So you just landed your first job! Well done. A steady paycheck means no longer surviving on Ramen noodles and finally having some money left over after you pay all your bills. Unfortunately, this also a time when many people make huge financial missteps. Avoid these five major money mistakes as you start your career and get yourself on a solid path to financial freedom.
1. Buying a New Car: Let’s say Jessie gets a job making $40,000 per year and to reward himself, he buys a new car worth his first year of salary. He pays a modest deposit and finances the car over five years. Jessie tries to justify this purchase by saying he needs a reliable car for work, and he thinks his salary can cover this expense. Here is why Jessie’s logic is flawed. First, Jessie overestimated his earnings by basing the purchase on his gross salary. After the government deducts Federal and State taxes, his salary is closer to $33,000 per year.
Second, Jessie failed to consider all the other expenses that come with owning a car such as interest on his car loan, gas, tolls, insurance, and maintenance. In total he will spend far more than $40,000 on this car over the next five years. Poor Jessie, he just got a job and he is already in a financial hole. As a better alternative Jessie could have skipped buying this car and used public transportation or moved closer to his employer so he can walk or ride his bike. If he absolutely needed to purchase a car he could have bought a reliable used car that would provide the same transportation at a significant discount.
What is more important to understand about Jessie’s car mistake is that he just made a tremendous shift of power from himself to his new employer. When you are free of consumer debt you have power. You are nimble and can make course corrections without the burden of high monthly payments hanging over your head. Jessie may have to stick with this job for a while even if it is a bad fit in order to pay his debts.
2. Not Maxing Out Retirement Accounts: When starting a new job, you want to immediately file all the necessary paperwork to maximize your contributions to your employer’s retirement program. There are two reasons why this is such an important step on your path to financial freedom. First, you do not miss money you never had. If these contributions are deducted from your salary right away, you will learn to live on a lower paycheck. Second, you will benefit from the free money earned by your employer’s match. If you save $5,000 and your employer matches it with $5,000, you have doubled your money with zero risk. You will never get those odds in Vegas! As you continue to save and this money compounds year after year, it will grow into a sizable nest egg.
3. Succumbing to Lifestyle Inflation: Even if you are smart enough to avoid Jessie’s expensive car mistake, you still need to monitor your spending across the main categories of expenses. Once people begin to make more money they tend to spend more to match this increased sense of wealth. This is called lifestyle inflation and it causes people to choose more expensive brands, restaurants, housing options, entertainment, and travel. Spending increases across each category will quickly add up. A person that was living paycheck to paycheck while making $40,000 a year gets a $10,000 raise and now is living paycheck to paycheck at $50,000. That raise should mostly go to investing to build wealth.
You want to set a goal of saving 20% of everything you earn from your very first job. If you start with this goal you will find that you can save more each time you get a raise or switch to a higher paying job. If you can save 20% of your salary when you are earning $40,000 per year then you will probably find you can save 30% to 40% once you are earning $60,000 per year. Your savings rate dramatically increases because you have avoided lifestyle inflation.
4. Focusing on Just a Paycheck: When you have not had money, it can feel amazing to get those first paychecks, especially if you struggled financially in the preceding years. But, this sense of newfound wealth can make a new hire feel like they have crossed the finish line. They now have a good job and they will work hard to climb the career ladder. The problem with this strategy is wage income is taxed higher than income from investments like stocks, real estate, or businesses. In addition, if you get laid off from your job, that comfy paycheck disappears.
When a recession like the global financial crisis in 2008-09 or the one caused by COVID-19 hits, jobs become scarcer and people who are laid off can suffer major financial setbacks. The goal from your first day on the job is to begin converting the dollars you earn into investments that generate passive income. Over time you will replace the income from your job with this passive income and become financially free.
5. Not Having Roommates: When people start earning a steady paycheck they often choose to get their own apartment to have more privacy. This privacy is nice, but it has a huge financial cost and is a common example of lifestyle inflation. According to the Bureau of Labor Statistics, housing accounts for 33% of the average household’s spending and is usually their highest annual expense.
This also means housing is a prime target for reducing expenses. If you rent an apartment with roommates you can often cut your housing expenses in half, which means the savings can go towards investing. If you buy a property and take on a few roommates you can often live free or earn a profit each month. Being strategic in your housing decision can enable you to eliminate this 33% expense and channel these funds into investments to build passive income. This one decision at the start of your career can put you on the path to becoming a millionaire.
Whether you are a new hire or a seasoned veteran, applying these financial lessons and avoiding these common mistakes can help make significant progress towards financial freedom.
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