A recent article by the WSJ listed out the biggest money mistakes by decade. For those in their 20s, the #1 mistake was playing it too safe. Numerous studies have shown this to be the case. This is crazy! Your 20s are the decade where you should be taking the MOST risk. If things go wrong, you have plenty of time to make up for mistakes or recover from a market crash. One study in particular was performed by Lindsay Larson, an assistant professor of marketing at Georgia Southern University’s College of Business Administration. Here’s an excerpt from the WSJ article describing what she found (emphasis mine).
Her team sampled a group of roughly 100 millennials and found that they tended to favor retirement accounts with little stock and more guaranteed income—choices that would bring skimpy returns over time. When asked why they chose such a conservative portfolio, participants said things such as, “I honestly know nothing about money right now,” but explained that a portfolio with a lower risk level seemed like the “best option.”
What really stands out to me is that so many millennials are so clueless about money. This is a complete failure of parents and our education system to prepare kids for the real world.
In addition to having a low financial literacy, the study also suggests millennials often struggle with independent thinking, decision making and risk taking because they fear making mistakes. Some of that stems from the environment they’ve grown up in. One crisis after another has impacted their lives. From the dot com bubble burst, to 9/11, to the recent financial crisis. It’s no wonder why they fear the stock market. The media predicting a big market correction for stocks over the last 4 years doesn’t help their perception of the stock market either.
Failure to Educate
Parents and the education system have failed to teach this generation about money. I myself am technically a borderline millennial. Depending on the publication you look at, I either fall at the beginning of the Millennial Generation or at the end of Gen X. In my case, I was lucky to have a father knowledgeable about investing and personal finance. When I was in my early college years, he was always trying to get me more interested in investing. His attempts failed as at the time, as I was more concerned with the here and now, and didn’t care about growing my wealth (which was none at the time). But after college he gave me a copy of David Bach’s Automatic Millionaire. That was when the light switch flipped on for me. It outlined how easy it was to accumulate a sizable nest egg just by starting early and investing regularly.
Not everyone is so lucky though. Without a parent to educate them, where is the Millennial Generation going to learn about money? Our education system isn’t going to teach them. We’re more concerned with making sure they know about the Spanish Inquisition than personal finance. Learning history is great, but maybe we should also be teaching them some real life skills? Especially before they make one of the biggest financial decisions of their life in deciding what school to attend, which could result in student loans in the 6 figure range. Perhaps a little bit of financial education would be helpful for Billy to realize his $35,000 starting salary doesn’t go too far after making payments on $100,000 of student loans.
Getting Started in Your 20s
1) Pay Yourself First!
Before you pay the government…before you pay on student loans…before you spend money on anything…pay yourself. Read David Bach’s Automatic Millionaire. This is a great book to get you started saving and investing. Most importantly, it will teach you the wonders of compound interest. Start investing early and the pain of having money taken out of your paycheck will decrease immensely. You won’t miss what you never had.
2) Enroll In Your Company’s 401k Plan.
Many companies now have 401k plans that automatically enroll new hires into their 401k plan. Find out if your company does this. If so, great! The first step is already taken care of. Don’t just forget about it though. Automatic enrollment is typically done at a very low percentage of your income, typically 3%. This won’t get you on the road to financial freedom anytime soon. Start by contributing at least 15% of your gross pay and work your way towards maxing out. The maximum contribution for 2016 and 2017 is $18,000 per year (not including your employer’s match). Again, it will hurt a lot less in the beginning than if you wait and get used to having this additional money in your take home pay.
3) No 401k? Open an IRA.
If your company doesn’t offer a 401k plan, open up an IRA. The contribution limits are much lower than a 401k ($5,500 per year) and you won’t receive a company max. Despite that, you’ll still get tax deferred growth on your investments. Invest in low cost ETFs. You can then supplement your IRA with an after tax account. Utilize a robo advisor, like Wealthfront, for ease of startup. You’ll be able to set up automatic contributions that will be invested for you according to your predefined investment strategy which they help you determine.
4) Invest in Low Cost ETFs.
Keep costs low by investing in Exchange Traded Funds (ETFs). These funds track an index, such as the S&P 500, and are not actively managed. This keeps fees very low. The Vanguard 500 ETF (VOO) has a 5 star rating from Morningstar and a fee structure of just 0.05%. Compare this to mutual funds which are actively managed and carry higher expense ratios. Many times these expense ratios can reach 1.50% and higher. That means they have to outperform the index by 1.50% just to break even for the investor.
5) Increase Your Financial Literacy.
Take control of your financial future. By not having a plan you are planning to fail. There are so many resources available today to new investors. There is absolutely no reason why anyone should be lacking in financial literacy. Read Automatic Millionaire by David Bach and The Millionaire Next Door by Thomas Stanley and William Danko. There are tons of great personal finance books out there. These are just a few. Read blogs on personal finance, like Go Finance Yourself! (shameless plug), and replicate the investment strategies of those who have done it before you. The goal is to educate yourself, so you don’t have to rely on others.
Readers, why do you think Millennials have such a low financial IQ? What recommendations do you have for someone in their 20s to get them started on the right path towards financial independence?