Written by: Grant Wilburn
In an economic environment with relatively stagnant wages and rising costs across the board, financial management on both the individual and professional level is becoming more important every day. Young adults in particular face costs that are somewhat unique to them: rising education expenses (resulting in a cumulative student loan balance of $1.6 trillion as of 2020) and the increasing barrier to entry for the housing market are some of the most commonly cited. Unfortunately, the financial challenges that young adults face don’t stop there; while costs they incur today continue to rise, the need to save for retirement is also higher than it’s ever been before. With the rapid shift from defined benefit to defined contribution plans (e.g., 401(k)s), workers of all ages are starting to depend on personal savings as their primary source of income in retirement. Don’t get me started on social security benefits, either – that topic could be its own post!
While I’ve painted a pretty bleak picture for young adults so far, it isn’t all doom and gloom. Thanks to the never-ending stream of information available to us today, it’s never been easier to brush up on financial literacy and learn how to be fiscally responsible. The sooner the better too – your future-self will thank you.
What Does It Mean to Be Fiscally Responsible?
Fiscal responsibility, in general, simply means that you’re utilizing your financial resources in the best way possible. Pretty easy, right?
In reality, that’s a gross oversimplification – being fiscally responsible has many layers and is much more challenging than it sounds. It involves not only managing your current financial needs, but also means being aware of needs you may have in the future, both short- and long-term. Knowing what obstacles you might face doesn’t mean much if you don’t know how to navigate them, so fiscal responsibility also requires a solid foundation of financial literacy.
The Importance of Financial Literacy
A 2009 study published in the academic journal Numeracy found that financial literacy in college-educated young adults aged 25-34 was shockingly low, with only 49-60% of respondents (with varying levels of degrees, n = 4,500) correctly answering questions to test basic financial literacy. I bring this up mainly to illustrate that financial literacy is not something that’s traditionally taught in schools, so the responsibility to become financially literate rests on the individual.
As it relates to personal finance, being financially literate requires at least a surface-level knowledge of a wide range of topics, which can understandably be very intimidating. Interest rates, loans, taxes, and now even basic investment knowledge are just a few examples of things people are left to figure out on their own. Obviously, everyone can’t be a financial expert on top of everything else they do – that’s where we come in – but the importance of establishing financial literacy from an early age is something that can’t be overstated. Those that don’t develop a sense of financial literacy, at least to the point where they can identify red flags, may end up learning the hard way; the 18-year-old who ends up with a 15% car loan (even though the monthly payment is small!) is a classic example.
Managing Money as a Young Professional: Time is On Your Side
Luckily, young professionals have one key advantage that some others don’t have the luxury of: Time. As the saying goes, the best time to plant a tree was 20 years ago and the second-best time is now. Building financial literacy and your investment portfolio are no different, and starting at a young age means that time is on your side.
For example, consider two employees who both contribute $6,000 per year to their 401(k)s and earn 5% annually, with one starting contributions at age 25 and the other at age 35. Assuming both retire at age 65, the employee who started saving early will retire with a 401(k) balance of nearly $725,000 compared to their coworker’s $400,000, even though the employee who started earlier only contributed an additional $60,000 over the years. While this example doesn’t include any employer match on their 401(k) contributions, young adults should also make sure that they’re capturing any match that their employers do provide. Failing to do so would be leaving free money on the table, which isn’t very fiscally responsible!
Young adults’ long-term time horizon also gives them the benefit of being able to take on more risk in their investments, becoming more conservative as they age. An investor approaching retirement age needs a more conservative asset mix since they’ll be tapping their retirement funds sooner rather than later, but investors with 30+ years until retirement can tolerate a much more volatile portfolio simply because the value has time to recover. Over time, this higher risk should correlate with a higher return on investment, allowing funds to grow more rapidly while the investor’s risk capacity allows it. Building on the first example, let’s assume that the 25-year-old contributing to their 401(k) invests in risky assets for 15 years and earns 10% annually before reallocating themselves to the more conservative portfolio earning 5%. Retiring at age 65, their 401(k) balance would now be just over $930,000. While I admit that you’re not likely to consistently hit the return targets used in my example, the main takeaway is that compound interest and sequence of returns is something that works in favor of those with a long time horizon.
Whether you’re a young adult or an adult of any age, it’s never too late to start on the path to becoming fiscally responsible. Please feel free to reach out to us at Agili if you have any questions or would like help in becoming fiscally responsible and financially independent.
Check out our illustration describing Agili’s Emerging Wealth Program.
If you are a young professional with significant graduate school debt, Davis Barry‘s recent blog post, Prescription for Financial Health: Financial Management for Doctors provides strategies and recommendations which are applicable to all. For some back to basics financial education, check out Agili’s recent blog post, Three Components of Personal Financial Planning.