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The twenties are a perfect age to start planning a solid financial future. How completing my education, building a good credit history, buying a home and saving for retirement set me off on the right track for building long-term wealth.
Completed my education: According to a 2010 U.S. Department of Education study, young adults with a bachelor's degree earned 28% more than young adults with an associate's degree, 53% more than young adult high school graduates, and 96% more than young adults who did not earn a high school diploma.
Having scholarships and working two jobs ensured I did not take out student loans at the undergraduate level. I chose my major and minors in subjects that interested me (which helped me get good grades), and also those that had good earnings potential. I got a job at a major investment bank on Wall Street, which has a generous pay (for onerous hours) and also positioned me well for a future MBA.
However, since the median of the earnings of young adults with a master's degree or higher was only 20% more than those with a bachelor's degree, it did not seem cost effective to give up my income, get a student loan, enroll in a masters program for two years, and then return to the same career. I instead opted for the Chartered Financial Analyst (CFA) program, a rigorous diploma that was highly regarded in my field of work. My employer paid for the program without requiring additional commitment from me and I completed the program over three years, the same time it would take for a part-time MBA but at no cost to me. I got my 20% raise soon afterwards.
Built a credit history: Oftentimes, students or young adults are offered credit cards with annual fees or high APRs. These help protect the credit card companies in case the consumer defaults. My first credit card was as an additional user under my parent's account (and therefore no-fee). This got my social security information on file with the credit bureaus and started building my credit history. A few months after I graduated from college and got a job, I opened my first independent credit card. I kept my spending in check, paid diligent attention that my monthly payments were on time, and I never carried a large balance on the credit card. Over time, I opened a handful of other accounts (never over a short period of time) keeping in mind that my overall debt was low, especially as a percentage of my total credit limit. This helped keep my FICO scores in the "excellent" category and allowed me to buy both a house and car by my mid-20s.
Bought a house: For a single person with limited deductions, a home can provide two important deductions that offset taxes: mortgage interest and property taxes. Rent is not tax deductible. I got pre-approved for a mortgage before I started looking for a house, which kept me within budget. I also shopped around and got a good rate without points. My personal goal was to pay over 20% down to avoid paying private mortgage insurance (PMI), keep my recurring (mortgage plus escrow) costs in check, and have enough cushion for property tax increases and unexpected maintenance costs. Luckily, when I got married, I was able to sell my first house after three years of living in it at a decent profit. Per IRS rules for principal residence, the capital gains from this sale were also tax free.
Opened a Roth IRA: With a Roth IRA, you contribute post-tax dollars into a retirement account, and the income from it is exempt from taxes at retirement. Soon after I started working full-time, I opened a Roth IRA account. The amount was modest, but it allowed me start the 5-year "seasoning" clock required for taking early distributions for qualified first time home purchase (tax-free and without penalty), or for higher education (without penalty).
Contributed to a 401(k): A 401(k) plan is a qualified defined contribution plan that allows employees to contribute pre-tax income to their retirement account. Withdrawals are taxed as ordinary income upon retirement, which effectively postpones income taxes.
Although investing in both a Roth IRA and a 401(k) seems counter-intuitive given their opposite bet on future taxes, for me, a 401(k) offered the allure of free money from my employer -- if I could kick in 4% of my paycheck, they would as well. It seems unbelievable in hindsight that almost half of my 401(k) consists of funds that were not contributed by me.
More from this contributor:
- Investing Education
- Personal Finance - Career & Education
- credit history