One of the most common misconceptions about money is that income
is the biggest driver of wealth.
While of course income helps, in
reality, the main determinant of wealth (or erosion of) is
dictated by your spending habits, and many people fall into the
habit of spending more as they earn more.
Making smarter decisions about
money presents a big opportunity for people under 40.
The benefits of making smart
money moves now will compound over time and have the potential to
make a big impact on your financial picture.
1. Don't stop after maxing out your 401(k)
contribution
If you're able to make the
maximum annual contribution to your 401(k) and still have funds
left at the end of the month after your other obligations,
congratulations!
But that doesn't mean you should
spend the extra cash. What you should do is investigate other
opportunities to put your surplus funds to work for you.
The most flexible type of
investment account is a brokerage account. There are no limits on
how much you can contribute and the funds can be liquidated and
used for any purpose at any time. It's important to keep in mind
that a brokerage account is a taxable account, so unlike
tax-deferred retirement account like a 401(k) or IRA, you'll need
to square up with the IRS every year based on your gains, losses,
and proceeds from dividends or interest.
2. Keep your investment strategy boring
Buying single stocks in search of
the next unicorn is certainly more fun than a diversified
low-cost investment strategy, but trying to win big comes with a
lot of unnecessary risks and questionable rewards. Especially if
you have a day job, it's probably unrealistic to find the time to
pour over financial statements and speculate on earnings reports
in hopes of competing with Wall Street analysts who use satellite
images to count the number of cars in the parking lots of major
retailers.
Instead, keep your investment
strategy boring. Don't try to time the market or buy a stock
because you like a company's product. Diversify your holdings
with a global portfolio of investments, like low-cost ETFs and
bond funds aligned with your risk tolerance and time horizon. Try
not to limit yourself to just one or two asset classes either.
For example, if you only hold an ETF that tracks the S&P 500
you will miss exposure to small cap and mid cap equities in the
U.S. and abroad.
3. Get life insurance right
There are many different types of
life insurance — all of which have additional options and
variations, and it can be confusing and overwhelming for many
consumers. However, when it comes to buying life insurance, it's
really important to get it right.
Of course, what is "right" for
you will depend on your goals, budget, family situation, and so
forth— but it's important to keep these key points in
mind:
Term life insurance is the
cheapest option, and for many individuals, completely adequate
for their needs. As the name implies, term life insurance will
provide a death benefit if an individual dies within the policy's
term, up to 20 years typically.
In contrast, whole life insurance
is permanent insurance and will cover your entire life. Before
buying (or getting sold) a whole life policy, step back and
assess your needs. Many parents realize they would only need
coverage from a life insurance policy until their children are
out of college.
If you are single, depending on
your situation, whether you have dependents and so on, you may
not actually need life insurance at all.
Finally, don't buy an annuity
without doing your homework. Annuities are complex and expensive
insurance products that aren't appropriate for a lot of
investors.
4. Take an honest look at your spending
Let's dispel one big money myth
to start: the more you earn, the more you save. For most people,
spending on lifestyle items — like houses, cars, vacations, and
so on — only increases with income. Sometimes growth in spending
even outpaces growth in earnings.
While it is important to enjoy
your success, the truth is that it doesn't matter how much you
make if you spend all (or nearly all) of it every year. Taking an
honest look at your spending and finding ways to cut back can
really pay off later in life.
To do this, consider focusing on
your big ticket items, ones that really move the needle. Keep the
ones that really make you happy and add value to your life.
Consider cutting back on the others.
This may be particularly
important if you have children or plans to in the future. Getting
a head start by saving aggressively while expenses are lower can
provide a lot of flexibility down the road.
You can only spend a dollar once,
but a dollar saved and invested can grow significantly over the
long-term, which is a unique opportunity for those under
40.
