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A Young Worker’s Guide to Saving for Emergencies and Investing for Retirement

When Emily Bailey graduated in management from Indiana University in Bloomington six years ago, she was in a group of graduates called “Lost Generation” while they tried to maintain a foothold in their careers in an economy still rooted in the 2008-09 financial crisis and recession. Like many, she had thousands of dollars in student loans, had no job in her field, and opted for the position of wedding planner to pay the bills.

And then, when her career was finally evolving, a pandemic broke out last year and she lost her job as a project manager she got at GE Aviation a few months earlier. “I was pretty desperate,” she said, turning to DoorDash for a gig job as she sought full-time employment.

Despite these setbacks, Bailey, now 28, and hired on a new project, just bought a small ranch house in a suburb of Indianapolis with a 10% deposit. Even after buying a home, she still keeps at least $ 10,000 for emergencies at the bank and regularly saves 6% of her 401 (k) retirement pay at work, so she qualifies for her employer’s maximum contribution.

Her discipline could be an example to this year’s college graduates, who are entering the workforce in an economy still recovering from a pandemic, said Paul Fenner, a trading city in Michigan, a financial planner who taught Bailey how to finance and extract meager wage savings.

He and other financial planners point out that even in difficult times, people often have more power than they think to stretch limited wages and start building wealth. Here are some of their tips for new graduates:

Emergency savings

Starting salaries may not leave much to be delayed, but financial professionals say it is crucial for young workers to adopt savings from each salary rather than from what is done with the rest of the cash. Automatically redirect your savings to your bank account so you are not tempted to touch them.

This means that before you make a payment for an apartment or car, first calculate whether you can afford what you watch and still save a certain portion of each salary.

Some of the basic rules can help you. Rent or mortgage – including utilities and insurance – should not exceed 28% of gross income, car payments and insurance should not exceed 10%, and the length of a car loan should not exceed the number of years you are likely to drive a car before than what others buy. In addition, the repayment of the student loan should not exceed 8% of income; although it may be too late to control that share, graduates can apply for “income-based repayment” if their income is too low to be able to make large loan payments.

Some financial planners suggest using a 50-30-20 budget so people don’t spend on their income: 50% of post-tax payments would be reserved for necessities – rent, car payments and insurance, student loan payments, health insurance, phone, food and so on; 30% could go to a party – anything from

Netflix

travel bills; and the remaining 20% ​​should be saved.

Conclusion: Shocks occur and preparation for them is necessary, because young adults are usually among the first measures as economic conditions tighten. Therefore, financial planners say it is crucial to prepare by paying off credit cards in full each month and have an emergency fund to cover basic expenses such as food, housing, health insurance, phone and car payments, in case a person loses their job. The goal is three to six months.

Retirement savings

In addition to saving for emergencies, financial planners say retirement savings should start with the first job, especially if employers offer free money to employees who save 401 (k) s in their jobs.

As a rule, if a person saves 10% of every salary starting from the first job and continues to discipline up to the current full retirement age (67), he should have what he needs to pay for retirement, even if he lives in his 90s.

If 10% is too much, start smaller and work upwards. Let’s say you’re 21 and paid $ 40,000, try saving 5% or $ 2,000 in your 401 (k) plan. If your employer matches with a match, say by giving you half of what you put in 401 (k) yourself up to a certain percentage, you would get $ 1,000 on top of your contribution – putting in $ 3,000 for retirement or a little more than 7% of your salary.

If you continue to increase your savings each year with any raises, and your employer matches the contributions, the combination will soon be over 10% of your salary, and by the time you retire you should have about $ 1.1 million if the 401 (k) investment pays back conservative 7 % per year.

Today, several financial planners are telling young clients to fill in their 401 (k) as needed to get the most out of their employer each year, but to invest additional retirement savings – up to $ 6,000 a year – in Roth’s individual retirement account. When you save at Roth, you will not receive a tax in advance as is the case with a contribution to a typical 401 (k) account or traditional IRA. But once you invest money in Roth, it will never be taxed if you leave the investment in the account until you have at least 59½.

Anyone who has earned a job or a job or a spouse can open a Roth IRA as long as their income does not exceed the limits: $ 140,000 for singles and $ 208,000 for couples.

Where to save and invest

You can’t dare with an emergency fund or with the savings you’ll need within five years for an advance on a house, car, wedding, or graduate school. For specific short-term needs, stocks are too risky because the stock market can lose 20% or more during bear markets.

Although safe money choices now pay almost no interest, money for short-term needs should go to money market funds or to high-yield savings accounts or certificates of deposit. Look for the best prices at DeposititaCcounts.com or bankrate.com.

Retirement money, however, does not have to be protected as short-term cash must be. In fact, excessive conservatism with investing in retirement can be dangerous because the savings will not grow adequately.

Historically, the stock market – measured by the S&P 500 – averaged about 10% a year. But it could be years like 2008, when the stock market lost 37%, or years like 2019, when it gained 31.5%.

Since guessing when these cycles will happen is crazy even for investment professionals, financial planners say they bet on averages: Put most of your 401 (k) money into a diverse mix of stocks through a fund like a total stock index fund, add on her with every salary and don’t touch her even if the market falls. Although bear markets and losses will occur, historically good years have far outweighed bad ones.

Another diverse investment common to 401 (k): date-targeted funds. Find them among the funds offered to you by looking for a number in the name that is close to the year you are likely to retire, maybe 2060. That fund for the 2060 target date will be more prone to stocks as you get younger as the idea is to give your money the best chance for growth over 40 or more years, while the fund for the 2030 target date, for example, would have fewer stocks and more fixed-income investments because owners would likely be closer to retirement.

Write to penzija@barrons.com