Navigating personal finance can be a daunting task for young adults, especially since it’s not typically taught in high schools or colleges. This lack of basic financial education often leaves many ill-equipped to manage their money effectively and avoid debt.
However, the importance of financial planning cannot be overstated. Starting early allows young professionals to grasp money management concepts sooner, accelerating their path to financial independence and long-term goals.
In this article, we’ve sought insights from Daryl Wright, Managing Director at Lumnya Investments, a $15 billion boutique asset manager specializing in developing and marketing alternative investment funds. With 20 years of experience in financial services, Daryl has designed investment products and innovative solutions for clients.
Daryl emphasizes the need for personalized financial advice, considering the diverse circumstances, incomes, access to products/services, and tax regimes individuals face. Despite these differences, he offers eight general tips that should benefit most young people looking to improve their financial health, cultivate good money habits, and build wealth.
1. Earn More Than You Spend
The most crucial financial tip is to earn more than you spend. It might seem obvious, but it’s surprising how many people overlook this basic principle and find themselves in financial trouble. Achieving financial security requires discipline and sometimes means making sacrifices. While we all want to indulge in nice things, it’s essential to weigh our desires against our earning capacity. Before making a big purchase or splurging on luxuries, ensure that you either already earn enough to cover the cost comfortably or have a concrete plan to increase your earnings. Since increasing income isn’t always easy, the more practical approach is often to adjust your spending habits. This requires careful budgeting, setting achievable financial goals, and being willing to make lifestyle changes as necessary.
2. Education! Education! Education!
There’s no substitute for education when it comes to managing money. The more knowledge we have, the better decisions we can make. Whether it’s learning about investing, exploring sources of passive income, or understanding how to avoid common financial pitfalls, prioritising learning is crucial. Thankfully, there are numerous free resources available today, including YouTube videos, podcasts, and books. While the abundance of content might seem overwhelming, you can start by finding one resource that focuses on a topic of interest and gradually expand your knowledge from there.
3. Investment vs Savings!
According to Wright, it’s important to understand the distinction between investments and savings. They don’t have to be separate; in fact, your savings can be used for investments. The key is to align your risk tolerance with your savings objectives. For instance, if you’re saving for a house deposit, it wouldn’t be wise to invest in a risky stock market venture. However, you might find relatively low-risk investments that offer better returns than a standard bank account. Before investing, it’s crucial to assess your risk tolerance. Ask yourself questions like, “How would I feel if I experienced a 10% loss?” or “How would I cope if I lost all of the money?” Compare your answers with the likelihood of such losses occurring to make informed investment decisions.
4. Compounding is Your Friend
The fourth tip emphasises the power of compounding in finance. By earning positive returns or interest over time, you can earn interest on the interest you earned in previous years. For example, an investment that gains 10% each year will double your money in just 7 years. Therefore, it’s important to focus on finding stable investments that will consistently produce positive returns.
5. Compounding is Also Your Enemy
It’s crucial to understand that compounding can work against you when you have debt. For instance, credit card debt can quickly escalate due to high-interest rates and the practice of encouraging minimum monthly payments. This situation causes your debt to grow rapidly, as you end up paying interest on the interest. Therefore, it’s important to prioritize paying off any credit card debt promptly to avoid compounding. If you receive a cash windfall, consider using it to pay off high-interest debt before seeking other investment opportunities.
6. Debt is a tool, so sharpen your skills
Contrary to popular opinion, debt should be viewed as a tool that can be used wisely to achieve positive outcomes. Like any tool, it can be beneficial when used correctly but can also be harmful if mismanaged. For example, a mortgage used to purchase real estate can create leverage and enhance returns on the property. Therefore, being overly fearful of debt may not be sensible or realistic. Instead, it’s important to understand the cost of the debt, typically disclosed as APR, and compare it against the expected rate of return from the investment or the cost you are willing to pay for the purchase.
7. Plan for the Unexpected Plan
It’s important to plan for the unexpected in your financial strategy. As Mike Tyson once said, “Everyone has a plan until they get punched in the mouth,” and this can certainly ring true when faced with unexpected financial burdens. These could include the costs of an unexpected funeral, expenses related to a natural disaster, or the loss of a source of income. While it may be challenging to plan for these events, there are tools available that can provide some assistance. Insurance policies, such as income protection or funeral cover, can be purchased to provide a lump sum payout when such events occur, helping to alleviate the financial burden. It’s essential to explore the insurance policies available to you to ensure you are adequately prepared for unexpected events.
8. Pension? That’s for my grandparent right?
Many young people may not prioritise a pension as it can feel like retirement is a long way off. However, this is precisely why starting a pension should be one of your first investments. The earlier you begin, the more time you have for compounding to work in your favour, allowing your money to earn interest on the interest. Additionally, in most countries, you benefit from paying little or no taxes on investment gains made within a pension. Starting a pension early also means you can afford to take a bit more risk with your investments, potentially leading to faster growth. Even if you experience some losses, you have time to recover and grow your pension pot before you retire.
In summary, discipline is crucial for building wealth and maintaining strong financial health. It’s important to manage your spending, as this is often within your control. Continuously educate yourself about money, focus on investments that compound over time, and steer clear of high-interest debts that can compound rapidly. Explore insurance products that can provide financial security during unexpected events, and start investing in a pension as early as possible to take advantage of compounding and tax benefits. By following these principles, you can lay a solid foundation for a secure financial future.
