5 Financial Tips for Millennials to Build Wealth

Conversations for Millennials quickly shifted from discussing Legally Blonde and Backstreet Boys to how to build wealth faster than Ricky Bobby (Okay, that may have been too many 2000s references in one sentence). All jokes aside, wealth accumulation at an early age can impact financial positions as we mature.

Increasing wealth begins with work, and Millennials are doing precisely that. Millennials are the largest working generation, making up 35% of the working population globally. With work comes compensation, and compensation leads to decisions. So, what steps can Millennials take to start the wealth accumulation process?

The simple answer is to save more than you spend. Execution, however, is a different story. While this may seem overwhelming, it can be condensed into 5 simple tips that even Karen from Mean Girls can follow:

1. Create and stick to a financial plan
2. Do not keep large cash balances
3. Make use of compounding interest
4. Avoid unnecessary debt
5. Take advantage of real estate appreciation.

1: Create a Financial Plan

Financial planning for Millennials should be strategic and deliberate and goes beyond simply understanding your personal finances. Trying to build wealth without a financial plan is like building a home without a blueprint. You may have the materials you need: wood, nails, shingles (i.e., a steady salary, employer match, solid financial habits), but without the know-how and a result in mind, you are left with a pile of wood.  

You can begin to construct a financial plan for yourself with two simple steps: understanding your current financial position and imagining your future financial position.

Current Financial Position

You can begin to understand your financial situation by looking at your cash flow. Take some time to sit down and ask yourself the following:

How much money do I make in a month? How much money do I spend in a month? What are my liabilities? What percentage of my income am I contributing to my retirement plan? What is my employer’s 401(k) match? How much money do I have in cash? Am I saving to an investment account?

If you do not know the answers to these questions, take the time to find out, as they can be compared to the vitals a doctor takes: blood pressure, temperature, oxygen levels, etc. These answers are all indicative of your financial health.

Future Planning

The next step to building your financial plan is envisioning a future for yourself. Here are some questions to consider:

What do I want my future to look like? Will I be responsible for caring for a parent? Do I have children whom I would like to send to college? What is the likelihood I will need long-term care? What lifestyle do I want to lead throughout retirement?

This is not an exhaustive list, but it will help you think deeply about how your money can align with your goals. Wealth is built through solid financial habits, and solid financial habits build wealth. The following tips elaborate on how you begin to align your financial actions with your financial goals.

2: Avoid Keeping Unnecessarily Large Cash Balances

There are ways to use cash in your financial plan. It is prudent to have 3-6 months of monthly expenses in an emergency reserve account (you will know this number easily after looking at your current financial position). You should also keep any anticipated expenses within the next year in cash to avoid market correction. All excess cash should be invested.

Inflation is Costing You Money

The rising inflation rate has been a topic of discussion since consumers began to feel the post-pandemic pinch. Although the word “transitory” was added before the dreaded “I” word for some time, prices continue to increase rapidly. In fact, the inflation rate in February of 2022 was 7.9%. With checking and savings accounts earning a mere 0.01%, cash is losing 7.89% while sitting in a bank account. Therefore, it’s beneficial to invest your excess cash instead of leaving it in savings.

3: Make use of Compounding Interest

Taking advantage of compound interest is key to building wealth. Compound interest is when interest accumulates on both the initial principal and the interest earned; when your money makes money on money it already made! While your cash is currently losing 7.89% in the bank, our Research Team at Allegheny Financial Group has found that a portfolio with 20% bonds and 80% equities has historical returns of 7.9% per year on average.

You should not keep excessive amounts of cash; instead, it should be invested. But where do you start? Think about the financial plan and goals you constructed in Tip #1. Consider how time, diversification, and professional management can help you make your money work smarter, not harder.

Time to Grow Your Money

One of the most important pillars of financial planning is time. Knowing when you will need the money is step one in determining how the funds should be allocated. If you need the money to replace windows in a year, it is not wise to expose it to market volatility. However, if you are looking to retire in 20 years, your allocation will look different. Millennials who are investing for retirement will have a more aggressive allocation, as the money will have time to withstand market correction before access is needed. Millennials who are looking to save money for shorter-term goals will allocate portfolios more conservatively to avoid too much volatility.

Diversification

Millennial investing is much more than investing in stocks. Holding investments that behave differently over changing market conditions is how to reduce risk during market downturns while continuing to optimize return. Your portfolio should be allocated to the investments that reflect your expectations of volatility and return.

Once your allocation is determined, reviewing and rebalancing your portfolio to keep it in line with your target allocation will allow your portfolio to behave within proper expectations.

Professional Management

At Allegheny Financial Group, we believe clients’ portfolios succeed over time by holding funds with top-performing managers across different asset classes. These managers act rationally in times of uncertainty.

Millennials have lived through the Dot-com Bubble and directly felt the harmful brunt of the Global Financial Crisis while entering the workforce in 2008. As a result, they tend to have higher distrust of the volatility of markets. Not even Warren Buffet can predict a market correction; however, we can prepare for this by diversifying our portfolios to protect on the downside and avoiding rash decisions when faced with market volatility.

4: Keep an Eye on Your Debt

Excessive debt is the opposite of taking advantage of compound interest. Albert Einstein said it best, “Compound interest is the eighth wonder of the world. He who understands it, earns it . . . he who doesn’t, pays it”. 44% of Millennials believe they carry too much debt. These beliefs need to be translated into actionable debt reduction steps to build wealth.

Know Your Debt-to-Income Ratio

Start by comparing your assets (cash, retirement accounts, investment assets) to your liabilities. If you have a 1:1 ratio, you are moving in the right direction. An example would be a 30-year-old investor with $30,000 in cash reserves, $90,000 in a retirement plan, $30,000 in an Individual account, and $150,000 mortgage. This investor’s asset to liability ratio is 1:1, so she should feel comfortable with her debt position.

Millennials who get this ratio to 2.5:1 by the time they enter their 40s will continue to stay on track for debt management. For example, this ratio looks like a 39-year-old couple with $25,000 in the bank, $200,000 in retirement accounts, $100,000 in an individual account, and $250,000 mortgage.

Some debts, such as student loans and mortgages, may be unavoidable. However, it is important to pay attention to the interest rates on your debts. Credit cards have comparably high interest rates, so carrying balances on these from month to month can cause your debt to grow exponentially. If you do hold large credit card balances, revisit the questions asked in Tip #1 to begin to understand your cash inflows and outflows.

Creating a plan for debt management is essential. It is not sustainable to focus all financial efforts on building assets while ignoring liabilities, and not balancing the two is like taking one step forward and two steps backwards. Below are some tips on how to effectively manage debt:

• Know What You Owe
  After taking a deep dive into your current financial position, this step should be easy. Look at your debts and the interest rates associated with them. Extra payments should be applied to the loan with the highest interest rate if you have excess inflows of cash. This is often referred to as The Snowball Method.
• Refinance When Possible
  If you have a series of loans charging high interest rates, consider refinancing them for a lower rate. This will save you money, especially on long-term debt like a mortgage.
• Do Not Increase Your Debt Balance
  Our goal is to build wealth, not to decrease wealth. Therefore, debt should only be used when it is beneficial for financial situations because otherwise, it can hinder building wealth.

Remember, do not let your liabilities consume your financial energy. Debt is okay- it only becomes problematic when ignored by borrowers.

5: Own A Home

Forbes conducted a study in September 2021 that analyzed the relationship between Millennials and home buying. The study found that this generation, on average, is purchasing homes later in life than older generations. Only 42% of Millennials were homeowners by the age of 30 compared to 48% of Generation X and 51% of baby boomers.

Buying your first home is simultaneously life-changing and intimidating. When deciding if you would like to rent or own, consider the following: a home is a long-term investment, provides potential tax deductions, and the cost of borrowing is as low as it will be in the coming years.

Market Appreciation

It is not news to us that home values have been growing exponentially in recent years. According to the Federal Reserve Bank of St. Louis, home prices in the United States increased, on average, by 28% from 2009 to 2019.  

Homeownership not only offers you an opportunity for a return on your investment but also a safe space to explore your color “palate” (see what I did there?).  

Federal Tax Benefits  

Mortgage interest, interest on home equity loans, and up to $5,000 (if a single filer) of property taxes can be deductible from your taxable income. It is important to note that you can either itemize your deductions or take the standard deduction, not both. Therefore, the federal tax benefits are only applicable to taxpayers who have itemized deductions that exceed the standard. The standard deduction for married filing jointly taxpayers is $25,500 and $12,950 for single filers.

Interest Rates

With efforts to combat rising prices, the Federal Reserve began the first in a series of interest rate hikes this March. Unfortunately, borrowing will continue to get more expensive as interest rates rise. Locking in a low interest rate now can save money in the long run.

Homeownership not only offers Millennials the ability to channel their inner HGTV but also offers market appreciation, potential tax benefits, and competitive cost of borrowing.

Final Thoughts

Building wealth has never been, is not, and never will be an overnight process. It is a series of prudent financial decisions that can turn into financial freedom over time with the right guidance. This is how generations proceeding Millennials have found success and how generations following Millennials will find success.

Although this blog post offers guidance to help Millennials build wealth, it Is not an exhaustive list. Consult with a personal financial advisor like those at Allegheny Financial Group for these and other financial planning services.

Author: Maria Koedel | Planning Associate | Allegheny Financial Group | April 2022

Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.