Young families are certainly facing more challenges than was typical for baby boomers at their age. The high costs of college — your own and your children’s, the uncertainty of employment, the high cost of housing and the disappearance of pensions all make demands on planning.
Start Right With an Emergency Fund
Everyone needs an emergency fund. Otherwise, you’ll end up with a lot of credit card bills as soon as the first emergency occurs. It can take quite a while, a couple of years, at least, before your emergency fund builds to the three to six months’ worth of expenses usually recommended. It’s important to strive to accumulate at least $1,000-$5,000 before considering any investments.
What’s first? Pay the minimum on your student loans. Next, invest enough in your company retirement plan to get any employer match. Building the emergency fund is next in line, before you pay extra on any debts and start saving for a house or the kids’ college. Until you have at least a minimum emergency fund, you should be very frugal about any other expenses. Don’t consider this money an investment: Put it in an easy-to-access savings account. Internet savings or money market accounts may offer higher interest, but you need to be able to have it available for spending with very little lag time.
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Pay Off Debt
If you have student debt, you already know you have plenty of company. No matter what is in the wind politically, don’t stop paying your loans, and if you’re able to pay more, don’t stop. We have no idea what will happen and can only work with what is, now. The interest meter is ticking away.
I’m going to assume you’re not eligible for income-based repayment, since it’s a complex topic beyond this article. Do everything you can to make the minimum payment on all loans. If you can scrounge up at least a little more, take the following steps:
- List all your loans, with total amount owed, minimum payment due and interest rate.
- Rearrange them by interest rate —highest first.
- Pay the minimum on all loans, every month, no exceptions.
- Concentrate all extra payments on the highest interest rate loan (or the lowest total balance, if paying off something would give you more satisfaction.
- Once that loan is paid off, move your extra payment and the minimum payment from the paid off loan to the next highest loan. Keep on.
Too often people pay a little more on each and every loan, but that’s not the fastest way. If you have low rate college loans say, under 5% interest — you may be better off devoting possible extra payments to savings or college savings for your own kids rather than rushing to pay these off.
Long-Term Savings and Retirement
Do your utmost to save at least 10% of your earnings into long-term, don’t-touch-it accounts. Once you’ve gotten the 401(k) match, typically 3%-6%, can you save more? For most young people, their next account should be a Roth individual retirement account. You can contribute up to $6,000 per person, but do it early in your career. With any luck your earnings will rise to the level that you’re no longer eligible to contribute: $122,000 single, $193,000 married filing jointly. Building that nest egg early in your career will allow it to grow for a long time. Unlike a 401(k), a Roth can be invested in individual stocks. This is a great account in which to begin making any individual stock investments.
If you’ve maxed out the Roth, circle back to the employer plan and consider contributing more. You might not get a match but your contribution will reduce your taxable income.
Many people change jobs and either cash out their retirement plan (no! no! no!) or leave it behind, half remembered. You can roll it into your new employer’s plan, open an individual IRA and roll it into your own choice of investments, including individual stocks, or leave it where it is, if you keep careful tabs on it. Whatever has the lowest fees and good options determines what you should do.
College for Kids
I’ve yet to meet the client who was sorry they’d saved so much. The earlier you begin saving for your children’s college, the less you’ll need to stash away each month. But focus on your own high rate college loans first. If you have paid off college loans, or have only low rate ones left, you can begin saving for your kids’ college. Remember that you don’t have to save every penny; you’ll probably be in your highest earning years as your children reach college age and will be able to pay some out of then current income.
Don’t assume that because your child is so intelligent or athletic, he or she will get scholarships. Most “scholarships” these days are need-based, not merit-based, and the ones based on merit are often small and short term.
The most common vehicle for college savings is the 529 plan. Evaluate your own state’s plan first, because you’ll likely get a tax deduction from your home state. Plans don’t allow you to invest in individual stocks, so carefully consider index options: age-based for most people, but a more aggressive balance if you can tolerate the risk or have other sources to cover any shortfall.
You’ll be glad for any savings, even if it doesn't cover all costs. Save nothing and your kids will be burdened with many years of debt payments.
For many young families, buying a house is a primary goal. If you live in a high cost city, this can seem out of reach. Can you live in a cheaper area, factoring in the cost of a long commute? Can you settle for less space but close to work?
Not every child needs an individual bedroom, a luxe kitchen isn’t strictly necessary and people lived for centuries without a family room. Can you get by with public transportation or one car?
None of these frugal strategies need be forever, but it’s important to build up a fund reserve before increasing consumption, rather than trying to save what’s left, because there never will be any “extra.”
Talking to Your Parents
In many families, discussing parental finances is taboo. Yet I urge you to have this discussion. Young families are caught in a web of their own needs and their children’s needs, possibly even the needs of their aging parents. It’s much easier to discuss estate plans and medical and long-term care when they’re healthy and decisions are far away. You should know what your parents plan should they ever be unable to manage for themselves and do whatever you can to put those plans in place.
If your parents are investors, try to learn from them about their investments, why they were chosen, and what their intentions are for selling or holding. It’s much easier to ask questions now than when you inherit the portfolio and better to learn over time than in the midst of a crisis.
The first principle of an inheritance? Don’t plan on it. So many things can happen — the need for extended long-term care, changes in the investment market, changes in the real estate market, remarriage of a widowed parent — that an inheritance isn’t certain unless you’ve received it.
But let’s say you have received it. If you are married, no matter how happily, keep an inheritance in a separate account in the name of the heir only. This keeps the inheritance from being joint property, not only in the event of a divorce but also if one party is sued by creditors, or becomes disabled and needs to qualify for Medicaid. At 35 or 40 it can be hard to imagine all the eventualities that might happen 20 years in the future, but estate attorneys, personal injury lawyers and financial planners deal with unexpected life changes every day.
Try not to blow it or use it for lifestyle augmentation. Use it for more important goals, like a home down payment, but you need to try to guard it as money that will not be easily assembled again.
If you have inherited a long-held portfolio, don’t rush to make changes but don’t delay forever, either. All of these points apply to any investment portfolio you ever assemble.
- Find out if you’re being charged fees for account management and what they are. You should be skeptical of annual fees over 1% of asset value.
- Your grandparent may have had a relationship with a bank, but the same adviser may not be appropriate for you.
- What are the fees to trade?
- Are there frequent trades in the account? If the original owner was an active investor in individual stocks, you might see more frequent trades than in a portfolio of mutual funds, but more than a few per quarter is too many.
- Is the portfolio right for you? If you inherited from an older person, the portfolio may slant to safety and dividend payers. A younger investor can tolerate more risk and a stronger emphasis on growth.
- Do you understand the investments? I’ve seen portfolios of 50 to more than 100 stocks. Unless you are a very experienced investor who can devote full time to managing them, this is far too many for an individual.
- Are there concentrated positions? Often people have purchased stock in the companies they worked for and over time a portfolio can be very heavily weighted in only a few stocks. Grandma may have had a sentimental attachment to her company, but you should diversify.
BetterInvesting’s Stock Selection Guide is ideal for your initial screening of individual stocks. If you have a large lump of cash, you might consider parking it in a balanced fund, which can be sold off as you identify other investments.
You may feel that you don’t have a lot of excess to invest in the market at the moment, given all the competing demands. But this is probably the best time in your life to begin learning: when you are only putting small amounts at risk and have plenty of earning runway to recover from any mistakes and build compound returns.
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This article was originally published in the October 2019 issue of BetterInvesting Magazine.
Danielle L. Schultz, CFP, CDFA, is a fee-only financial adviser with Haven Financial Solutions, Inc., based in Evanston, Illinois.