The reputation portrayed by the media of Millennials is that we are not necessarily the most financial savvy generation. Whether it’s $8 Starbucks lattes or $20 avocado and toast, certain spending habits of younger Americans leaves older generations rolling their eyes at times.
Because Millennials and Generation Z are known for emphasizing experiences over physical goods, certain challenges and mistakes exist in the habits Millennials make with their money.
Because of their youth and longer time horizons, the financial choices that younger Americans make can either result in a life of financial success that is free of monetary worry or cause is to be filled with regret from the lost opportunity cost due to our choices.
Since the financial decisions we make will compound over time, it is very important for us as Millennials to understand the financial consequences of bad decisions and comprehend the incredible wealth that can be generated from making good choices.
1. Signing up for student loans
With the average cost of college tuition over $100,000, the next generation is finding themselves increasingly saddled with student loan debt. With a society that has normalized student loans as the only way to get through 4 years of college, many students have turned to government programs and banks to finance their education with the hope that they will be able to pay back the loan with a higher income over the next decade or longer.
While obtaining a college degree in a field of study that is in high demand is certainly worth pursuing, many students are opting to get degrees in fields that may not generate a good enough return on their college investment. Even though there have always been fields of study that are not known for their earnings potential, when coupled with the debt burden, the choice to major in lower paying industries can be financially disastrous.
Instead of forking over hundreds of thousands of dollars for college at any price, Millennials and the future generations should instead determine their end goal (i.e. the career they wish to pursue) and then determine the most cost-effective ways to reach their goal.
One of the big issues that substantially increases the cost of college is where the student chooses to go to school. While many students have their eyes on prestigious institutions, unless you have scholarships and financial aid, or money set aside to cover the costs, paying two-to-three times the cost of other institutions to obtain the same degree is simply not worth the cost.
For instance, if your end goal is to be a 4th grade teacher (which is certainly an admirable and respected profession), why would you pay $200,000 for a private education when an in-state, public college will provide ample education to land your dream job teaching the next generation.
For the vast majority of careers, being top-of-the class from an Ivy League institution is not a prerequisite for success in a given industry or career. Granted, if you are top of your class in one of the premier institutions, this could solidify your chances of going to a top-tier law or medical school which could land you a great job. However, unless you are getting financial aid or have a substantial sum saved in a 529 Plan, by the time you graduate in 8+ years, you are likely to have $500,000 in loans. If something were to happen and you didn’t land a six-figure salary in an area with a reasonable cost of living, you could be paying for college for the next 20 years. If, instead you had gone to respected but affordable state school, you would probably have equally as great of an education at half the cost.
Another huge cost driver is changing a major or discipline of study multiple times. While asking an 18-year old what they want to do the rest of their lives is certainly hard to determine, their primary goal should be choosing a field of study they are interested and that can earn a reasonable income. Even if it is not their life’s passion, by making a great income, they will be able to have free time and extra money to pursue their hobbies and dreams instead of working a ton of hours for minimum wage just to survive.
2. Buying a house too soon
While buying a house can be a good long-term investment once the mortgage is paid off, the reality is that owning and maintaining a home is as much of an expense as it is an appreciating asset. For many Millennials who are looking to get settled into a home of their own and stop “wasting money on rent,” taking the plunge into home ownership seems like the rationale approach.
Have a leaky roof? Toilet will not flush? When you are a renter, simply submit a maintenance request or call your landlord, and they are responsible for the repair and associated costs. However, when you own your home, you are 100% responsible for sourcing the handyman or contractor, obtaining bids, and paying the full cost of repair. Not only do you have to pay the price to keep your home functioning, you also have to fork over thousands of dollars on aesthetic expenses such as flower beds, landscaping, and lawn mowing to keep up appearances in the neighborhood. On average, a home owner can expect to spend 1-2% of the home’s value on maintenance and repair expenses.
In addition to required repairs, there are other expenses such as real estate commissions, financing charges though interest on the mortgage, private mortgage insurance if you put down less than 20%, property taxes, as well as home-owners insurance. Factoring in all of these expenses as well as additional flexibility, renting while you are in your 20s may be the best move financially until you are more established – especially if you rent cheaply and invest any excess you have to make a good down payment.
Buying a home is not all bad and can be quite lucrative in the long run if done responsibly. While you will be happy if your home’s appreciation after expenses meets or exceeds inflation by a few percentage points, unlike rent which will steadily increase over time, your mortgage payment is fixed and will not rise with inflation in housing costs. This allows your housing costs to remain fixed while you progress in your career and receive annual compensation increases.
Unfortunately, many Millennials anticipate these pay raises in calculating the mortgage that they can afford today. Often times, potential home owners will qualify for loans that stretch their budget well beyond what they could actually afford after all of their other spending requirements, making them “house poor.”
Instead of immediately buying a house after only a couple of years of working, young people should consider waiting until they are more established financially, have the end in sight for any consumer debt, have begun investing in their 401(k), and understand their likely career progression.
Because Millennials and the next generation are just entering the workforce, often times their career is not yet on stable footing. What if, after a few years of working, you were to decide the career you chose is not what you want to do long-term? Locking yourself into the obligations of home ownership may prevent you from going back to graduate school or pursuing a different career path in another city.
After establishing themselves financially and their careers, Millennials will be able to enter the life of home ownership from a position of strength and stability rather than barely scraping by and barely affording random repairs.
Waiting and renting also allows flexibility and optionality in your life. If you have a mortgage looming over your head, pursuing a lucrative career opportunity with added risk may be a much harder choice to make – even if that choice better in the long-term.
Renting also allows you the opportunity to “try out” certain areas in your city prior to putting down roots and buying. You may think a certain area is the ideal place, but after renting, you may identify that it does not work for your commute or has higher crime than you initially thought.
While buying a home and paying off the mortgage as soon as possible is a wonderful tool to build wealth, immediately saddling yourself with a mortgage right out of college or only a few years into your career can end up leaving you house poor and financially stressed.
3. Buying a vehicle right out of school
Let’s face it, most of us are tempted by that wonderful new car smell. Compared to the beater car you drove in high school or college, the new technology and luxuries that many new cars come loaded with as standard equipment will make you feel like you have been living in the Stone Age and deserve to upgrade your ride.
After all, you have successfully navigated college and have a degree, or you’ve been working the last several years and have money in the bank. You deserve to drive something nice that tells others of your successes.
However, another huge financial pitfall that many Millennials make is buying a new car as soon as they start working. While transportation is certainly necessary, and most Americans need a vehicle to commute to their work, tying up a substantial portion of your net worth in a depreciating asset like a car is no way to build wealth. With a 50-year investment time horizon, a $35,000 car would cost a 25-year old over $4 million in lost opportunity cost had the cash instead been invested in the market at the average historical rate of return of 10% annually.
Coupled with student loan debt, servicing a vehicle payment right out of college is a surefire way to keep yourself handcuffed to debt and unable to build wealth for the next decade unless your income is substantially higher than the average college graduate right out of school.
Even if you can afford the payments, owning a vehicle that is worth as much as you make in an entire year is just not a financially sound game plan. Because vehicles generally depreciate 30% or more in just 2 or 3 years, the depreciation in the value of the vehicle will often times depreciate faster than your savings rate, resulting in a decrease in your overall net worth. Meanwhile, this effect is exaggerated even more when considering that this money could have been used to invest in your 401(k) or IRA, grown in value, and subsequently increased your overall net worth.
4. Not budgeting and or tracking your finances
Another huge financial mistake that many young people make is not setting up a budget and tracking their spending and overall net worth. Instead, many Millennials live paycheck to paycheck or blow what they made on an unplanned expense.
Now that you are an adult, there are responsible behaviors to do to set yourself up for financial freedom.
By setting up a budget, you will be able to track each dollar you earn and dictate where each dollar of your paycheck is spent. If you’ve never used a budget before, you may be surprised at how much money you are wasting on dining out, alcohol, or other miscellaneous expenses that you could easily eliminate.
After setting up a preliminary budget, one of the first steps you should take is to set up an emergency fund in a separate money market account. Generally, setting aside 3-6 months of expenses in an account you only touch for emergency situations is a good rule of thumb that will help you sustain yourself should you lose your job, become ill, or some other life emergency occur. Obviously, this should be in a separate account to keep you from blowing the money on something you really want or spending the money as part of your daily expenses. By having a separate account that you do not automatically draft bills from, the balance will be able to sit there unscathed in the event you need cash immediately.
When you set up or monitor your monthly budget, you should also begin the process of tracking your net worth. Your net worth is everything you own such as cash in bank accounts, investment accounts, jewelry, as well as equity in a home or vehicle minus all of your liabilities such as credit card bills and other debt including student loans or a mortgage. Essentially, if you were to convert everything you own into cash, how much cash would you have in a single bank account or how much would you owe? This is your net worth in a nutshell.
Tracking your net worth is important because it allows you to see how your overall financial value is trending over time. By tracking what impacts your net worth in a positive way such as increasing your investments and savings or decreasing your liabilities by paying off debt, you will be motivated to exercise behaviors that are financially positive. Watching your net worth steadily rise as you pay off debt or increase investments will be positive affirmation that the decisions you are making will give you the freedom to pursue the career or passions in life.
There are almost certainly an infinite number of money mistakes that young people make. However, by living frugally, paying off and avoiding consumer debt, and saving and investing, Millennials can be set up to be one of the wealthiest generations that has the ability to pursue life’s experiences rather than the almighty dollar.