The Most Important Skill for Young Adults
Personal finance scares most young graduates. Despite 4 years of higher education, most college grads struggle with financial literacy. This critical skill isn’t taught at any level of the American education system. Confusing jargon doesn’t help. However, the most important pieces are also the simplest. Do you know how much you earn and spend each month? Do you know what you spend it on? Most people don’t. For young professionals in their first or second full-time job, it’s critical to know your monthly cash flow because it will set you on the path to mastery of your financial life.
Graduation is an exciting time. Young professionals jump from paying money to work for a grade to earning a full-time income. The class of 2019 is expected to earn over $50,000 in their first year on the job, with expectations often higher in coastal cities. This presents immense opportunity, as younger people have the longest time horizon to save and invest.
But there are also dangers. This is the first time these people are earning and handling significant amounts of money. Since financial literacy isn’t taught in school, many grads start making money and don’t know what to do with it. Pay down student loans? Fly to Europe? Invest? What’s most concerning is that most of these young people couldn’t tell you how they’re spending their money beyond ballpark numbers.
It’s hard to make basic financial decisions without knowing your personal information. How big should your emergency fund be? Depends on how much you spend each month. Should you contribute more to your 401k? Depends on how much you currently receive after payroll deductions and if you’re comfortable lowering it.
While this is relevant for everyone, the margin for error is thinner with young people’s cash flow. The average monthly student debt payment was between $200 and $299 per month in 2018. The problem is only getting worse. Student loans continue to grow faster than other forms of non-housing debt. With less room for mistakes, younger people need to be extra diligent about their spending and saving habits.
Graph source: https://www.bloomberg.com/news/articles/2020-02-11/u-s-household-debt-exceeds-14-trillion-for-the-first-time
The solution is to create a budget and then compare it to your actual expenses to see how you did. There is a distinct difference between budgeting and tracking your expenses. The former is a forward-looking planning exercise, where you decide ahead of time how much money will be allocated to various spending categories. Expense tracking, or cash flow analysis, is looking backward to see how much money entered and exited your account, and where it went, over a period of time. Using the two strategies together is a powerful way to get a comprehensive understanding of your finances.
Budgeting is seen as the top sign of "adulting". Expense tracking is the complementary piece that keeps you accountable and helps you think about your spending habits differently. Young adults are at a vulnerable age where the financial habits that develop will stick with them the rest of their lives. Budgeting and tracking performance can help steer the ship in the right direction.
I started tracking my cash flow during my senior year of college. I’d begun job searching and realized I needed to know how much income I’d need to maintain my spending habits. Here’s what I’ve learned:
It can be…fun?
Not something people usually say about personal finance. It’s not Friday happy hour but it’s far from pulling teeth. There’s immense satisfaction in reviewing your performance and feeling confident about knowing your finances.
The time commitment is minimal
I typically spend 30-60 minutes per month reviewing all my financial activity. Tools like Mint and Tiller Money automatically categorize purchases so it’s easy to analyze. Your bank may have some expense tracking features too. I can’t think of another activity with the same positive impact per minute spent.
You don’t need to check your budget before each purchase
Simply seeing my performance at the end of each month is enough to calibrate and adjust. It’s hard to manually check a budget before each purchase (although there are apps do this). I find it’s enough to just review monthly and adjust. Spent too much eating out last month? I’ll think about it next time I’m debating going out or cooking at home.
Infrequent expenses are hard to budget
Fixed costs like rent are easy to budget. Groceries are usually consistent too. But there are some items that can throw a budget out of whack because they are so infrequent. For most of 2019 my transportation spending looked high, but that was just because I renewed my tabs and spent $900 on car repairs in February. Averaged over an entire 12 months it was much more reasonable. Traveling is another good example. I often spent nothing on travel for several months and then a lot all at once. Looking at expenses averaged over several months can give a better understanding of your spending than just one month.
Analysis doesn’t need to be complex:
You don’t need AI or a data science degree to analyze basic trends. Were you over budget last month because of a large one-time purchase or do you need more careful going forward? Was your budget for a category low or are you consistently over-spending? Are all your expenses starting to increase? This analysis is simple but asking these questions can make a world of difference.
Everyone crawls before they walk. The reality is that many financial topics are complex. Everyone will need to make big financial decisions in their lifetime regarding homes, investing, and retirement. Once you know your income and expenses, you can start to make other serious decisions. Knowledge is power. The budget for your current lifestyle can help you plan for the future. Understanding monthly cash flow is great, but it’s only the first step in developing a true mastery of your financial life.