By Dmitriy Fomichenko
When you hit your 30s, you may start thinking about your major life goals, both personal and financial. Although you may be able to defer some of your personal life decisions, such as career changes, starting a family or moving to a new place, some major financial decisions should not wait any longer.
Many financial decisions can have a gradual, yet enormous, impact on your life. Making them at the right time ensures that you can meet your goals and achieve financial security. Here are seven key financial steps people in their 30s should take.
1. Build an emergency fund
Whatever your current income is, you need to establish an emergency fund. Think about how you would pay next month’s rent if you lost your job. Or, if your car broke down, would you have enough money to repair it? Having a financial buffer means you don’t have to hit the panic button — or go into debt — when faced with an unforeseen expense.
Start by aiming to save enough to cover up to three months of your household expenses and gradually grow your emergency fund to cover at least six months of expenses. If money is tight, building an emergency fund can be overwhelming, so start small. Contribute an hour’s worth of wages each workday and gradually increase it to two hours’ worth of wages per workday. If that’s unrealistic, save $50 per week ($200 per month) and increase it to $75 a week or more as you are able. Use automatic deposits to your savings account to ensure regular contributions.
2. Make a plan to pay off debt
As you turn 30, it’s smart to think about setting a strong financial foundation for your future, and that starts with paying off your debt. Not all debt is bad. Good debt includes your home mortgage or education loan, but if you have high-interest credit card debt or personal loan debt, it’s time to take these financial matters seriously.
The best strategy is to start paying off debt with the highest interest rate first. For instance, clearing credit card debt with a 22% interest rate would yield a better return on your money than paying off your home loan with a 4% interest rate. If you need help, work with a debt management professional to figure out how best to tackle your debt.
3. Start (or keep) maxing out your 401(k)
Unlike maxing out your credit cards, maxing out your 401(k) or other retirement plans is a good thing — and now is the time to start.
If you have an employer-sponsored retirement plan, contribute as much as you can. If you’re not yet able to make the maximum allowable contribution, you should contribute at least enough to get the matching contribution from your employer if the company offers it. This is essentially free money; don’t let it go to waste. If your employer doesn’t provide a retirement plan, open a traditional IRA or Roth IRA account. With an IRA, you can contribute up to $5,500 in 2016.
If you work for yourself and don’t have access to an employer-sponsored retirement plan, you should establish your own. Some of the most popular options include a self-directed Solo 401(k) if you have an owner-only business or are self-employed, SEP IRA, or SIMPLE IRA plan. For these plans, the contribution limits each year are as follows:
Solo 401(k): Up to $53,000 for 2016, plus catch-up contributions of $6,000 for individuals over age 50.
SEP IRA: Up to $53,000, or 25% of compensation.
SIMPLE IRA: Up to $12,500, plus catch-up contributions of $3,000 for individuals over age 50, if the plan allows it.
4. Start investing now
One of the biggest advantages you have in your 30s is time, so it pays to start investing early. Consider this example of two investors. At 30, Steve started investing $1,000 a month and did so until age 40. Even though he stopped, he didn’t withdraw his investment and let it grow until his retirement at age 60. On the other hand, Bob started investing at 40, contributing $1,000 a month until age 60.
Assuming an average rate of return of 5% compounded annually, Steve accumulated $154,992 at the end of the 10 years, but since he didn’t withdraw this money, it grew to $411,240 by age 60. Bob ended up with $407,460 with the same investment terms. This is the magic of time — and compound interest — working in Steve’s favor. With compound interest, your return is added to your principal each year, so your savings grow much faster than with a simple interest rate, when the return amount is the same each year, based on the original principal amount.
For newer investors with a limited understanding of the investment landscape, it’s a good idea to stick with passive investing, strategies that try to capture the overall movement of the market rather than predict which sectors or assets will outperform. You can invest passively through mutual funds or exchange-traded funds that are based on a broad-market index. I recommend starting with ETFs because of their lower fees and transaction costs.
5. Figure out the right investment strategy for you
If asset allocation is a foreign concept to you, now is the time to demystify it. Asset allocation is about picking the right proportion of different investment types (or asset classes) to match your portfolio with your risk appetite, investment time frame and financial goals. Some investments, like stocks, are more risky — and tend to yield higher returns — than others, like bonds. For instance, if you wanted a more aggressive investment strategy, you would want to create a portfolio with more exposure to stocks, and if you wanted less risk, you’d dial up your exposure to bonds.
Your asset allocation will have a huge impact on your net wealth over time. A portfolio that is too conservative may leave you with an insufficient nest egg, whereas a risky allocation could yield higher returns, but might keep you up at night when the market is volatile. It may be best to consult with a financial expert to come up with an investment strategy that fits with your goals and your tolerance for risk.
6. Diversify your investments
The other important part of building a portfolio is diversifying your investments. For example if you are invested in stocks, you would want to diversify your equity holdings by including stocks from companies of various sizes (such as large-, mid- and small capitalization stocks), categories (like growth or value stocks) and parts of the world. By holding a diverse selection of investments, you are able to spread around your risk and reduce overall volatility.
You may also want to start considering alternative investment options that can help you further diversify your portfolio to weather stock market fluctuations. The goal is to add investments that tend to not move in the same direction as the stock market and can offer stable returns over a longer period. Some of the most popular alternative investments include real estate, precious metals, life settlements, private debt placement or private stock. However, keep in mind that alternative investments require deep understanding, so make sure you are comfortable with how these investments work before you jump in.
7. Start saving for college
You should begin saving for college expenses as soon as you have a child. It may seem a bit early to get started, but college costs are going up, and the sooner you start saving and investing for this major expense, the better off you’ll be. A tax-advantaged plan, like a 529 college savings plan, can help you come up with the necessary funds to support your child’s college education. Considering the long time horizon, you may want to follow a relatively aggressive investment strategy for the plan.
Take the long view
“Setting goals is the first step in turning the invisible into the visible,” says author, entrepreneur and motivational speaker Tony Robbins. When it comes to your financial life, this couldn’t be more true. While working on a financial plan, you must consider the long-term perspective — the far-off personal and financial goals you want to achieve — to determine the best steps to take today.
Though it may not always feel like it, you have control over your financial life. Making educated decisions and taking action early can help set you on the path to financial security and achieving your goals.
Dmitriy Fomichenko is president and founder of Sense Financial, a provider of self-directed retirement accounts.