By Wealthspire Advisors. Originally published at ValueWalk.
Your 20s are often a great transitionary phase. For many, this is a time dedicated to self-discovery, learning about life at a lightning speed, and entering what may start to feel like your first stage of “real life.”
As you enter this era, you are experiencing quite a few “firsts” – likely your first “real” job, with your first “real” salary that includes benefits and at least a few days of paid vacation every year. Your 20s may also include a few moves across a city, a state, or the country. And just as you are getting settled into that new job or new apartment, life has a funny way of handing you a few lemons, stirring things up, and creating new opportunities.
It’s undeniable that these transitions can be exhilarating, fulfilling, and challenging all in one! In addition to the excitement of change, the monetary cost of these new experiences quickly becomes apparent. It can be daunting to realize that you’ll need to understand and manage these costs. So, here are seven considerations to keep in mind when building your first budget.
Tip 1: Understand Your Gross vs. Net Income
A common challenge many young adults face during their first year out of college is accurately estimating what their actual take-home pay (also known as net income) will be. Understanding the distinction between gross and net income will be important as you begin building the rest of your budget. If you are already working and receiving a steady source of income, you may already be familiar with how much of your gross salary is withheld for taxes, 401(k) contributions, health benefits, etc. However, if you are not yet employed, there are many online tools that can help you estimate what your take-home pay will be.
Tip 2: Saving is a Must
When building a budget at any age, one of the most critical line items is your intended savings amount. If you have not built a budget before or haven’t thought much about saving on a regular basis, it can be helpful to think of your savings as a fixed, non-discretionary expense – meaning savings are a must.
When determining what the “must save” amount is, make sure you understand what exactly you’re saving for. As financial planners and advisors, we tend to think of money in different buckets:
- Short-Term Bucket: This will typically include your emergency fund and maybe some additional cash set aside for upcoming needs (like bi-annual insurance payments, a security deposit on a new apartment, etc.). For the emergency fund, it’s recommended that you have three to six months of your fixed expenses saved (including rent, groceries, insurance, etc.). Having a clear idea of these expenses makes it easier to see how much you’ll need to save.
- Mid-Term Bucket: This is a bucket of money for items that may not be needed in the next few months, but also aren’t too far away. This could be a new car or a large trip you have planned. Saving for these goals is more of a discretionary form of savings, as the amount you’ll need to save is highly dependent on your goals.
- Long-Term Bucket: These are dollars you’ve set aside for items that are in the distant future and are potentially invested dollars (such as retirement savings). For a retirement account, the actual amount you plan to save can depend on external factors like your 401(k) match or your overall free cash flow (dollars that aren’t going to other non-discretionary expenses). A nice goal can be to save between 15 – 25% of your gross income. However, with retirement savings, something is always better than nothing! If you can’t quite save 15%, start small and slowly increase your savings as you go.
Another important concept to keep in mind when determining your budgeted savings amount is the idea of habituation. If you can start developing saving habits in your 20s, you’ll be more likely to stick with these habits throughout your lifetime.
Tip 3: Manage Your Rent, Don’t Let it Manage You
Rent is typically one of the largest portions of your budget in addition to being a non-discretionary expense – meaning, you must have somewhere to live! A general rule of thumb for rent is that it should be no more than 25% of your gross income. However, if you are living in a major city like San Francisco, New York, or Seattle, this may seem unattainable. Do spend some time thinking through what is most important to you when it comes to housing (amenities, proximity to friends, square footage, etc.), and don’t forget that there are dozens of platforms to help you find your perfect place to call home.
Tip 4: Housing Costs Go Beyond Just Rent
Before signing a lease, it’s important to remember that housing costs include more than just rent. Here are a few additional expenses to make sure you’re accounting for:
- Utilities: If you’re renting an apartment, check with your landlord or property manager so you know what you are responsible for.
- Wi-Fi and/or TV Services
- Parking: Depending on your housing situation and mode of transportation, you may need to consider what the additional cost of parking will be each month.
- Renter’s Insurance: Many property managers require that their tenants carry rental insurance. This can usually be bundled with your auto policy and is relatively inexpensive given its more limited nature of coverage.
Overall, a good target for your total housing costs is 36% or less of your gross income.
Tip 5: Account for Student Loans
As a recent college graduate, a new expense that will need to be incorporated into your budget are your student loan payments. Depending on the type of loans that you have, you may have a grace period (often 6 months) before payments are required. While you may have time to delay payments, when building an initial budget, ensure you have accounted for this amount.
Tip – For many federal student loans, if you sign up for direct payments from your bank account, you could be eligible for an interest rate reduction of 0.25%.
Tip 6: Don’t Underestimate Transportation Costs
As you are reviewing your budget, you may be earmarking dollars for transportation. Depending on your main mode of transportation, this amount can vary greatly relative to other categories. If you’re living in a metropolitan area, you can probably use public transit as your main method of travel. A great aspect of public transportation is that it sometimes offers a fixed monthly cost for unlimited use. Discover what options are available to you in your area, such as a monthly bus or train pass.
For many young adults, public transportation is not the only way to get around. If you already own a car, you may not need to factor in the cost of ongoing payments, but you will need to factor in the following:
- Ongoing Maintenance: This will include regular maintenance like oil changes which typically occur every few months. However, there are also inevitable larger expenses that will be incurred on an irregular basis, perhaps every few months or every few years. If you’re not in tune with the ongoing maintenance your car needs, consider adding some cushion to this area in your budget or increasing the amount that you dedicate to your short-term savings (emergency fund), knowing these dollars can be tapped into for a major car expense.
- Insurance: When you first began driving, you were probably added to your family’s insurance plan. For some families, there are clear expectations around when an adult child will be moved off their plan, but for others, that conversation may not have taken place yet. Auto insurance premiums can be lower when bundled with other coverages, so if you’re able to stay on a plan with your family, the premium may be more affordable. If you will be moving off your family’s insurance plan, make sure to shop around and do your research into what coverages are included, understanding that the lowest premium plan may not meet your needs. Don’t be afraid to ask questions about the coverages included and what they mean for you.
Tip 7: Make Smart Choices with Food, Groceries, and Miscellaneous Expenses
When reviewing the various categories within your budget, you may be identifying which items feel more discretionary (shopping, travel, restaurants, and bars) and which ones are more non-discretionary (rent, savings, insurance). While food and dining costs are non-discretionary in nature, the overall portion of your budget dedicated to this will vary depending on the choices you make at the grocery store, restaurant, and on the go.
Groceries: Unlike rent and savings, there is no widely agreed upon “rule of thumb” or benchmark for food costs. However, there are a few tips to help you stick to a regular grocery bill rather than one that fluctuates greatly. Why not try to plan out your meals ahead and limit grocery trips to one to two times per week? Remember, the more you visit the store, the more you will be inclined to buy and the more impulse purchases you’ll be tempted to make.
Dining Out: This is an area of your budget that will be heavily dependent on your lifestyle. It can be helpful to set a target for the number of meals you’d like to eat out each week, then to estimate what the average meal cost would be. You can then determine what your monthly “dining out” budget will be. This is also an area that many people tend to over-spend in. But rather than getting frustrated or feeling defeated by slipping on your budget, just think of the trade-off – “For every extra $10 I spend on dining out, this is coming out of another area in my budget”.
While achieving balance and having it all “figured out” by your mid-20s is not likely, getting your toes wet with budgeting can be a great start. In addition to helping make sense of the various changes happening, starting a budget early on will help instill positive life-long habits.
About the Author
Julie Penwell, CFP® is a senior advisor associate at Wealthspire Advisors.
Wealthspire Advisors LLC is a registered investment adviser and subsidiary company of NFP Corp.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, Certified Financial Planner, and CFP® (with plaque design) in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. © 2022 Wealthspire Advisors
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