Youth is Entrusted to the Young

There’s an old joke that youth is wasted on the young.  Financially, it’s easy to back that up.  According to tax information service CCH, for example, just 28 percent of workers younger than 25 are contributing to an employer-sponsored retirement plan.

Of course, the best way to take advantage of the power of compound interest is to begin investing when you are young.  However, for young people that can feel like an impossible time to begin investing.  Incomes are low, the costs of starting one’s adult life are high, and besides, retirement is just some vague concept set far in the future.  There will be time to get to that later.

Maybe all that’s missing among the young is a little bit of financial knowledge.  Here are two financial insights I wish someone had shared with me when I was younger.

First, learn the benefits of getting started early and the penalties for waiting.  Use an online calculator to estimate the results of starting to invest at various ages.  For example, if you invest $200 a month starting at age 20, earn an average of 7 percent interest per year, and do that until age 70, you will end up with over $1 million dollars.  Wait until age 25 to get started and you’ll end up with about $300,000 less.  Hold off until you’re 30 and you’ll lose out on $500,000.

Here’s another eye-opening illustration.  Person A invests 200 per month starting at age 20 and then stops investing after 10 years.  Person B waits until age 30 to begin investing $200 per month and continues doing so for the next 40 years.  Person A invests a total of $24,000.  Person B invests a total of $96,000.  Assuming a 7 percent annual return, at age 70 person A ends up with $550,000 while person B ends up with $500,000.

Now here’s the second insight: As early as possible get in the habit of prioritizing your use of money properly.  There are only five things you can do with money once you have some.  You can spend it, use it for debt payments, save it, invest it, or give it away.  And that’s the order encouraged by our culture: use it for lifestyle spending first (where to live, what to drive, where to vacation), make the monthly debt payments that always seem to come with a lifestyle-first life, save and invest if there’s anything left over, and then maybe throw a few bucks toward charity.

The far better order is to be generous with the first portion of any money received, save or invest the next portion, and then build your lifestyle on what remains.

What about debt?  Never carry a balance on your credit cards, don’t finance vehicles, and if you have education debt pay more than the minimum so that you can wipe out that debt as soon as possible.  When you buy a house, take out a mortgage that requires no more than 25 percent of your gross monthly income for the combination of your mortgage, property taxes, and homeowner’s insurance (if you live in a high housing cost state, you may need to go as high as 30 percent).

With these two insights, youth need not be wasted on the young.  If you’re in your 20s, are you putting these ideas into practice?  If you’re older, what other financial lessons do you wish you had learned when you were younger?

6 Responses to Youth is Entrusted to the Young

  1. Matt Bell March 25, 2010 at 8:42 AM #

    This is some good back and forth, Ivan. I think the point about how long you keep your vehicle is one of the most overlooked issues when it comes to buying new. When you plan to keep your vehicle 10-15 years, then buying new can make sense. One other point I’d make about zero percent financing: I would not recommend that unless you have the full purchase price in savings. Otherwise you’re presuming upon the future, which is never a good idea.

  2. Ivan March 24, 2010 at 11:45 PM #

    Thanks Matt,

    I almost convinced my parents to sell their new car (since I had been helping to make the interest free payments on). In retrospect, every vehicle in the family has lived through its full life cycle, averaging more than 150k miles each. In their planning, purchasing new was also the smart choice as it ensured full control over the maintenance and operation of the vehicle, given their drive-it-into-the-ground plan.

  3. Matt Bell March 23, 2010 at 2:42 PM #

    Ivan, In many cases it makes the most sense to buy a vehicle that’s one or two years old. However, it also depends on how long you plan to own the vehicle.

    At the end of 2003 we bought a 2004 model year van. It was a dealer demo, so we got a good deal on it and it came with the full warranty. Plus, it was pretty basic — no high cost added features. And here’s the most important key: we plan to keep it as long as possible. It’s been six and a half years since we bought it, but it only has about 50,000 miles on it. I could easily see keeping it for 15 years.

    Because of all of these factors — we plan to keep it a long time, it was a good price because it was a dealer demo, and it had the full warranty — it made sense to buy it new.

  4. Ivan March 23, 2010 at 1:43 PM #

    Matt, I see your larger point. Indeed, once I drive the car off the lot, I am already owing more than the vehicle is worth.

    Your larger point is the value of new vehicles. You believe that no new vehicles are worth their weigh, regardless of how much they are financed because once you drive off the lot, you lose 20-40% of the (resale) equity.

    Then, you support only the purchase of used cars as they are much more properly valued?

  5. Matt Bell March 22, 2010 at 9:10 PM #

    Ivan –

    A major issue with using zero percent financing for a new car is the fact that a new car depreciates rapidly in the first few years. Even when paying only principal, you end up quickly owing more than the vehicle is worth.

    As for student loans, I’ve found that the best way to be able to live generously, save and invest adequately, and enjoy some financial margin is to have no debt other than a reasonable mortgage.

  6. Ivan March 22, 2010 at 7:03 PM #

    Matt, I’ve read your Money Purpose Joy book and understand your point about debt. However, when it comes to ‘financing’ vehicles, I’m assuming the logic behind your distaste is the interest. Hence, all things being equal, would you support the purchase of a vehicle on 0% apr?

    If I purchase a $20k car I’m basically getting $20k worth of asset up front, with a large time-value-of-money (tvm) advantage as I’m only slowly repaying principal. Even if I had the cash, making monthly payments is the smarter way as I’m obviously making more with with the cash in the bank – nevermind the opportunity cost of investing that sum of money.

    I’m using almost the same logic as maximizing subsidized loans where the interest is paid for by the government.

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