The 5 Most Important Financial Lessons People Learn in Their 20s (Did You?)

by Nora Dunn on 22 April 2014 1 comment

Your 20s is a time for living life and discovering your path. It's also an incredibly important time to create a lasting effect on your finances. Financial planning isn't something you do when you get old; in fact, due to the financial lessons I learned in my 20s, I "retired" at 30 to travel full-time, knowing my financial future was safe because of what I did in my 20s. Here are the five most important financial lessons you can learn in your 20s to set you up — for life. (See also: Retirement Planning if You're Under 30)

1. Compound Interest

Because of the beauty of compound interest, saving money early allows you to put away less money overall, but end up with way more.

For example, let's look at retirement savings. Hypothetically speaking, you invest a chunk of money — $10,000 — at the age of 20, and leave it for 40 years, growing at an average of 8% per year. By the time you're 60, that $10,000 is worth $217,245.

If you wait until 30 to invest the same $10,000, it will only be worth $100,626 by age 60. In order to get the same $217,000 at 60, you'd need to invest $22,000.

If you wait until 40, $10,000 is only worth $46,609. To get $217,000 at 60, you'd have to invest $47,000.

Thus, when you're in your 20s, even if you can only put away a small amount of money for your long-term goals (like retirement, buying a house, investing in business, and more), it's totally worthwhile.

2. Dollar Cost Averaging

Most of us don't have $10,000 to invest at 20. (In fact, many are inundated with debts, but we'll get to that in a minute). This is where dollar cost averaging is invaluable.

The technicalities of dollar cost averaging are simple. You invest a set amount of money on a regular basis. You set it up so it's automatic, ideally coming out of your account on payday, and ultimately you don't even miss the money.

For example, let's say you invest $200 a month, starting at age 20, with an average rate of return of 8% per year. By the time you're 60, it's worth $648,361, and the money you invested totals $96,000.

If you wait until 30, your $200 per month would be worth $283,522; to get the same $650,000 if you'd started at 20, you'd need to invest $430 per month, totaling $154,800.

If you wait until 40, your $200 per month is worth $114,532 at 60, and to get the same $650,000 you'd need to invest $1,100 per month, totaling $264,000.

In addition to compound interest and ease of investing automatically, dollar cost averaging is about getting a good rate of return in a variable market. Most of us don't have the time, inclination, or expertise to time the markets, nor do we have the stomach to buy at the best time — which is when the market is tanking. Over time, dollar cost averaging allows you to take advantage of all markets, without having to watch stock prices or play the (dangerous) game of market timing.

3. Choose Your Debt Wisely

Your 20s are not only a time of great opportunity to set up your finances for life, but they're also a time for making — or avoiding — the biggest mistakes. One of these mistakes (which can take a lifetime to recover from) is getting into debt, specifically bad debt. (See also: Good Debt, Bad Debt)

In your 20s, you're likely setting up your own home and life away from your parents, which costs money. Many 20-somethings turn to credit cards — a bad choice if you can't pay them off right away.

Bad Debt

For example, if you charge $5,000 in expenses to a credit card at 18.75% interest, and only make minimum payments of 2.5% of the balance per month, it will take you 50 years to pay it off, totaling $13,000 spent on a mere $5,000 in charges. Even flat payments of $100/month will take 7 years to pay off and $9,000 in payments. (See also: What 20-Somethings Can Do About Credit Card Debt)

But sometimes debt is unavoidable, and it can even be considered good.

Good Debt

For example, buying a house is often considered good debt; your initial down payment buys you an asset worth much more than the money you currently have, and it appreciates accordingly. Although you're paying interest on the mortgage, part of your payments also go toward equity in the house — which is your money, and your own growing asset.

The trick with buying a home (or investing in other good debt) is to avoid committing to repayments that cripple your other financial goals and quality of life. People often buy houses they can't afford, forgetting about technicalities like property tax, utilities, repairs, and other costs of home ownership beyond the mortgage. (See also: You Shouldn't Buy a Home If...)

4. Insurance

Another financial lesson you might not consider in your 20s, but which can pay off in spades, is to get insurance while you're young and healthy. Things like life insurance and critical illness insurance often allow you to lock in your rates based on your age (and state of health) at application. You might not see much need for insurance while you're young, but it's one of those things that you wish for the most when it's too late. Similar to dollar cost averaging and compound interest, a small investment now can save you a ton of money later.

5. Developing Good Habits

The above financial lessons involve developing good habits early on. In our 20s, we're malleable to what life offers, and if we create good habits right away, they're much easier to maintain (and build on) than if we have to readjust our ways later in life — and pay the price.

When I was a financial planner, I loved working with clients in their 20s, because we could achieve so much and set everything up to be easily maintainable. Thus, a great way to develop good financial habits in your 20s is to align yourself with a financial planner who can help you with all the above important lessons, and so much more. (See also: 9 Signs You Need to Fire Your Financial Planner)

What financial lessons do you wish you had learned in your 20s?

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If I could get 8% a year, I'd retire too...