Real financial planning for millennials is a bit more extensive than just contributing to your 401(k) and investing in low-cost index funds. In many cases, young professionals have just as many complexities and even more life events than retirees. Life in your early working years is full of growth, change, and opportunity. There are a wealth of planning opportunities available for young professionals. While not a complete list, this post discusses 5 important strategies that millennials should consider when building a financial plan.
1. Build an Emergency Fund
Storing 3-6 months of essential living expenses, in the case of an emergency, is one of the first, yet commonly missed steps in planning. Nearly 80% of Americans live paycheck to paycheck and often the answer to breaking the cycle is to sit down and plan.
Start small and set goals. Use automation to your advantage. For instance, begin allocating a portion of your direct deposit paycheck to a high-interest savings account. However, with automation, just remember to occasionally adjust your emergency fund as your life changes. This first step in risk management planning is simple yet so incredibly effective.
2. Protect your Most Valuable Asset
While it is very easy to become over-insured (e.g. phone insurance, travel insurance, product warranties, etc.) in today's environment, there are some insurances that are imperative. Disability insurance is one of them. The purpose of disability insurance is to protect your income. For young professionals, your ability to earn an income in your respective profession is easily your most valuable asset. Without disability insurance, your financial plan is incomplete. Not to sound morbid, but the risk is real. One in four millennials can expect a long-term disability before they retire.
Disability insurance comes in a variety of options with some more comprehensive than others. Your employer may offer some group coverage, but odds are, it only covers a portion of your income and certain fine print may limit its benefit. For high-income earners, buying private coverage is often needed. Disability insurance is cheaper when you are young and healthy so securing coverage now can be a smart move as you are locking in your premium. Due to the complexity of disability insurance and the ability to customize, it's best to consult with a professional to see what types of plans are appropriate given your situation.
3. Maximize your Employee Benefits
With a strong job market, employers seem to be one-upping each other by offering more robust benefit packages to entice the best talent. Instead of reading too much into the free snacks and gym memberships, focus on the game-changing items. These include 401(k) match, stock purchase plans, restricted stock units, health savings accounts, health insurance options, disability insurance, education reimbursements, and potentially deferred compensation plans.
Coordinating the employee benefits with the rest of your financial plan can be a challenge. It can be easy to get lost in the details. Tackle these items by focusing first on the "free money" benefits e.g. 401(k) match, stock purchase plan discount, health insurance, etc. And remember, while it may be tempting to ask your colleagues how to maximize your benefits, don't copy their strategy entirely. From taxes to financial assets, everyone's situation is different. For example, for someone who has already built a large globally diversified portfolio, they may have a completely different approach to restricted stock units than you.
4. Build a Long-Term Savings Plan
Simply relying on your 401(k) plan is unlikely to yield the retirement you imagine. It is important for young professionals to get into the habit of saving at least 20% of their income. These dollars should be allocated across your various long-term savings vehicles, e.g. 401(k) / 403(b), IRA, Roth IRA, taxable brokerage account. Choosing how much to allocate into what specific accounts depends entirely on your specific goals and your overall financial situation. If you are unable to save 20%, work your way up. Start with 10% then steadily increase.
Implementing this strategy early in your career creates the greatest benefit, a habit. It forces you to live on 80% or less of your income. And as you begin to earn more income, it can even act as a defense to lifestyle creep. Far too many individuals pay themselves last after a raise. Pay yourself first by adding to your long-term savings plan.
5. Use Time to your Advantage
If you’re a millennial, the exciting part is that time is on your side. With a longer time horizon, you can afford to take on more risk in your long-term investment portfolios. More risk means a greater percentage of your portfolio is allocated towards equities. However, you must stay disciplined during market peaks and dips. Don't fall victim to recency bias i.e. acting on news happening now. Many millennials are 30+ years away from retirement. There could be 4 or more presidents, a dozen trade wars, and more by the time you retire. News happening now has little to no effect on your long-term investments.
Make a plan, develop strong financial habits, protect your income, and use time to your advantage. These are the important takeaways as you consider how to best maximize your financial resources. It may be hard to imagine now, but your life will encompass many changes. You may change careers, start a family, go back to school, lose a loved one, start a business, etc. Money tends to move in motion during these events. It is important now to have a strong financial base to support any and all future life transitions.
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