have risen.

Financial planning for an older demographic is different than for a millennial.  Goals are much different.  There is more emphasis on asset allocation and protection of capital through more conservative means.  Younger people can be more aggressive in their approach, and financial planning will take on a different look for them as a result.  The discipline of spending, saving, and investing regularly is most critical at this stage, as opposed to the size of the investment.

Identifying short- and long-term financial goals

Financial planning requires establishing several long-term and short-term financial goals to get you to that big-picture goal.  You have the advantage because you’re young, but as you move through life, time can slip away quickly.  Before you know it, time becomes the enemy and not your ally.

Consider the following steps to take as you begin charting healthy long-term financial security goals for you and your family:

Stop living paycheck to paycheck.  You need a cushion, even a small one, to insulate you from the unexpected.  Trim expenses.  Don’t acquire large sums of debt.  Create a budget.  And stick to it!

Develop an emergency fund.  Most experts recommend starting with three months’ pay as a guideline.  If you can grow this to a more substantial amount for a bigger cushion, you’ll protect yourself even more from downturns.

Diversify your investments.  As you start putting money into various investments, diversify your funds to help reduce risk.  When the market drops, you may minimize your losses this way.  Also, don’t panic and sell when the market does fall.  Because you are young, you have time to recover from the drops that are inevitable from time to time.

Take care of your family. Consider term life insurance in case something happens to you.  Create an estate plan.  It doesn’t need to be complicated.  Having a will or a living trust in place can save your loved ones a lot of trouble at a time when they’ll least be able to handle it.

Keep your investments simple.  Fancy investments may produce dramatic results, but you may also lose your shirt as well.  Stick to mainstream investments, and remember to let time do the work for you.  Figure out what level of risk you’re willing to take for your lifestyle and match investments to that level of risk.

Consider the 50/30/20 rule.  As your savings grow, you can allocate money to various parts of your life while still protecting your long-term goals.  The 50/30/20 rule states that 50% of your income should go to necessities, such as your house and taxes, 30% toward discretionary items, like vacations and meals out, and 20% toward savings.

Establish a relationship with a financial planning professional. At some point, you’ll want the benefit of a professional’s advice. A significant life change, such as having a child, or getting a job with a big bump in pay, may trigger the need.  Don’t go it alone.  The stakes are too high to make errors that you may never be able to recover from.

Formulating and implementing spending and savings plans for millennials

The first thing you need to do is to build a buffer that will protect you from unexpected downturns.  That could be a major car expense, getting laid off, a health issue, or any number of unforeseen incidents.

But how do you build that buffer if you’re already stretched thin?

The simple rule is to save before you spend… pay yourself first!

Just like taxes come right off the top of your paycheck, so too should a dedicated amount for savings.  If you can, set up a direct deposit of a portion of your earnings, so you don’t even see that money.  Participate in your employer’s retirement plan, such as a 401(k).  You’ll be surprised at how quickly money can build from one year to the next when you aren’t thinking about it every day.

Spending and savings plans are the results of habits that you build.  The earlier you get into proper habits, the easier it is to protect yourself financially.  Even if it’s just $20 a paycheck, always try to stash a little something away.

The other key is to live within your means.  Credit card companies target millennials with attractive offers to get them hooked into a long-term relationship.  A little credit is a good thing.  Too much credit, used poorly, will kill you.  Stick with just a few cards with attractive terms, and pay off the entire balance each month.  If you can’t do this, you aren’t being financially honest with yourself.

As far as big-ticket items go, don’t get sucked into buying too much car or too much house early on.  If you’re responsible, make those long-term goals, not short-term goals.  Don’t become car poor or house poor for any reason.

You can make it easier on yourself if you start early, develop good habits, and allow the magic of compounding to work in your favor for as long as possible.  You might think it a bit crazy to be thinking of retirement while you’re in your 20s and 30s, but that is precisely the time to use your advantages to your favor.

Tips for paying off debt

Paying off debt is a function of discipline and time.  With so many things competing for your attention, it’s easy to lose control and run up bills that can leave you with monster financial hangovers.  The first battle you have to win is with your desires.  Understand when you delay a little gratification now, you can enjoy a lot more later, especially when your personal balance sheet is clean and in order.

If you’re at a loss at where to start, here are some commonsense ideas that may help you.

• Don’t spend more than you have. Obvious, right?  In theory, it is, but when you’re out on the town, shopping or dining out, or taking weekend road trips or indulging in a pricy bottle of wine, you can easily run your bottom line into the red.  Credit has its place in your life, but that should be for big-ticket items, like a car, a house, or investing in your education.  As for all the small stuff, only sweat it if you buy it and can’t afford it.  Discipline starts here.
• Build a cash buffer. It doesn’t have to be much, but at least have an emergency fund on hand for those unexpected hits that should always be expected.  Start with $500.  Build it to $1,000.  A little bit of insurance can bring you a lot of peace of mind.
• Make at least the minimum payments on all debts every month. You’ll make a bad situation much worse if you don’t make minimums because you could do some long-term damage to your credit score.  Be diligent, and if you can afford to pay more than the minimum, then do so.
• Start budgeting. Add up all your expenses and compare them to your income.  Track your essentials vs. your optionals.  If you can pay more toward debt each month, you’ll save money because you won’t be incurring interest charges, which can turn a $100 item into a $150 item quite easily.  Be realistic, so you’ll stick to your budget and not get frustrated when you don’t meet your goals.  Habits, even good ones, are hard to break once they’re established.
• Choose either an avalanche or a snowball payoff strategy. That involves paying more than the minimum each month.  The avalanche method is also known as debt stacking.  After paying minimums, you aggressively focus on and pay off one loan at a time.  Focus on your high-interest debt first.  That’s what saves you the most money until you get to zero.

With the snowball method, you pay off your lowest-amount loans first before moving onto bigger loans.  Interest rates do not factor into your order of payoffs.  You will pay more money over the long-run and will be paying off the debts over more time, but you gain the satisfaction and momentum of knocking out those smaller loans upfront.

Both methods work.  It’s up to you to pick the one that’s easiest for you to live with, depending on your habits and willpower.

• Pay debts with compound interest first. Compound interest means that the interest you are charged is added to your existing debt (i.e., credit card debt).  It builds over time, sometimes at a faster rate than you can pay it down if you only make minimum payments.  In effect, you could end up paying interest on interest.
• Debt with simple interest (i.e., student loans) means the interest you’re charged is only calculated off the amount of money you initially borrowed or the principal.
• Automate payoffs when possible. The less you think about it, the less likely you will be to deviate from your plan when your willpower and discipline waver.  Consider automating payments if you’re comfortable doing so.

What are the main categories of debt?

There are many forms of debt, but all fall within four main categories:  secured debt, unsecured debt, revolving debt, and mortgages.

Not all debt is created equal, so you should be familiar with the different categories and how they function.

Secured debt is backed by an asset that serves as collateral.  For example, you buy a car on credit, and the vehicle is the collateral against the loan.  A lender will supply you with the cash necessary to purchase it but also places a lien, or claim of ownership, on the vehicle’s title until the debt is paid off.

Unsecured debt does not have any collateral.  Lenders rely on good faith with your promise to pay back the loan.  A contract binds you, but the only way to reclaim money is to file suit against you if you default.  Credit cards and medical bills are typical examples of unsecured debt.

Revolving debt is an agreement that allows a consumer to borrow up to a maximum amount on a recurring basis.  Credit cards and lines of credit are good examples of revolving debt.  Revolving debt can be unsecured (i.e., a credit card) or secured (i.e., a home equity line of credit).

Mortgages are loans made to purchase homes.  The real estate is the collateral for the loan.  A mortgage typically has the lowest interest rate of any consumer loan product  Loans are normally issued at 15- or 30-year terms to keep monthly payments affordable for homeowners.

Understanding your credit score and why it’s important

Credit scores impact your finances in many ways.  Scores affect what kinds of loans we get, at what rates, whether or not we can rent an apartment or buy a house.  In some cases, they are used by employers in deciding whether to hire someone or not.

Take the time to understand your credit score.  Credit scores are often referred to as a FICO credit score.  That is because Fair, Isaac, and Company, founded in 1956, focused on credit scoring services.  Since that time, it has evolved to become a measure of credit risk for consumers and is considered a standard in the United States.

Your credit score is based on items found in your credit report.  That includes your past and present credit accounts, who you owe money to and how much, and most important if you have paid on time or not.

Your FICO score evaluates risk by dividing your credit information into five parts:

• Payment history
• Amounts owed
• Length of credit history
• New credit
• Types of credit used

Your payment history and the amount you owe are weighted more heavily than the other three categories.  Potential new creditors are most interested in knowing whether or not you have paid other creditors on time in the past.  Also, the amounts you owe carry different levels of importance based on what kind of accounts they are.  For example, student loans and other installment loans don’t negatively impact your score like high balances on revolving accounts such as credit cards.

Overall, FICO wants to see you consistently bringing your total debt level down and maintaining a low utilization ratio.  A utilization ratio is the amount of total credit you have versus the amount of credit debt you ow.  For example, if you have $10,000 in total credit and have $3,000 of credit debt, your utilization ratio would be 30%.

The amount of weighting in each category will also vary from consumer to consumer.  For example, younger consumers who have not had credit for a long time might have credit scores that emphasize payment history more than the length of their credit history.

FICO scores typically range from 300 to 850. Generally, a score above 670 is considered a good credit score on these models, and a score above 800 is deemed to be exceptional.

Essentially, the better your credit score, the better the terms you will receive when you borrow money.  Better terms mean lower interest rates and loans that are easier to repay.  Consumers with higher credit scores will also be offered opportunities that those with lower scores won’t.  That can mean the difference between getting a home loan or not or taking out a loan to buy or grow a business.

The three major credit bureaus are TransUnion, Experian, and Equifax.  Each uses slightly different criteria to develop a consumer credit score, but they are generally pretty close in the end.  Many creditors report consumer credit activity to all three bureaus, which is then used to generate a credit score.

By law, you are allowed one copy of your credit report from each of the three bureaus annually. You can get this at www.annualcreditreport.com.  You can also pay a fee if you want to see your credit report more frequently.  Many people spread out the free reports and request different copies every four months to check for errors that may appear.  If errors do pop up, its best to dispute these errors immediately and get them resolved, so your score doesn’t take a hit.

In recent years, free credit services such as Credit Karma, Credit Sesame, and Quizzle have started offering free web-based tools to track credit scores.  While this can give a general indication of a credit score, the caution here is they do not use official FICO scores.  As a result, they may not be as accurate and reliable.

Also, VantageScore is another credit score model that is a direct competitor to FICO.  VantageScore is more inclusive than FICO because it puts a greater emphasis on recent credit history.  That can be important for millennials who are new to the world of credit.   It is also more open to incorporating “non-traditional” data into its model, such as rent and utility payments.

Investing for millennials: Understanding different investment options

The goal of investing is to maximize your reward while simultaneously minimizing your risk.  But how to best go about this?

Some people continue to think that investing is gambling.  But just the opposite is true because you can control the amount of risk that you take.

There are more choices than ever before on where and how a millennial can invest to meet short and long-term goals.  That can be both a blessing and a curse.

Understanding different types of investment options is critical to creating optimal investing opportunities.  About one-third of millennials cite cash as their favorite long-term investment, which lags quite a bit behind other generations who are more diversified in their approach.

Money in savings accounts is safe but provides a low rate of return.  It can become stagnant and subject to rising inflation.  Conversely, stock market investments can compound over the years.  For example, large capitalization stocks returned 10% compounded annually from 1926-2018.  That creates a snowball effect on your money.

According to the National Institute on Retirement Security, saving for retirement, budgeting, and establishing a financial plan remains a challenge for millennials.  Nearly half of all millennials are already concerned about their ability to retire when they choose, and two-thirds are worried about outliving their retirement savings.

To achieve more financial independence, millennials will need to do a better job of educating themselves on what options are available to them and diversify accordingly.

Millennials should start by calculating how much debt they have.  Next, they need to determine how much risk they want to undertake and then decide where their investment funds will come from.

Understanding different types of investments should be the next step.  That ongoing process should include learning about:

• Mutual funds
• ETFs
• Bonds
• Money market accounts
• Certificates of deposit
• Individual stocks
• Stock options
• Equity index funds
• 401(k), 403(b), and 457(b) accounts
• IRAs
• Roth IRAs
• Various short-term investments
• Various long-term investments
• Various retirement investments
• Company match funds

Why millennials need a financial advisor

Millennials love technology, so using technology for financial planning seems like a natural extension.  While it does have a place as part of an overall strategy, millennials should not overlook developing a relationship with a financial advisor.

A human advisor brings another dimension to investing and financial security.  A truly comprehensive approach to financial planning also must include estate plans, tax strategies, risk assessments, and retirement plans.  Building these factors into an overall plan needs a human hand to custom tailor the best course of action for each person’s needs.

A technology-based mindset can bring a wealth of information to a consumer in an instant.  But where technology misses the boat is with the give and take of ideas, using intuition, feelings, and personal values also to drive results.

A human advisor can challenge and react better when your life changes.  Couples get married, have children, buy homes, and send kids to college.  Each of these and so many other life events can have a dramatic impact on family finances.  Building a relationship with an advisor early in life means you will have a long-term partner with institutional knowledge of you as a person as well as your financial portfolio.

Top athletes and entertainers have teams of coaches to protect their interests, and so should you.  It’s one thing to set a plan in motion, but quite another to have someone challenge you on tough questions, hold you accountable, and help you change course when needed.

Planning for the future: Will millennials be able to retire?

Yes, of course, they will.

But don’t think it will happen by accident.

Setting up a financial plan is only half the battle.  Working the plan takes discipline over a long period.  But the rewards are worth it.

If you’re a millennial and you want to retire, consider following these simple steps to start charting a course to retirement:

Figure out how much you can invest regularly.  Even little amounts can add up over time.  Consider paying yourself first.  You can automate this by putting your money in a 401(k) or IRA automatically through a payroll deduction or as soon as it is deposited in your bank account.

Allocate funds to both short-term (5 years or less) and long-term (more than five years) investments.  An example of money you might need in the next five years or less is a down payment on a home, education expenses, or money for a car or other major purchase.  Long-term a Roth IRA is the best deal for young investors and will have significant tax advantages over time. You can open a Roth IRA or a Traditional IRA for as little as $10 a month.

Decide on your level of risk.  Experts advise that if you’re under 35 and are starting to invest in a 401(k), it is best to invest in an aggressive growth portfolio heavily weighted in stocks.  If you are older, go a more conservative route.  A typical asset allocation that makes sense for a millennial is around 90% stocks and 10% bonds.

 Invest heavily in tax-advantaged accounts.  Choosing vehicles that minimize your taxes over time is important.  Getting into tax-advantaged accounts early in life means your money can grow tax-free over an extended timeframe.  Most companies also offer an employee match.  That occurs when an employer contributes to your retirement account, up to a certain percentage of your income.

Start early.  Even if it means starting with just a few dollars every pay period, getting the investment habit early in life gives the power of time to work its full magic.