Setting up your financial framework for success in your 20s

Setting up your financial framework for success in your 20s

If you wish to become financially independent, being in your twenties is arguably the most important decade in your life as you have a long runway ahead of you. It is also at this stage where we are prone to making the wrong financial decisions as we are not trained financially.

For many, receiving their first paycheck would often mean that their spending would increase accordingly. Also, insurance advisers would approach and encourage you to purchase a barrage of confusing insurance products. Most would be afraid to start investing and accumulating wealth. Sum it up, most of us are losing precious time and giving up opportunities imperative for compounding to take effect in your favour.

In article, I will share more about setting up a financial framework for young working adults.

1. Build an Emergency Fund, NOW!

Build up an emergency fund which would cover 3 – 6 months worth of expenses. The need for this is prominent, especially in today’s Covid-19 environment. The fund protects against unforeseen medical expenses, home repair and most importantly, unemployment. This helps prevent you from liquidating your investments at the worst of times, as unemployment usually coincides with a recession.

2. Getting the right insurances

When it comes to insurances, I adhere to Warren Buffett’s suggestion “Never ask a barber if you need a haircut.” Do not rely solely on your agent’s advice and spend time to understand the products. Without careful consideration, 2 seconds spent on signing the contract may result in 2 decades of regret.

Having said that, insurances are essential as they protect against downside risk. As a rule of thumb, NEVER EVER mix investment with insurance products. For instance, Investment-Linked Products (ILPs) and endowments should be avoided, especially if you are young.

To help streamline your research, I have listed a summary of essential insurances, in order of importance:

The following are good to have if you can afford it:

3. Coming up with a budget and automating your finances

When it comes to budgeting and following through on it, I recommend Sethi Ramit’s method. Create a spending plan into 4 major buckets where your money will flow:

  • Fixed costs (e.g. phone bill, rent, utilities, insurance)
  • Investments
  • Savings (e.g. holiday, wedding, mortgage down payment)
  • Guilt-free spending (e.g. shopping, movies, restaurants)

The key to success here is in automating the flow of your money. By automating the flow of money into your Investment account and Savings account, you protect your budget against temptations.

You may apply the 50-30-20 rule here for simplicity:

  • 50% for Expenses (includes fixed costs and guilt-free spending)
  • 30% for Investments (retirement)
  • 20% for Savings

4. Consistently investing in an ETF

Successfully picking individual stocks can be difficult and time consuming. For most people, picking a diversified low cost index fund would work best. Over the past 90 years, the S&P 500 averaged a 9.53% annualized return. Beating 90% of the active fund managers on an after-fee basis.

Investing in an index such as S&P 500 is akin to buying the 500 biggest companies in USA, including the likes of Amazon, Google and Apple. The procedures are relatively simple, you just need to open a brokerage account and set recurring purchases (e.g. Regular Savings Plan). You may consider setting your purchases on monthly or quarterly basis.

Apart from low fees, indexing helps to fight against an investor’s greatest enemy, themselves. This prevents us from buying high (out of FOMO), and selling low (out of fear). It is also a great solution for investors with no time or interest in researching companies.

I would recommend against Singapore’s ETF (i.e. Straits Times Index) as the portfolio of companies in STI are of lower quality (i.e. less growth).

You may consider the following low-cost ETF for exposure to S&P 500 (USA) and Hang Seng Index (Hong Kong):

To sum it up

Your actions today will determine if you are able to retire comfortably decades down the road. It is important to not just take action on building an emergency fund, budgeting and investing, but also on avoiding mistakes when it comes to purchasing insurances.

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