Thursday, September 20, 2007

Finances in Your 20's

A few days ago an anonymous reader left a detailed comment regarding the "Finances in Your 20's" series of posts I did a couple of months ago. I thought it would be interesting to post the full text of the comment and share my thoughts about it.

Here is the comment in full. I added emphasis in a number of places:

"Thanks for the great series. I read it very carefully as I AM in my 20's, fell into a GREAT job, and realize there is great financial potential if I make the right choices now. Everyone says "start young" or "don't make mistakes when you're young" or "I wish I would have... when I was young." But not very many people offer practical advice of what to do WHILE you're young, have a great paying job, and need to know what to do with all that disposable cash.A few

Points of reaction:

1. House. I bought one. The housing market where I live was far too tempting not to, I couldn't stand living with family a second longer, and I wasn't about to throw away thousands in rent. I think if you're planning on staying with your current job for at least 5 years, and you are in a strong growth area, you can't do any harm purchasing a house. It also helps TREMENDOUSLY at tax time, since I have no dependents to claim on my return.

2. Savings: I currently contribute 6% to the company 401k and my company kicks in an extra 4% (yay for free money), but having non-taxable savings seems VERY attractive. I will definitely look into the ROTH IRA. I hadn't considered IRAs, since I have pretty much maxed my current paycheck out.

3. Stock: I have several thousand shares of options in my company, and have just started participating in the company stock purchase program which allows me to purchase stock every 6 months at 85% of the lowest market value. I am maxed out at 10% of my gross in that program.

4. Charitable donations. This is one you didn't mention that I think you should have. Young people, no matter how poor, should get in the habit of giving back. I give between 10-12% to my church and other charitable organizations. It helps at tax time and it's the right thing to do. If you wait to be "rich enough" give back, you will wait forever.

I wish I could do more... like start a ROTH, or diversify my portfolio, but I'm pretty maxed out. I had to give up my glamorous vacations to start doing the stock purchase program. Now I just go home for the holidays. I have to constantly evaluate my life/money balance, and certain things like gym memberships and cable TV have all met the chopping block.

Also, I really liked your post about investing in yourself/career; spending the extra time and effort while you don't have attachments. I spend my evenings doing work on my own start up company, and while it gets tiring, I'm hoping it will all pay off in financial independence in the future.Any ideas, feedback, suggestions are welcome... "

First of all, what an awesome comment to receive. I really enjoy writing this blog, and it's nice to know that my readers find my articles useful. Thank you very much for taking the time to write such a detailed comment.

Let me comment on some of the points the reader made:

My anonymous reader is clearly well on his way to financial security. He seems to have made many smart decisions, and he understands the trade off between spending and saving. He has taken those first steps to financial stability a decade or more before most of his contemporaries will start to think about issues of financial planning. Kudos!

Regarding the purchase of a house while you are in your 20's. I have written a number of posts about why I don't think that real estate is a good investment, and particularly why I don't think it is a good investment for people in their 20's. However, if you are buying your house because you want to move out and own your own place - and not as an investment - there is absolutely nothing wrong with it. I completely understand that some people really need the emotional attachment, convenience and perceived security of owning a home. However, I always find it strange when people refer to renting as throwing away money. I have many points to make on this topic and will address them in a future post. For now, I will share only one important thought: by renting I am able to take the large chunk of cash that would otherwise be tied in bricks, and invest it in highly diversified, high yielding investments. I am not throwing away money on rent, what I am doing is the equivalent of taking out a low cost loan to invest in a highly profitable opportunity. Somebody else's capital is tied up in the house I live in.

One a different note, there are two financial errors I think that the commenter is making. The first is owning a large number of shares in his own company stock. To find out why I think this is a big error, see my post on the subject. I also think that the reason the commenter is accumulating shares is his company's ESPP which allows him to purchase shares at a discount. Purchasing the shares is the right move. Hanging on to them is not. Once the shares are purchased at a discount, it is probably a good idea to sell them and pocket the difference. More about my proposed ESPP strategy in this post.

Although the commenter does not say so explicitly, I am getting the sense that he thinks he is not diversified. If that is the case, this is a serious financial error. To diversify your portfolio you don't need to have a lot of money, and you don't need to to pay through the nose to achieve diversification. Here is a good way to take a step in the right direction: when you sell your company shares, use the proceeds to purchase a diversified index fund, such as Vanguard's Total Market Index Fund. Diversification is a sound financial strategy that will pay off in the long run.

The reader is clearly doing almost everything right financially, but he appears to be paying a high personal cost for some of his decisions. For example he mentions that he is no longer taking "fancy vacations". To me it's all a question of happiness. I used my 20's to travel the world. Yes, it cost a lot of money, but I don't regret that expense for a second. Let me tell you something: as a mid-career professional, taking large chunks of time off to go traveling is not very feasible. Doing it with three small kids is pretty much impossible. So, yes, plan for your financial future but make sure you don't fixate on the money. Enjoy your youth. Your memories will last a lifetime and the money is very well spent.

Regarding the after hours start-up and giving back to the community, all I can say is "more power to you!"

As you can see, I read every comment left on my blog, and respond to pretty much all of them. So, keep 'em coming. Let me know what you think about my posts and let me know if there are any topics you would like me to tackle. I will be glad to do so.


plonkee said...

A misspent youth is certainly invaluable. I own my own home now, but I never thought of renting as throwing money away. I have to live somewhere, much like I have to eat and I don't consider grocery shopping throwing money away.

Anonymous said...

I bought a house in my early 20s also. I am still torn about whether this was a good decision or not. I feel like I missed out on some opportunities because I was tied to a mortgage and couldn't take on as much risk and adventure in my life. I'm not sure I would recommend it to other young folks.
I agree completely about selling the company stock shares. One thing though, that might be a good idea, is to hold on to them for a year to get the lower capital gains tax rates. Hold each batch for a year, then sell.

frugal zeitgeist said...

Well said, sir.

High Interest Savings Account said...

I agree so much! I have thought about being a fee based planner - but then your focus changes: you need to get clients so you end up focusing on sales versus just writing about what you are passionate about.