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One of the questions I see frequently asked by young professionals in regard to their finances is, “How do I know if I’m on track?”. This can be a very challenging question to answer because it completely depends on your future financial desires. This is why it is important to work with a financial professional who can create a tailored plan that takes into account your current and future goals. But for the purposes of this blog, I came up with four easy benchmarks for young professionals to see if they are on a good financial course.
1. Emergency Fund & Cash Flow
The first benchmark is all about ensuring you have the basics down. It includes having a proper emergency fund in place and knowing where your monthly cash flow is going.
An emergency fund is exactly what it sounds like – a rainy-day fund set aside in case of any unforeseen expense that exceeds what you can pay out of a monthly paycheck. If you do not have a proper emergency fund in place and something were to go wrong, (an issue with your car, for example) then you would either have to put the expense on a credit card or get a personal loan.
What is a proper emergency fund and how do I calculate how much I need? An emergency fund should include 3-6 months of living expenses set aside in a safe place like cash in a savings account - think mortgage/rent, utility bills, medical insurance, car insurance, and groceries.
The first step to determining how much cash you should keep in an emergency fund is understanding your monthly cash flow. I’m not saying everyone needs a budget, but you should at a minimum understand where your money is going on a monthly basis.
Roughly how much do you spend on groceries each month? What about dining out? More importantly, is your cash flow repeatable? Month-to-month cash flow should look very similar without too many variations. To me, understanding cash flow is the most important aspect of personal finances. It’s the foundation everything else is built on. Figure out how much you spend on a monthly basis and set a goal to keep 3-6 months’ worth of those expenses in an emergency fund.
2. Housing Expenses
Housing expenses are most likely your largest monthly cash outflow. Keeping home expenses low in comparison to your take-home pay is extremely important because this allows funds to be deployed elsewhere.
Too often I see people worried about making changes to small pieces of their cash outflow like spending less on groceries or spending less on dinning out. Spending less money and saving more is always great for your financial situation, but what if you reduced your mortgage or rent payment? This will make a huge impact and one that’s somewhat permanent.
A benchmark for housing expenses is that they should not exceed 28% of your take-home pay. To calculate this, take your mortgage/rent payment plus your monthly homeowner’s/renter’s insurance premiums and divide that by your monthly take-home pay (the amount that hits your checking account).
Having home expenses that are less than 28% of take-home will only make your finances less stressful and more rewarding. You’ll have more cash flow to dedicate to short-term goals, experiences, and building wealth.
3. Retirement Contributions
“I’m 31-years-old, how much should I be putting away for my retirement?”, is a question we often get asked as financial planners. As stated in the introduction, a typical response to this is “Well, it depends”.
How much someone should save for retirement depends on many factors, including how much you are earning, if you have high interest rate debt, when you plan on retiring, and what your vision of retirement looks like, to name a few.
According to Fidelity1, you should aim to save at least 15% of your income each year for retirement. In my experience, it is very unlikely someone starts out their professional career socking away 15% of their income. For young professionals, I believe it is better to give them a range based on age.
If you are between 20 and 30 years old, an industry target would be a contribution rate of 10% - 15% of your gross income to your retirement accounts. If you are between 30 and 40 years old, your contribution range the target would be between 15% and 20%.
Here are two quick tips for starting those retirement contributions. At the absolute minimum you should be contributing enough to receive your employer match. This could be a 100% return on your money. Where else can you instantly get a 100% return? Also, an easy way to quickly boost your retirement savings is to increase your contributions at least 1% per year. With annual raises you will most likely not notice a change in your cash flow from the 1% savings increase and it will have a lasting impact.
4. Retirement Account Balances
The last benchmark is all about how much you currently have dedicated for retirement. As stated in a Fidelity study2, you should have 1x your gross salary saved for retirement by age 30, 2x by age 35, and 3x by age 40. So, if you are married and you both earn $50,000, then by age 30 you should have $100,000 saved in a dedicated retirement account(s).
To some this may seem like a shock, to others a reinforcement that they are on track. If you find yourself in the first group, the most important thing to remember is, it is never too late to start saving!
I hope these benchmarks give you a good idea of where you stand with your finances and also give you some ideas of where you can improve. Remember these are just benchmarks, everyone’s finances and goals are different. That’s what makes personal finance personal.
1 How Much Should I Save for Retirement? (Fidelity)