We need to talk. More specifically, we need to talk about one of the most common myths I see making its way around the personal finance world. That myth is:
“Renting is a waste of money.”
Multiple times per week, I hear from people who want to buy a home because they’re worried they’re throwing away money by renting. Maybe they heard this from their parents, or maybe it was strangers on the internet.
But wherever they heard it, they made a major financial decision based on other people’s decisions rather than what’s actually best for their situation.
In this article, I want to clear up that misconception by showing you how renting is definitely not throwing away money.
Why people say that renting is a waste of money
Before I talk about why renting is definitely not throwing away money, let’s cover the reasons why people think this is the case. Because in the interest of full disclosure, there are some benefits of homeownership that have made it so popular.
1. YOUR MORTGAGE BUILDS EQUITY IN YOUR HOME
Every month when you pay your mortgage, a portion of your payment goes toward your principal (meaning the amount you initially borrowed).
Your equity is the difference between your home’s value and the principal you still owe on your mortgage. And so, as you pay down your principal, your equity in the home increases.
2. HOMEOWNERS BENEFIT FROM RISING HOME VALUES
The real estate market may ebb and flow, but just like the stock market, home values generally increase over time. As a result, many homeowners are able to sell their homes for more than they paid for them, resulting in a capital gain.
I’m not going to argue the validity of either of these statements. It’s absolutely true that paying your mortgage builds equity in your home and that your home’s value is likely to rise over the years. But in the next couple of sections, we’ll talk about why those things don’t matter as much as you might think.
The return on investment of homeownership
It’s true that home values have consistently increased over the years. Since 1940, home values have increased an average of 5.5% per year.
Depending on your investing experience, you might think 5.5% sounds pretty good. But what about when you compare it to other investments?
According to the Securities and Exchange Commission, the stock market sees an average annual return of about 10% per year. That’s nearly twice as much as the increase in the value of a home. And stocks don’t come with the maintenance costs required of homeownership, as we’ll discuss later.
SO, JUST HOW DIFFERENT ARE THOSE PERCENTAGES?
Let’s say you invested $100 per month for 30 years into an investment with a 5.5% annual return. After 30 years, you’d have more than $87,000.
But if you had invested that same $100 per month into an investment WITH a 10% return? Because of compound interest, you’d end up with just shy of $200,000 — more than twice the return on a 5.5% investment.
It’s also important to note that the amount you pay for a house is far from the only investment you make into it. When you account for all the other expenses, it’s likely your returns from the increase in value are completely wiped out.
Let’s do the math: Renting vs. buying
It’s easy to think you’re throwing away money by renting because the money you pay each month doesn’t build equity in your home. But let’s look at an example that might change your mind.
Closing costs aren’t an ongoing expense of homeownership, but they make up a substantial cost in the first year. Closing costs run between 1% and 3% of the home’s purchase price. For a home priced at $335,000, your closing costs would be $3,350.
Let’s say you rent an apartment for $1,500 per month. You’re sick of throwing away money renting, so you buy that $335,000 home with a monthly mortgage payment of $1,500.
But that entire $1,500 doesn’t build equity in your home. In fact, in the early years of homeownership, most of your monthly payment goes toward interest. If you have an interest rate of 3.5%, then about $11,622 of your payment goes toward interest in the first year.
Note: I found these numbers using Bankrate’s mortgage amortization calculator for a mortgage of $335,000 and an interest rate of 3.5%.
Next, let’s talk about property taxes. Rates vary depending on where you live. But according to the U.S. Census Bureau, the average household spends about $2,471 on property taxes each year. We’ll use that for the purposes of this example.
Another ongoing cost of homeownership is homeowners insurance. The cost will vary depending on where you live, the size of your home, how much coverage you want, and many more factors. According to ValuePenguin, the average cost of homeowners insurance is $1,445 per year.
Finally, let’s talk about home maintenance. As a homeowner, you’re responsible for any repairs that need to be done. There’s no more landlord to call.
Unfortunately, it’s impossible to predict how much you’ll spend on maintenance each year. However, experts recommend planning for about 1% of the cost of your home. On your $335,000 home, you could expect to spend $3,335.
RENTING VS. BUYING: WHAT’S THE VERDICT?
People like to argue that renting is throwing away money. But as you can see, there are many expenses of homeownership that don’t build your equity in the home. Let’s compare how much money you throw away renting versus in your first year of homeownership.
As you can see, you “throw away” significantly more in your first year of homeownership than you would be renting. And sure, closing costs are a one-time cost rather than an ongoing one. But even if you eliminate that cost, you still throw away more money per year owning a home than you do renting.
Owning a home vs. real estate investing
None of this is to say that you can’t make money from real estate investing. In fact, It’s important real estate can be incredibly profitable. But your primary home is not an investment property.
When you purchase an investment property, the increasing home value isn’t really where you make your money. You make your money by renting out the property and bringing in passive income each month.
In other cases, you can make money by flipping homes, where you buy a home, renovate it, and then it for a significant profit. Neither of these situations applies to your home.
Is renting better than buying?
You might be reading this article and thinking that I’m saying homeownership is a bad idea or a waste of money. But that’s not remotely true. In fact, my husband and I are saving for a home right now.
We want to own a home because we love our community, and we want to become a more permanent part of it. We want a space that’s truly ours. We want a yard where our dog can run around and where we can entertain friends.
Edit: Since I originally wrote this post, my husband and I bought a home. Buying comes with a huge price tag and lots of responsibility, but we’ve found it worth it, even without the financial gain.
There are also many reasons I love renting a home. I love that I don’t have to mow the lawn in the summer or shovel the snow in the winter. I love that if an appliance breaks down, my landlord replaces it. I love that if I want to move, I can do so with very little notice because I don’t have to sell a house first.
There are many great reasons to own a home, and there are many great reasons to rent. But the benefits of homeownership aren’t financial.
We’ve all heard the financial myth that renting is throwing away money. And while there are many great reasons to own a home, thinking that you’re saving money isn’t one of them. In fact, as we figured out above, you actually throw away a lot more money by owning a home.
The good news is that you can make the right choice for yourself, regardless of what your parents or society has told you.
Are you a millennial? Then we need to talk about why you should be investing and how you can start today.
Millennials are those born between the early-1980s and mid-1990s. Made up of about 83 million people, our generation is the best-educated and most diverse, but we’ve gotten a tumultuous start to our financial adulthood.
Many millennials entered the job market during and immediately after the 2007-2008 financial crisis. In other words, we got off to a rough start.
Because of that, it should come as no surprise that millennials are a bit leery of putting their money into the stock market. Data shows that more than two-thirds of millennials have nothing invested for retirement.
It’s time for us to fix that. In this article, I’m sharing a few simple steps to help you start investing as a millennial.
Why you need to be investing
The first question you might be asking yourself is why you need to invest. After all, isn’t investing risky?
Investing is the most effective way to build wealth and help your money to grow for the future. It’s a way of putting your money to work to make passive income so that you aren’t relying on trading time for money.
Another important reason to invest is that without doing so, most people would never be able to retire. It’s only because of compound interest that invested money grows large enough for people to retire.
Finally, investing helps protect your money from inflation. Many people feel safest with their money in a savings account. But because of inflation, money in a savings account is losing its value every year.
The Federal Reserve has a target inflation date of 2% each year. And I think we all know that throughout 2022, it’s been far higher, meaning your money is losing value more quickly.
In most cases, you’d be hard-pressed to find a high-yield savings account that pays that much as the rate of inflation, no matter what that rate is. As a result, your money becomes less valuable each year.
But what happens when you invest that money? According to the Securities and Exchange Commission, the stock market has an average annual return of 10%. Not only are you protected from inflation, but your money is actively growing each year.
HOW COMPOUND INTEREST WORKS
The reason investing is so effective is because of the miracle of compound interest. In other words, your money makes money. Then, the money you made also begins to make money.
Let’s look at a quick example:
Let’s say you were to save $250 per month each year from ages 25 to 65. By the time you retire, you will have $120,000.
But what if you put that same $250 per month into the stock market with a 10% return? You’d retire with about $1.34 million. So you can see how important compound interest is.
One of the biggest misconceptions I hear from millennials is that they hear they should be investing, and they think that means opening a brokerage account and buying individual stocks. So before we dive in any further, I want to clarify what I mean when I say investing.
Trading generally refers to buying short-term investments with the intention of selling them after a short time for a profit. Traders usually try to time the market, selling before a stock price falls and buying before it rises.
For many people, day trading is a full-time job. It takes an incredible amount of research and understanding of the stock market, and most people are still ultimately unsuccessful. Unless you have the time and understanding to do it properly, I would avoid trading.
Investing, on the other hand, is a long-term strategy. It involves buying and holding investments over many years for the purpose of growing wealth. Investing is less about timing the market and more about time in the market.
Investing for retirement
The most important type of investing that everyone should start with is investing for retirement. In fact, you may already be investing without realizing it since the first place many people start investing is in their employer’s 401(k) plan.
If your employer offers a 401(k) match, make sure you’re investing at least enough to get the match. If you have more room in your budget, you can increase your contributions even more.
Outside of an employer 401(k), another great way to invest is through an individual retirement account (IRA). This option offers more flexibility and a way of diversifying your tax advantages.
Not sure how much you should be investing for retirement? Personal Capial’s retirement calculator is my favorite way of figuring out much to set aside each month to live comfortably during retirement.
Investing for financial goals
Your first priority should be investing enough to reach your retirement goals. But if you’re doing that and still have room in your budget, you might consider investing for other financial goals as well.
As a general rule of thumb, you shouldn’t invest any money that you plan to need within the next five years. The stock market can be volatile, and when you invest your savings, you risk seeing your portfolio’s value decrease substantially right before you need it. For goals less than five years out, you can put your money into a high-yield savings account and earn a bit extra.
So what does this look like in practice?
Let’s say you’re saving for a home you plan to purchase in about three years. The best place to save that money is in a savings account. But that dream vacation home you plan to purchase in 10+ years? Feel free to save for that in a brokerage account.
Investing while paying off debt
Many of the people I work with are in the process of paying off debt. And many find themselves wondering whether they should be investing while they’re paying off debt.
There’s a little more that goes into it, but the short answer is: Yes!
No matter what, I always recommend investing at least enough to get any 401(k) match your employers. Once you’re doing that, your next priority should be to pay off any high-interest debt, such as credit cards or personal loans.
Once you’re left with only low-interest debt like student loans, you can split your money between investing and paying off debt, or you can decide to go all in on one. Yes, the debt is important. And yes, there’s a huge emotional burden that comes with carrying debt.
But ultimately, the return you can expect to get in the stock market is higher than the interest rate you’re paying on your debt. And the more time your money has to grow in the market, the better off you’ll be during retirement.
When it comes to investing for other goals beyond retirement, that really comes down to what you’re comfortable with. Some people are more worried about getting their debt paid off as quickly as possible, while others are more focused on building wealth.
Determining your asset allocation
One of the biggest questions people have when it comes to investing is what they should actually invest in.
The first thing to know about asset allocation is that you should be diversifying your portfolio. In other words, don’t put all your eggs in one basket.
First, you can invest across asset classes, meaning you put your money into a variety of different assets. For example, rather than just investing in stocks, you would also invest in bonds and other securities.
You should also diversify within asset classes. For example, rather than buying stock in just one company, you’d buy stock in many companies across various industries.
The idea of choosing your investments might be overwhelming, but there are tools to make that job easier. Index funds, mutual funds, and ETFs are investment vehicles that hold many different assets. When you invest in the fund, you’re investing in every security in the fund.
THE BEST INVESTMENTS FOR MILLENNIALS
When we land on this topic, many people want to know what are the best investments for millennials. I can’t answer that question for you, and neither can anyone else on the internet. The best investments for you depend on your financial goals, risk tolerance, and more.
Personally, I rely on both a robo-advisor and diversified index funds to help reach my various financial goals. The same strategy may or may not be right for your goals.
Choosing the right investing platform
Another important decision you’ll have to make is the investing platform you use. If you invest through your company’s 401(k), you won’t have to worry about this. But if you’re investing in an IRA or a taxable brokerage account, you’ll have to decide which type of account is right for you.
There are two primary options to choose from:
Traditional brokerage firm: With a traditional brokerage firm, you’re responsible for choosing your own investments. This option is ideal for those who want to be hands-on investors. Popular brokerage firms include Vanguard, Fidelity, and Schwab.
Robo-advisor: For those who don’t want to choose their own investors, a robo-advisor is a great alternative. You answer a few simple questions about your goals and risk tolerance. Then the robo-advisor chooses your investments for you. My favorite robo-advisor is Betterment.
For many millennials, the idea of investing feels overwhelming. People who are new to the investing game consider it to be too risky, often compared to gambling.
But long-term investing and gambling couldn’t be more different. Additionally, investing is one of the most effective ways to build wealth and financially prepare for the future.
When my husband and I got married, we had six figures of student loan debt. And unfortunately, we definitely aren’t alone.
The average student loan balance is nearly $38,000. And a significant number of borrowers are in the same position my husband and I were, where our student loan debt was considerably higher than the average.
When you throw in credit cards, car loans, and other debts, most people are paying off debt for the majority of their adult lives.
I know as well as anyone how easy it is to lose motivation when you’re paying off debt. There have been plenty of times in my adult life when I simply made the minimum payments because anything more felt too overwhelming. I knew I would have to increase my payments to get the debt paid off more quickly, but I couldn’t bring myself to do it.
I’ve worked hard over the past couple of years to find strategies to keep my head in the game. These strategies helped me start paying more than the minimum payment to pay off my debt more quickly without sacrificing my lifestyle.
In this article, you’ll learn 8 tips to help you stay motivated while paying off your debt.
There are affiliate links in this post, meaning I may make a small commission at no additional cost to you. For more information, see my full disclosure policy here.
Have a debt payoff plan in place
One of the most common problems people run into when paying off debt is that they simply make their minimum payments every month. Either that or they pay a little extra on each debt but still barely make progress on any of them.
The most important first step to tackling your debt is crafting a debt payoff plan. The two most popular are:
Debt snowball method: Prioritize the smallest debt, putting all extra money there while making the minimum payment on your other debts.
Debt avalanche method: Prioritize the debt with the highest interest rate, putting all extra money there while making the minimum payment on your other debts.
I prefer the debt avalanche method because you end up saving the most money in the long run. But the debt snowball method often results in small and quick wins, which helps keep people motivated. At the end of the day, the best debt payoff plan is the one you’ll stick it.
Once you have a debt payoff plan in place, you’ll start seeing progress on your payoff and start to see the end in sight.
Undebt.it is hands-down my favorite tool to create a debt payoff plan. Just enter your debts, and the tool will help you prioritize and tell you how long it will take you to pay them off. The best part is that it’s a free tool.
Create helpful habits
Motivation is great to help you jumpstart your debt payoff plan, but unfortunately, it’s not always enough to stick with it. That’s where habits come in.
Your habits will keep you moving on your debt payoff plan when you aren’t feeling motivated. Helpful habits to help you pay off debt include tracking your spending, using a budgeting app, and scheduling weekly or monthly money dates with yourself and/or your partner.
The benefit of creating helpful habits to help you pay off your debt is that it no longer feels like you’re working so hard. Some of the actions required to tackle your debt become automatic, meaning you’re putting in less effort without getting less of a result.
Break it down into small, manageable steps
When you’re paying off a lot of debt, it can feel overwhelming to look at the big number all the time. Instead, it can be helpful to break it down into small, manageable steps.
I like to focus on one debt at a time using the debt avalanche method. I make the minimum monthly payment on every debt except the one with the highest interest rate. That highest-interest debt gets all of my attention.
All of my extra money goes toward that one debt, and I regularly calculate how many months until I can expect to pay it off.
Breaking it down into small pieces helps to keep me motivated, because the end for that one debt is in sight, even if my final debt-free date isn’t.
Create a visual progress tracker
Visually tracking your debt payoff can be a great way to keep you motivated during your debt payoff journey. You’ll be able to see your progress first-hand and feel excited each time you get a bit closer.
There are many printable debt trackers available for free online. When we started paying off debt, we just used the whiteboard in our living room to create a visual representation of our debt.
There are also online services you can use to track your progress, such as Undebt.it, which I’ve already mentioned.
Make it automatic
No matter how motivated you are when you start, there will absolutely be months when you don’t feel like making those extra debt payments. You’ll find other things you’d rather spend that money on, and it’s super easy to talk yourself out of prioritizing your debt.
To plan ahead for those months, I recommend setting up automatic debt payments. Instead of creating an automatic payment for the minimum payment amount, set it up for the amount you actually want to put toward your debt to pay it off faster.
Paying off a huge amount of debt can feel incredibly lonely and isolating. But the reality is that there are millions of people going through exactly what you are.
One of the best ways to stay motivated while paying off your debt is to find a community of people to share your journey with.
Whether it’s a Facebook group or debt payoff accounts on Instagram, having people to share your journey with, vent to, and celebrate wins with will be a game-changer.
Remember your why
Putting extra money toward debt each month can be discouraging. Each month, I can think of things I’d rather spend that extra money on, and it makes me want to press pause on my debt-free journey.
But then I remember why I want to be debt-free. And I picture what our life will look like when that debt is gone.
If you’re feeling discouraged, think about what comes next. How will you feel when you aren’t in debt to companies? What goals will you save for when you don’t have money going toward debt each month?
In those moments when you lose your motivation, remembering your why is the perfect thing to help you find it again.
Celebrate small wins
Just because you’re prioritizing debt payoff doesn’t mean you can’t enjoy your life. Celebrating small wins will help keep you excited while paying off your debt and will prevent you from burning out.
Decide on a specific milestone — it could be $1,000, $5,000, or any number that makes sense for your debt payoff plan. Decide ahead of time how you’ll celebrate when you hit that milestone.
It doesn’t have to be expensive, but please make sure it’s not something you do on a regular basis. It should be exciting and out of the ordinary and something you only treat yourself to when you hit that milestone.
Paying off debt can be long and frustrating, and it’s easy to lose progress on your way. There are plenty of steps you can take to help boost your motivation and remember why you started in the first place.
Do you know what you’ll be doing with your money five years from now?
Chances are, no. Five years seems so far away, and it’s hard enough to figure out what you’re going to do with your money next month, let alone years from now.
But data consistently shows that those with a written plan are far more likely to reach their goals. And by making a plan for your future money, you can make intentional choices and have the exact future you envision.
There are affiliate links in this post, meaning I may make a small commission at no additional cost to you. For more information, see my full disclosure policy here.
Why create a five-year financial plan?
I know what you’re probably wondering: Why five years? It seems like an arbitrary amount of time, but it’s really not.
Five years is a short enough period of time that you can reasonably set goals for that period. While you don’t have a crystal ball, you may be able to picture what you’d like your life to look like five years from now.
Five years is also long enough that even for those bigger goals, five years could be long enough to help you save up enough money and accomplish them.
Saving for the down payment on a home seems daunting when you decide you want to buy next year. But if you know you’ll want to buy several years down the road, you can start saving early.
Five years seems like a long time, but it goes fast. And if you don’t make a financial plan for those five— years, they’ll pass before you know it.
How to create a financial plan
IDENTIFY YOUR VALUES
I truly believe that the first step in any goal-setting exercise — whether it’s setting an individual goal or making a full-blown financial plan — should be identifying your values.
Far too often, we live our lives on autopilot, doing the things we think we’re “supposed to” be doing. But we haven’t taken the time to really decide whether that life actually aligns with our values.
One of the first exercises I did with my money coaching clients when I offered that service was helping them to identify their most important values. From there, we could make sure their budget prioritized those values. And then we could set financial goals that aligned with them.
So think about what you value. Maybe you value freedom, and that manifests itself in travel. Or maybe you value security, and a life well-lived would include buying a home and having a large nest egg.
If you’re having trouble thinking of values, you can literally just Google “list of values.” You can read through it and see what resonates with you.
ENVISION YOUR LIFE FIVE YEARS FROM NOW
As you sit down to craft your five-year financial plan, consider what your next five years will look like. Envision your life one, and then three, and then five years from now.
Where do you live — both the location and the actual home? What do you do for work? Are you married? Do you have children? What hobbies do you do in your spare time? What kind of car are you driving? What trips are you taking?
It might seem like you can’t possibly know what you’ll be doing five years from now. But if you really think about it, I’m guessing you can come up with a vision for what you might like to be doing.
As you picture your life in the future, write down everything you see.
SET SPECIFIC FINANCIAL GOALS
Alright, you know that list you just made of what you envision for your life in the next five years? Well, it’s time to take that list and turn it into specific financial goals.
For each thing you’d like to accomplish, write down the date you’d like to accomplish it by and how much it will cost.
Some of these will be easy. You might know that a big goal is to become debt-free in the next few years, and you currently have $50,000 in debt. But some might be trickier. Maybe you think you’ll be having a wedding in a few years but have no idea how much you’ll need to save.
No matter what your goal is, chances are you can do a little research to find out how much you can expect to spend.
Once you have your list of goals, I want you to do one very difficult thing: prioritize them. I know it’s hard to look at a list of goals and decide which you want to come first. But at the end of the day, it’s easier to save for one big goal than many.
I recommend putting them in the order you’d like to achieve them and going all-in on the biggest one. That way, instead of making little progress on many things, you can make big progress on one.
Once you’ve figured out what goals you plan to save for over the next five years, it’s time to figure out how much you’ll save.
When you sat down and identified your goals, you hopefully identified when you want to reach each goal and how much it will cost. If so, this part should be pretty easy.
All it takes is a little math. Divide the amount you need to save for your goals by the number of months you have to save. You’ll know how much you need to save each month to make it happen.
You might see that number and realize you could be saving even more. That’s great news because it means you can move on to the next goal that much faster.
On the other hand, you might see the number and realize that your current list of goals isn’t exactly realistic over the next five years. That’s totally fine and pretty normal.
In that case, you have a few options:
Adjust your expectations so that your goals fit within your current saving capabilities, or
Decide that you’re willing to do what it takes to reach your goals no matter what, even if it means either drastically cutting your spending or increasing your income, or
Do a little of each. Adjust your goals slightly, but also reduce spending and increase your income to make sure you can reach your goals.
It’s okay for goals to feel a little uncomfortable.
When Brandon and I first set the goal of buying an RV and traveling full-time, I didn’t actually think we’d be able to do it. I ran the numbers dozens of times, and it just never seemed possible. But lo and behold, we accomplished our goal, and we even did it ahead of schedule.
So I guess what I’m saying is plan as much as you can and leave room for a little bit of magic.
STICK TO A BUDGET
Yep, we’re going to talk about the B-word. I’ve talked to so many women over the years who tell me they hate budgeting and they want a way to reach their goals.
And yes, there are personal finance experts who will tell you they can help you reach your goals without a budget. But then they describe the spending plan they teach, and it sounds an awful lot like a budget, just with a different name.
At the end of the day, the only way to be intentional about the amount of money leaving your bank account each month is with a budget. And when you budget, it’s easy to create a five-year financial plan because you know how much you’ll be able to save each month for the foreseeable future.
Tracking your progress is one of the most important steps to any plan, and your financial plan is no exception. After all, it’s all about follow-through. And how will you know if you’re following through if you don’t actually track your progress?
I track my progress in a couple of ways:
I sit down each week and update my budget and spending tracker to make sure I’m staying within my monthly budget. If I’m not staying on track, I can cut back as needed.
I sit down each month and plan my budget for the following month and update my net worth. If I went over budget the previous month, I adjust, either by changing how much I budget for or figuring out how I can cut back on certain areas.
CREATE AN ANNUAL CHECK-IN
As you make your way through your financial plan, it’s important to check in on your progress.
And while we’ve already talked about tracking your spending and your progress on a more granular level, it’s important to check in on the bigger picture too. Sit down each year and take an inventory of where you planned to be at that time versus where you actually are.
By scheduling an annual check-in, you can change course if things aren’t going quite the way you expected them to be.
It might be that you check in on your financial plan and find that you’re falling behind. In that case, you can either find a way to speed up your progress or adjust your expectations.
On the other hand, you might check in on your plan and find that you’re ahead of schedule. That’s great news! In that case, you can adjust your goals to accomplish even more in your five-year plan.
What to include in your financial plan
AN ANNUAL AND MONTHLY BUDGET
A five-year financial plan seems like a huge undertaking, and it definitely is. And if you look at it as one big picture, then it’s going to be hard to make strides.
Included in your five-year plan should be annual and monthly budgets.
The concept of a monthly budget is pretty common. You figure out how much money you have coming in each month, and you create a plan for exactly how you’ll spend it.
The idea of an annual budget isn’t quite as common, but it’s still an important way to make a plan for your money.
Creating an annual budget can help you identify those less common expenses, such as your annual vehicle registration or holiday spending. I use sinking funds to save for these expenses and my annual budget to plan for them.
An annual budget can also help you to see what’s going to be happening with your money three, six, nine, and twelve months from now.
Here’s an example: Let’s say you’ve got a monthly car payment, but you’ll be paying off your loan in just a few months. When you use an annual budget, you’ll know ahead of time where you’ll reallocate that money each month. As a result, you have a better idea of when you’ll reach your next goal after that.
I love planning, and helping people to craft long-term financial plans is one of my favorite things, but I also know that the foundation of every great financial plan is your budget.
AN EMERGENCY FUND
Building an emergency fund should be the first step in anyone’s financial plan. It helps prevent future financial mishaps from becoming disasters and helps set a solid foundation for the rest of your financial goals.
There are two reasons you need emergency savings:
One-time emergency expenses
Income replacement in the event of a job loss
There’s definitely some debate as to how much you should save in your emergency fund. Certain financial experts recommend saving just $1,000 while you’re paying off debt, but I’d strongly recommend against this.
As a minimum, I recommend saving three months of expenses in your emergency fund. Once you’re debt-free, I’d go even further and shoot for at least six months of expenses.
One of the reasons an emergency fund is so important is that it helps you avoid future debt.
Imagine you didn’t have an emergency fund and had an emergency $1,000 car repair. If you put it on the credit card and it takes a few months to pay it off, you’ll pay interest, meaning your emergency costs even more. But if you had an emergency fund, you could just pay for it and be done with it.
If you’re paying off debt, that should absolutely be a part of your five-year financial plan. Now, depending on how much debt you have, you may not plan to pay it all off in the next five years. For those with high student loan debt — which is many people these days — it’s okay to take longer if that fits your plan better.
The first step to creating your debt payoff plan is to decide which strategy you’ll use to pay down your debt. The two most popular strategies are the debt snowball and debt avalanche.
The debt snowball is where you prioritize your debt based on balance, paying down the smallest debts first. The debt avalanche is where you prioritize based on interest rate. You pay down the debt with the highest interest rate first.
The other decision you’ll have to make is how much you’ll put toward debt each month. It can be tempting to pay just the minimum payments and use the money for other goals. But I highly recommend paying at least some extra to pay it down faster.
Paying your debt off early can help you save hundreds, thousands, or even tens of thousands of dollars on interest. And if you have high-interest debt like credit cards, I think that should be your absolute priority.
I recommend using a tool like Undebt.it to help you plan your debt payoff. You can experiment with the order and see how much faster you’ll be debt-free by paying just a little extra each month.
Your financial plan should also include any other financial goals you might be saving for. In fact, this right here is why a five-year financial plan is so important. When you can anticipate the goals you’ll want to reach several years from now, you can start preparing for them now.
When crafting your financial plan, map out when you hope to achieve each of your financial goals and how much they’ll cost. From there, you can easily figure out how much you need to save each month.
As you’re mapping out your financial goals, be sure to map out any major life events you think will come up over the next five years. Unfortunately, we often don’t start planning and saving for these until they’re upon us, and then it’s hard to catch up.
Major life events to consider in your financial plan include getting married, starting a family, or moving to a new city.
Even if you don’t know for a fact that one of these things will happen, you can still plan and save for them. Plenty of people start saving for a wedding long before they’re engaged or start saving for kids long before they’re pregnant.
When you’re young, it’s easy to brush off saving for retirement, thinking you have plenty of time. This is how I felt for years, and I was incredibly lucky to have an employer that required us to contribute a certain percentage of our income to our retirement accounts each year.
No matter your age, retirement savings should be a part of your financial plan. Your age and how much you want to have when you retire will determine how big a part of your financial plan.
For younger people who don’t plan to retire until they’re 60s, saving for retirement is actually pretty simple.
The Securities and Exchange Commission reports the stock market produces a return of about 10% per year. Using that number, if you start saving when you’re 25 and invest $250 per month until you’re 65, you’ll retire with more than $1.3 million.
In some situations, you may need to save more per month to reach your retirement goals. That might be the case if you’re closer to retirement age or if you’re working toward early retirement.
I’ve found increasing my income to be the best way to speed up my financial plan and reach my big financial goals. And the good news is that there are many ways to do this.
Many people hope to start their own businesses someday. If this is you, make sure it’s a part of your financial plan. Online businesses today often quire little start-up costs, but it’s worth setting aside money either way. Luckily, you’ll ideally then see a return on that investment.
If you aren’t interested in starting a business and simply want a way to increase your income temporarily, that’s even easier to do.
There are plenty of side hustles — either online or in-person — where you can earn extra money in your spare time. Once you know how much you can make each month, you can work that into your financial plan to help you reach your goals even faster.
Having a financial plan is essential to making sure you are where you want to be in the future. Five years is the perfect amount of time — it’s just short enough that you have an idea of what goals to save for and just long enough that you have plenty of time to save.
Financial planning sounds a lot more complicated than it is. While you might picture sitting down with a financial planner and paying them a pretty penny to put together a plan for you, this is something you can do on your own — and for free!