Note: This is the second in a series of Lifecycle Planning articles for every age group.
In a recent article, we described some of the personal financial planning challenges faced by young Americans today — specifically, those in their 20s. The 20s can be an exciting time from a financial standpoint, but this life stage can also be a little bit scary financially as these individuals may be facing personal financial responsibility for the first time.
By the time they reach their 30s, many people have become more comfortable with financial responsibility, especially if they have implemented some of the strategies we discussed in our last article. They may have started to advance in their careers and move up the corporate ladder, perhaps enjoying a higher level of income than at any time yet in their lives. They may alternatively be experiencing increased success in pursuing their own path as a “freelancer” which will add additional complexities.
No matter what the path chosen, along with this higher income have come increased responsibilities, especially for those who have gotten married and started a family. A home mortgage, car payments, life insurance and the myriad expenses that come with raising children can easily consume the additional income that 30-somethings might be enjoying — even if both spouses are working full-time.
A Balancing Act
The biggest financial challenge for lots of people in their 30s is balancing the many different, and often conflicting, financial demands and responsibilities they are facing during this life stage. For example:
- You want to save for retirement, but it can be hard to squeeze extra money out of the monthly budget for something that seems like such a long way off.
- You want to start a college education fund for your children, but just covering all the normal childrearing expenses — food, clothes, shoes, entertainment, extracurricular activities, and the latest electronic gadgets — is taxing your current finances.
- You want to buy a house, but you haven’t been able to save up enough money yet for the 20 percent down payment typically required by the bank.
- You want to make responsible financial decisions, but you are feeling pressure to “keep up with the Joneses” when it comes to the home you live in, the type of car you drive, the types of vacations you take, etc.
Set Some Priorities
The best way to juggle these competing demands is to set some financial priorities. And the first step in doing this is to admit that you can’t have it all. This will free you up to start making the tradeoffs you need to make to avoid racking up debt in your 30s that could haunt you financially for many years to come.
Let’s start with your living arrangement, which is probably your largest monthly expense. How important is it that you buy your “dream home” at this stage of your life? This is a high priority for some 30-somethings who take out large mortgages to buy their dream home with their first home purchase. However, so much of their monthly income ends up going toward their mortgage payment that it makes paying for everything else in their lives a struggle.
Often, a better strategy for 30-somethings is to rent and build up savings or buy a less-expensive “starter home” instead. You can live in a starter home for five to ten years or so and build up valuable equity that you can put toward a more expensive home during your next life stage. Or, if your future finances permit, you can keep your starter home and convert it to a rental property.
Similarly, 30-somethings sometimes feel that they need to drive fancy, expensive cars, but this is often for no reason other than to try to impress other people. They often lease these cars, trading them in every couple of years or so for the latest and greatest models. A better strategy for many 30-somethings is to buy a quality, low-mileage used car and pay at least half of the purchase price in cash. This will significantly lower — and eventually eliminate — monthly car payments, freeing up valuable cash every month for other priorities.
Stay Focused on Long-Term Goals
When it comes to longer-term financial goals like saving for retirement and for children’s college educations, the 30s are a critical life stage. This is because 30-somethings still usually have time on their side: They are probably at least 30 years or so away from retirement, so they can benefit from the long-term effects of compounding interest if they start making regular contributions to a retirement savings plan like an IRA or 401(k).
For example, the Rule of 72 states that money doubles in the number of years equal to 72 divided by the rate of return. So if you earn a hypothetical eight percent annual return on your long-term investments, your money will double in nine years, and it will double again nine years after that, and again nine years after that. If a 35-year-old woman has saved $50,000 in her IRA and earns an eight percent annual return, the IRA will be worth $100,000 when she’s 44, $200,000 when she reaches 53 and $400,000 when she is 62 — even if she never invests another penny in the account. Understand, this example is assuming an 8% positive return year-after-year with no losses over the entire 27 years. This isn’t realistic, but the point is the magic of compounding interest/returns over time.
Meanwhile, the 30s may also be a good time to start a savings fund for children’s college educations. One popular college savings tool is a Section 529 plan, which allows tax-deferred growth and tax-free distributions if the funds are used for qualified education expenses. There are two different types of 529 plans: prepaid tuition plans, which lock in a specified amount of future tuition at today’s prices, and investment savings plans, which seek to provide market returns on contributions.
Coverdell Education Savings Accounts (ESAs) are another popular tool. These allow contributions of up to $2,000 a year on behalf of a child or grandchild. Other college savings options are zero coupon municipal bonds, which pay out the full face amount of the bond at maturity, and Roth IRAs. Contributions to Roth IRAs can be withdrawn at any age without tax or penalty to cover college education expenses. Equity index life insurance is another increasingly popular tool used for college savings. When considering your options you should keep in mind the historical rate of increase in the costs of a college education as you must seek to keep up with or ahead of these costs.
Unique Financial Challenges
Each life stage presents its own unique financial challenges. This includes the 30s, when the rewards of higher income due to career advancements are often offset by the growing financial demands faced by young couples and families. Successful financial management during this life stage requires a careful balancing act between long-term savings goals like retirement and college, shorter-term goals like buying a home, and the immediate priorities of paying the growing volume of bills every month. These financial decisions can get complicated and often it is best to seek the assistance of a qualified financial professional.
Start by admitting that you can’t do it all — and then set financial priorities that reflect the things that are truly important to you and your family.
Brad is a Registered Representative with, and Securities and Advisory Services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. CA Insurance License #: 0B22199.