Advice for a young adult learning to manage money

Note: Today's post is a little different. It's a letter to a young friend, who asked to remain anonymous. She's 21 and just landed her first job. Now that she's bringing home a regular income, she wanted advice on what to do with her money. Here's my response.

First up, I think it's awesome that you asked me for advice. That took guts! Plus, it's a sign that you're already making good decisions. You're being proactive, taking charge of your own life. I like that.

Like you, my parents didn't teach me how to handle money very well. They did their best, but it's tough to teach what you don't know. I've had to figure a lot of this stuff out on my own, and I've made a lot of mistakes along the way.

You'll make mistakes with money too, I'm sure. They key is to not let these mistakes compound. Don't let one mistake lead to another mistake. When something goes wrong, pause. Take a deep breath. Don't panic. Call me for advice, or ask somebody else who seems to have things figured out. Okay?

I have so much I want to share with you, but I'm going to hold back. I don't want to overwhelm you with stuff that you don't need to know right now. Do me a favor, though, and read that book I mailed you: I Will Teach You to Be Rich. There's a lot of good info in there. Some of it won't apply to you yet, but it doesn't hurt to read the whole thing so that you can know what's coming in the future.

For now, let's focus on the fundamentals.

First Things First

After thinking about this for nearly a week, I think that your focus should be setting up what I call your basic “financial infrastructure”, then creating three buckets for your money.

To start, you need two bank accounts: a checking account and a savings account.

You told me that you already have a Capital One 360 checking account, which is awesome. That account has no fees. (Some banks, like Wells Fargo, charge an outrageous $10/month fee for checking. This is insane. There's never a good reason to pay a bank for the privilege of having an account with them.)

It's also awesome that you're having your weekly paycheck automatically deposited to your checking account. Super smart.

The next step is to open a savings account. I know that you'd like to save for some future goals, such as possibly purchasing a house. To do that, it's best to separate your savings from the pool of money in your checking account.

Since you already have a Capital One 360 checking account, you should open a savings account with them too. Kim and I have some joint Capital One 360 savings accounts. We like it because we're able to have different accounts for different purposes, and we can name each one. (When we were saving for the RV, for instance, we had a specific account just for the RV.)

What about credit cards? Don't worry about them yet. As you said, you want to establish good money habits. Once you've learned how to save and spend without getting into trouble, then you might consider a credit card. But that's a talk for sometime in the future.

Make a Plan

Now that you have your basic financial infrastructure in place, it's time to make a plan for where your money will go each month. You don't need a detailed budget. If you want one, fine, but there's no real need.

You're bringing home about $200 per week, which is roughly $800 per month. Make sure you know how much is being taken out of your paycheck for taxes. If you don't have enough withheld, you'll owe money next April. Odds are, however, that everything is fine.

From your $800 monthly income, I recommend you route your money into three “buckets”: fixed expenses (or “needs”), discretionary spending (or “wants”), and savings.

Let's look at fixed expenses first.

I'm under the impression that you have $350 of fixed expenses right now: the money that you pay your mother for phone and housing. One popular rule of thumb is that you should spend less than 50% of your income on fixed expenses — and less is better. You're at about 44%, so you're in good shape. Nice work!

Now, here's something important.

You're 21 now, and you'll probably want to move out on your own in a year or two, maybe with a friend. That's great! When you do look for your own place, though, keep your housing cost as low as possible. Seriously, I cannot stress this enough. The number one way to screw yourself over is to pay too much in housing! So many people do this every day, and it's tough to recover from. Always always always do what you can to keep your housing costs low.

Remember this rule of thumb: Your spending on needs should be less than half your paycheck. Following that one rule alone will put you far ahead of your peers.

Now let's look at the other two “money buckets”: discretionary spending and saving.

Spending and Saving

After you've met your monthly obligations, any money you have left over is yours to do with as you please. You have two basic options here.

  • You can spend the money now.
  • You can spend the money later.

If you were in debt, you'd have a third option: You could repay money you've already spent.

At this point, I'm going to give you another piece of important advice: Avoid debt. Trust me. I know from personal experience that debt is like drowning. (Some people say it's like slavery.) Debt sucks. There is no reason for you to take on debt at this stage of your life. When the time comes to buy a car, buy it with cash. (If you decide to buy a house or go to college, then debt might be okay. We can talk whenever one of these becomes a possibility.)

Most people in the United States spend all (or most) of their money on the present moment. When they get paid, they spend whatever they receive. The advantage of this is that you get to do and have lots of stuff today. The disadvantage is that you have zero flexibility. If something bad happens to you, you're screwed. If an amazing opportunity comes along, you can't take advantage of it.

A lot of folks feel like saving for the future is risky. What if you die tomorrow? Then all of that money is wasted because you never got to use it! But you know what? Hardly anyone dies tomorrow. In fact, most people live into next week, next month, and next year. And the year after that. If these people are spending all of the money they earn, they never have the freedom to do anything other than work.

I used to be one of these people. For a long time, I spent every penny I earned. (I spent more than I earned, actually. I was deep in debt for seventeen years!) I know better now. After reading and writing about money for more than a decade, after talking with hundreds of people about how they handle their finances, I realize that saving for the future is not risky. In fact, the opposite is true. It's risky to not save for the future.

But you have to find a balance between today and tomorrow.

Oops. Sorry. I got side-tracked. Where were we? Right…

So, you have two basic options: Spend your discretionary income now or spend it later. What you want to do is a little of both.

Spending and Saving, Revisited

Now that you have your own money, there'll be things you want to do with it.

You'll want to buy clothes. You'll want to go out with your co-workers. You might want to buy a bicycle. These are all great uses for your money. But here's an important lesson that I learned the hard way: You can have anything you want, but you can't have everything you want. Does that make sense? Trying to have everything is what leads people to spend all of their money.

The real trouble is that if you don't set aside money for the future whenever you get paid, it's very easy to spend everything you bring home.

Because of this, I recommend that when you get paid, you immediately send a certain amount of money to your savings account. Put money into your saving “bucket” before putting it into your spending bucket. There are a couple of ways to do this.

  • You could say to yourself, “Self, I want to put $100 per paycheck into savings.” (Or $50 or $250. Whatever.) Each time you get paid, you religiously set that money aside.
  • Or you could decide to save a certain percentage each month. You might save 25% of each paycheck, for example.

You'll have to decide how much is right for you, but I encourage you to put as much into your savings account as possible. At a minimum, try to save 10% of your check, or about $20 per pay period. Saving 20% — $40 per pay period — is even better. I encourage my readers at Get Rich Slowly to save half of their income. And some people do! (For you, that would mean saving $400 per month, which would leave you just $50 per month for discretionary spending. But you know what? If you managed to save $400 per month, you'd be kicking ass!)

After you've put money into your needs bucket and your savings bucket, you'll still have some left over. If you save $80 per month — and that should be the minimum you aim for — then you'll have $370 left. If you save $160 per month, you'll have $290 left. If you save $400 per month, you'll have $50 left.

Here's the good news: This remainder is yours to do with as you wish. Whatever you want! Live it up!

That said, I'd caution you to spend this money carefully. Don't fritter it away. Spend it only on the things that truly make you happy. In your case, that might mean art supplies or fantasy novels. It's up to you to decide. But the key is to actually decide. Make a conscious decision about how you're spending your money. Make sure you're getting value for what you spend.

Final Thoughts

Obviously, there's much more to being smart with money than opening bank accounts and putting money into three buckets haha. But this is the place to start.

The basic rule of personal finance is this: To build wealth, you must spend less than you earn. There's no way around it.

I believe that your goal for 2018 should be to build the habit of setting aside money for needs, wants, and saving. And as much of that should go to saving as possible since you have some lofty plans for your future.

If you get in the habit of saving, then you should have somewhere between $1000 and $4000 set aside by the end of the year. That's a lot of money! When you're able to do that, then it's time to have another conversation about money. We can talk about how to invest and about the power of compounding. (You are so lucky! You are young, which means that your money has tons of time to grow. If you start saving now, you could be very rich by the time you're old like me.)

Let me know if you have any questions about all of this. And be sure to read the comments below. Get Rich Slowly readers are smart, and they're sure to have some excellent advice on what to do as you're starting out in life…

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freebird
freebird
2 years ago

First on my list would be to immediately have your employer deduct a future-self tax assessment from your paycheck. In other words sign up for your company 401k plan and contribute the maximum percentage allowed. Put all of this money into a globally diversified equity mutual fund with a low expense rate and leave it there. Understand that as its share value fluctuates your dollar cost averaging will come out ahead (ironically the more volatile it behaves the better). Then from the net pay that remains you can pick up where this post begins. Source: been there done that three… Read more »

Sequentialkady
Sequentialkady
2 years ago
Reply to  freebird

Freebird, what do you suggest for those whose employers don’t offer 401k plan? (Eg, those working in the public sector or those working for small private companies?)

S.G.
S.G.
2 years ago
Reply to  Sequentialkady

Auto-withdrawl into an IRA with automatic mutual fund investing.

Fidelity has a nice one, and all trades on Fidelity funds are free which is great for small time investment like she would be starting out.

I’m sure other brokerages offer similar account setup.

dh
dh
2 years ago
Reply to  Sequentialkady

S.G. is on the right track. I would modify her comments slightly to auto-withdraw into a *Roth* IRA with automatic *index fund* investing, not mutual fund investing and the high fees that come with it. Of course, an index fund is a type of mutual fund, but I think it’s important to make the distinction, as an index fund has the super low expenses and fees that traditional mutual funds do not have. Fidelity does have a nice index fund, and it’s called Spartan Total Market Index Fund (FSTMX). However, most people use Vanguard for index fund investing, as they… Read more »

S.G.
S.G.
2 years ago
Reply to  dh

Agreed. And that’s what I meant, I forget to clarify for newbies as we all seem to agree here that index funds are where it’s at.

Thanks for having my back on the clarification!

Sheila
Sheila
2 years ago
Reply to  dh

Is there a minimum deposit or because it’s recurring no minimum?

dh
dh
2 years ago

Use common sense when you decide to choose your college degree or career. “Find your passion” is not necessarily the right answer. Your passion could be writing fantasy novels or drawing an online comic, yet there is no realistic call for that in the market place. If you took every fantasy novelist or every online comic artist who can actually make a living from it, you could fit them all in a standard-size living room. So just realize making a career out of stuff like that is like winning the lottery, same absurd odds. Do stuff like that on the… Read more »

Sequentialkady
Sequentialkady
2 years ago

JD — what would you suggest that students who are on financial aid/work study do to manage money and save for emergencies/the future WITHOUT DISQUALIFIYING THEMSELVES for aid? My supervisor and I have given them our tips for cutting costs and being thrifty: don’t get the coffee/tea with the froufrou (plain coffee is fine), pack your lunch/dinner (eat out 2x weekly as a treat!), lower cost cell providers, there is no need to pay more than $200 for a phone, your student loan is for school + needs (use as little as possible), buy your clothes off the clearance rack/thrift… Read more »

S.G.
S.G.
2 years ago

I know living with your parents can save a lot of money. But I’d suggest on top of the savings you have suggested an additional chunk come out every paycheck to save for a deposit on an apartment and/or other emergencies. I don’t think she should be blowing her money before having a small savings cushion. I think it should be at least cover the expenses of moving into a small one bedroom apartment. Not that she should immediately plan to, but she will eventually and it would be prudent to be ready for it before she spends her extra… Read more »

Jill
Jill
2 years ago

Make sure you actually get a pay stub when you get paid, whether you have to log in online or whatever. My daughter failed to do this and found out in January that $600 something was taken out for health insurance, which she already had and didn’t need. We told her to go back to the employer to see if that can be refunded, but as of today, she “hasn’t had time.”

WantNotToWantNot
WantNotToWantNot
2 years ago

What a great thing to be thinking this way so early in life! Asking for help from the Money Boss is awesome! I wish I had been so wise at your age… One way I was wise though was in choosing my friends. At one point I was looking for a roommate situation and went on a bunch of “look-sees” for apartments in my price range. One apartment was absolutely gorgeous (and affordable!) but it very quickly became apparent that my potential roommates were trust-fund babes; they had as much money as they wanted from their daddies, their jobs were… Read more »

Dana
Dana
2 years ago

This is fantastic advice! I had never thought of that but I’m passing it along to my daughter.

lmoot
lmoot
2 years ago

Work early and often. When tou’re Single and it’s just you, it’s easier to make saceifices. Take care of and hang onto your 1st car for as long as possible. If you plan on staying in the same area 3-5 years, buy a cheap place and get a roommate/roommates. If college is important but you don’t want loans, do everything above, but establish it in the state/ area where you plan to attend school. If I could do it over, I would buy a cheap house near campus (after living at home after high school, and working as much as… Read more »

lmoot
lmoot
2 years ago
Reply to  lmoot

“to NOT work towards a goal”

S.G.
S.G.
2 years ago
Reply to  lmoot

I heard recently “When I have seriously worked toward a goal I have never been worse for it. I don’t always achieve my goal but I’m always better for setting it and working toward it.”

SoberFinance
SoberFinance
2 years ago

Baby steps are always a good thing. How many of us have those ambitious New Years’ resolutions that we forget about in March? It’s important to have a cash reserve if you lose your job, an unexpected medical situation occurs or other similar things pop up. BUT, having a large cash cushion when an opportunity comes around is equally as important. How many of us would have liked to not only continue dollar-cost averaging with our 401(k)s through ’08-’09, but also be able to invest reserve money at once in a generation prices?

Jennifer
Jennifer
2 years ago

I think it’s helpful to note that saving and investing early for women can help mitigate the wage gap that shows up after women have children. By harnessing compound interest, women can give themselves the freedom in their 30’s to switch jobs, go part-time, or stop working for a while without stressing about income. More than 70% of women 30-34 have at least one child, so this is a reasonable thing to plan for, even if your 21 year old friend doesn’t think she will have children.

Jake Jones
Jake Jones
1 year ago

That one quote:

You can have anything you want, but not everything you want.

It just sums up personal finance so well. I’ll try to keep that one in mind when I am making my decisions. 🙂

Wally1
Wally1
1 year ago

Well, I have to agree with almost everything here, however I disagree with direct deposit of your pay. It is none of your employers business where you bank. and set up an emergency fund. It will come in handy when an unanticipated needed car repair, etc… happens. Try to use cash, and go to garage sales, get some tools to fix things you can do for yourself. This will save you a lot of money in the future. OH before I forget. If your 21 and still living at home, great, use this opportunity to save like crazy. Want to… Read more »

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