Your 20s are a pivotal age. It's a time to enjoy the greatest freedom you'll ever know until retirement. It's also the ideal age to begin investing because you have so much time on your side and can enjoy the magic of compound interest.
Over the years, I have built 7-figure businesses for myself and made strong investments with significant returns. But making the right moves in my 20s saved me years of pain, heartache, and frustration - and it can for you, too.
There's a saying: "The more you risk, the more you can earn." Here are eight financial principles you can start practicing in your 20s that will help set you up for long-term success
1. Understand compound interest and valuation
One concept that usually gets overlooked when people are making long-term financial decisions is the impact and concept of inflation. My parents always told me to put at least 10 percent of earnings into a savings account and another 10 percent into a retirement account. Saving small today can add up to real wealth in the future thanks to compound interest. But be warned: Compound interest is a double-edged sword: A small debt today can add up to a large debt tomorrow.
In addition, try to make financial decisions based on valuations. Buying a home is not always a bad decision. In fact, one study from Harvard University found that homeowners have a higher net worth than renters. In contrast, investing in stocks at higher valuations is not a good decision. You should aim to invest in assets that are available at an attractive valuation.
2. Generate passive income
The quicker you can get your money working for you and generating revenue while you sleep, the quicker you'll be able to live the life of your dreams, reduce your stress, and likely live longer too. This one is hard to grasp especially for high earners. Every dollar that you earn passively is worth $10 that you earned by trading your time. When you generate passive income, you create the ultimate form of freedom. Your time on this planet is limited, and it's important to find ways to ensure you can maximize earnings while minimizing your time spent on working.
3. Avoid bad debt
Whether it is credit cards or student loans, make smart decisions when borrowing money. Borrowing money using credit cards, payday loans, and short term loans from a bank have the potential to lock you into a cycle of debt that seems impossible to overcome. This type of debt comes with a high-interest rate and should be avoided except in emergencies, and this type of debt should never be used to finance conspicuous spending.
4. Make friends with good debt
Not all debt is bad debt. Take, for example, a mortgage on a home. The median home price in the U.S. is around $310,000. If you take out a 30-year mortgage on a home at this price with a 20 percent down payment at 4 percent interest, you'll end up paying a total of $532,795.47 (including interest). However, the inflation-adjusted value of the home after 30 years is expected to be $613,240.33 -- so you actually earn a 15.1 percent profit on your debt. In contrast, had you spent that money on rent over the same 30-year period, you would own nothing.
5. Save to invest
Some young people, especially millennials who came of age during the 2008 financial crisis, are understandably wary of stocks, mutual funds, and other financial instruments. They would rather hold their money as cash instead of risking it in the market. But history has shown that, over long periods of time, giving yourself exposure to the market is the best way to ensure your money grows faster than inflation.
Sure, markets fluctuate over time. But on average, the S&P 500 has earned an average annual return of 4.2 percent since 2000, while average annual inflation over this period was 2.3 percent. One dollar invested in 2000 would have turned into $2.10 today. This is despite the recession following the dot-com bust and the Great Recession in 2008. If that same $1 was held as cash, it would only have 66.4 percent of its buying power today.
I would also recommend investing in assets that have these three benefits:
- Increase in value over time which can later be sold for a profit
- Pay you positive cash flow monthly/quarterly
- Have tax benefits like a 1031 exchange on real estate proper
While making investments, you should always think about the worst-case scenario and be ready for it. People generally expect handsome returns considering the best-case scenario but have no strategy in place when things go wrong. Diversification is also key —remember to never to put all your eggs in one basket.
6. Only borrow what you need
While having the right degree opens up opportunities for earning more over your lifetime, no one educated me on the debt I would accumulate in the process. Student loans can be a form of good debt, but only if your future income can support it. The debt you take on to finance higher education should never exceed your expected future income.
7. Avoid conspicuous consumption
The simplest principle that will help you gain immediate control over your financial destiny is to embrace minimalism and shun consumerism. Truly wealthy people don't flaunt their wealth. They save and invest their money instead of spending it on trinkets to make themselves appear wealthy. You might have to forgo that new pair of Nikes or eat in more often, but at least you won't be stuck eating cat food at age 70. This study from Integer Group reveals that 64 percent of consumers don't necessarily think that brand-named products are better than more affordable options. Truly wealthy people are not concerned about what others think of them and have no desire to impress others around them.
The way that I define minimalism is simple: Only spend money on the things that you need or that bring real value to your life.
8. Be patient
When I was younger, I wanted success and I wanted it now -- and I was willing to go into debt to get it. If you watch a lot of television, you might have the impression that people become financially independent and amass the trappings of an upper-middle-class lifestyle overnight. Later, I realized that wealth accumulates over a period of time. I had to learn to be patient and disciplined with my investing and spending.
Your health and mental peace are your biggest assets. Never compromise your health for money - even though you think you can when you're 22. We all have potential. We're unique, but we're not so different from one another. We all can be someone, but how much we want to become that person is what shapes your actions from today. And there's no better time than your 20s to dream big, think big and, most importantly, act big.
This article was published on the Entrepreneur South Africa Website on 20 February 2020.