Your 20’s 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 20’s also likely includes at least 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 great 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 experience begins to be apparent. It can be daunting to realize that you’ll need to understand these costs. In this article, we will cover seven consideration things to keep in mind when building your first budget.
Tip 1. Understanding your Gross vs. Net Income.
A common challenge many young adults run into, 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 will be helpful 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), 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, a helpful way to frame your savings can be to think about it as a fixed, non-discretionary expenses. Meaning this – savings are a must do.
When determining what the “must save” amount is, it can be helpful to 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 buffers or set aside for upcoming cash needs (such as bi-annual insurance payments, a security deposit on a new apartment, etc.). For the emergency fund, a typical recommendation would be to have 3 – 6 months of your fixed expenses (rent, groceries, insurance, etc.). Once you have an idea of these expenses – understand what you’ll need to save reach this amount.
- Mid-Term Bucket: This is a bucket of money for items that are maybe not 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. The amount you’ll need to save, is highly dependent on your goals.
- Long-Term Bucket: These are dollars you have set aside for items that are in the distant future and are potentially dollars which are invested (such as retirement savings). For a retirement account, the actual amount you plan to save can be dependent on external factors such as your 401(k) match or your overall free cash flow (dollars that aren’t going to other non-discretionary expenses). A nice target 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 determine your budgeted savings amount is the idea of habituation. If you can start developing saving habits in your 20’s, you’ll be 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 one’s budget, in addition to being a non-discretionary expense – meaning, you must have somewhere to live! A general rule of thumb for rent: 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 like an unattainable amount. 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 there’s dozens of platforms to help you find your perfect place to call home.
Tip 4. Housing Costs Go Beyond Just Rent.
Housing costs are typically the largest portion of one’s budget – and if you are living in a big city, they are likely a large dollar amount as well. Before signing a lease, it is important to remember that “housing” includes more than just rent. Here are a few additional expenses to ensure are built in.
- Utilities: If you are renting an apartment – check with your landlord or property manager to ensure you know what you are responsible for.
- 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 their tenants carry rental insurance. This can typically be bundled with your auto policy as well and is relatively inexpensive given it’s 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 expenses are your student loan payments. Depending on the type of loan you have, you will typically have a grace period (typically 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 payment. 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 the categories in your budget, you may be earmarking dollars towards transportation. Depending on your main mode of transportation, this amount relative to other categories can vary greatly. If you are living in a metropolitan area, you likely can use public transportation as your main mode of travel. A great aspect of public transportation is it typically has a fixed monthly cost for unlimited use. Discover what options are available to you such as a monthly bus or train pass.
For most young individuals, public transportation may not be the one and only answer to getting to where you need to go. If you already own a car, you may not need to factor in the cost of ongoing payments, but you will factor in the following:
- Ongoing maintenance: This will include regular maintenance such as oil changes which typically occur every few months. However, there are 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 increase the savings 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 likely 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 – for others, that conversation may not have been formalized yet. Typically, auto insurance premiums will be lower, when bundled with other coverages – therefore, if you’re able to stay on a plan with your family, the premium will typically be lower.
If you will be moving off your family’s insurance plan, do shop around for insurance and do your research to understand 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 means 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 are feeling more “discretionary” (shopping, travel, restaurants/bars) rather than “non-discretionary” (rent, savings, insurance). Food, groceries, and dining costs are non-discretionary (in other words, you need to eat), however the overall portion of your budget dedicated to this can vary greatly depending on the choices you make at the grocery store, restaurant, and on the go.
- Groceries: Unlike for 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 have a regular grocery bill rather than one which can fluctuate greatly. Why not try to plan out your meals ahead and limit grocery trips to 1-2x a week? Remember, the more you visit the store, the more you will be inclined to buy – and likely, more impulse purchases.
- Dining Out: This is an area of your budget that will be closely dependent on your lifestyle. I’ve found it to be helpful to set a target for a number of meals I would like to eat out each week, then to estimate what the average “meal” cost would be. I use this to determine what my monthly “dining out” budget will be. I also find this to be an area that I tend to over-spend in. Rather than getting frustrated or feeling defeated by slipping on my budget, I think of the “trade-off”. For ever extra $10 I spend on dining out, this is coming out of another area in my budget.
While balancing it all and having it “figured out” by your mid-twenties 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 life-long habits.
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