By Elizabeth Paal – CFP®
As January approaches the amount of commercials with weight loss programs and mailings for local gyms are at an all-time high. This is due in part to the common new year’s resolutions of losing 10 pounds, eating healthier and spending more time at the gym. I’m guilty of falling prey to these resolutions, but as we know, this new lifestyle usually lasts only a few months before the weather gets nice again, and happy hours and cookouts replace gym time and clean eating. So instead, what if I challenged you to a new year’s resolution of financial health for 2016?
There are many ways to become financially healthy, but here are a few where young professionals need the most guidance.
Budget – In my October article, I explained the importance of not spending more than you make. Before you can move forward with the advice below, it’s important to have a firm handle on your income and expenses. Once you know where you stand financially, you can start to make smart moves with your excess cash flow. Remember, if you have big purchases throughout the year, such as travel or holiday gifts, save for these on a regular basis throughout the year to avoid cash flow issues and big-bill anxiety.
Eliminate Bad Debt – It is not typically considered financially smart to pay for large purchases via credit card, where you are incurring high interest rate charges, unless you are able to pay the balance off each month.
In the financial world, we separate debt into two categories: good debt and bad debt. Good debt creates value for you while bad debt is used to purchase consumer goods. Examples of good debt would be student loans, real estate loans, business loans and mortgages. Credit card debt, on the other hand, is an example of bad debt. Many young professionals have credit card debt and are paying 12 to 29 percent in interest charges annually for their balances!
My best advice is to start chipping away at this immediately. If you have multiple credit cards with balances, start paying off the one with the highest interest rate. Once that is paid off, move to the next credit card. Depending on how much debt you have incurred, it might take a while to pay it off, but the sooner you start paying it down, the happier you will be! If you have trouble with impulse purchasing, then it also might be a good idea to get rid of your credit card until you are able to control your finances and spending habits.
I’m often asked if student loans are bad to carry, and the answer is no because student loans enabled you to invest in yourself and your career. If you have credit card debt and student debt, get rid of the credit card debt first and foremost. Also remember, if your income is below a certain threshold, you may be able to write-off part of the interest you are paying for your student loans. Check with your accountant or tax advisor to see if you are able to do this.
Save for Retirement – Start saving now for retirement through an employer sponsored plan or personal IRA. Most employers offer a 401(k), 403(b) or Simple IRA. These are tax-deferred retirement accounts. In most cases, the employer will match your contribution up to a percent of your salary. I would make this a top priority since you could be doubling your contribution by taking advantage of employer contributions.
Why is it so important to start early? The “Rule of 72” states if an account grows at 7 percent per year, it will double every 10 years through compounding. Therefore, the sooner you start, the more time the funds have for compounding, which equates to substantial growth. Review your budget to see how much discretionary money you have at the end of the day. But if you were debating between adding money to your retirement account versus buying that new purse, go with saving the money. I promise you will be happy decades from now when you have the money for retirement.
If you are picking between paying your credit cards off or contributing to a retirement account, I would suggest paying the credit cards off first. Once these are paid off then start adding to your retirement plan.
Next month I’ll discuss the difference between types of retirement accounts and the best order to save for retirement with the various accounts offered. In the meantime, if you have any questions, please do not hesitate to email me at Elizabeth.Paal@LFG.com. I hope you have a Happy and Healthy New Year!
Elizabeth Paal is a registered representative of Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and registered investment advisor.