Generations X and Y-the twenty and thirtysomethings who are still getting their financial lives started-can make their future more prosperous by avoiding a handful of myths that have been bedeviling adults for decades.
What are these myths and what’s the real truth? A guide.
– Myth 1. Take any job you can get. You need to work to pay your bills.
Reality. It is better to be working than to be unemployed, of course, but avoid taking “just any job,” says Nancy Dunnan, author of “Your First Financial Steps: How to Manage Your Money When You’re Just Starting Out.”
Don’t wait for the legendary “dream” job; most entry-level positions are decidedly undreamy, she adds. But make sure the job you take has potential to develop into what you want or gives you pertinent experience.
If you can’t find a full-time position doing what you like, consider signing up with a temporary agency that serves your target industry, Dunnan adds. Working as a temp can give you needed income and possibly the experience necessary to land full-time work.
– Myth 2. I’m too young, and have too many other financial goals, to worry about saving for retirement. I’ll save for retirement after I buy a house and a car.
Reality. Saving for retirement can actually help you get the house or car-if you have access to the right type of retirement account: a 401(k) plan that allows participant loans, to be specific.
Most of the nation’s biggest employers-and about half of all employers nationwide-do offer such plans, benefit consulting firms say. Better yet, many companies offer contribution “matching.”
How exactly does that help you buy your house? Let’s say you work for a company that has a 401(k) plan. You can contribute up to 12 percent of your income; the company will contribute an amount equal to 50 percent of the first 6 percent of your contributions-a fairly common arrangement. The plan allows you to borrow up to 50 percent of your account value for major purchases and medical emergencies-also fairly common.
You earn $25,000, or $2,083 per month, and contribute the maximum of $250 a month, $3,000 per year. The company kicks in $750 annually-50 percent of the first 6 percent you contribute. In five years, assuming you earn 8 percent on the money invested, you have nearly $23,000 saved and can borrow $11,500 to buy your house.
You’ll pay interest on the 401(k) loan, but the bulk of the payment-everything but a small processing fee-goes back into your own account.
– Myth 3. Buying a home is better than renting because when you buy, you build equity, and when you rent, your payments go for nothing.
– Reality. Buying can be a savvy financial decision, but not always. In addition to monthly mortgage payments, you incur expenses for homeowners’ insurance, property taxes and utility costs that you are not likely to face when renting. As a result, a house that could cost $500 a month to rent might cost $800 a month if you bought it.
A savvy renter can invest that $300-a-month difference and possibly end up ahead of the buyer in the long run.
Consider a hypothetical example to illustrate the point. Sally, a renter, has $10,000 that she can invest in a mutual fund or in a $100,000 house that’s similar to the home she now rents for $600 a month.
However, if she buys the house, the after-tax cost of her home-taking property taxes, insurance and tax deductions into account-is $850 per month. If she opts to rent, she’ll invest the $250 difference between her rent and the projected mortgage payment in equity mutual funds through her 401(k) plan.
Which gives her the most equity at the end of 30 years? The answer depends, of course, on how much each investment appreciates over time and whether her landlord raises the rent-things no one can predict for sure.
However, in the past, houses have tended to rise slightly faster than the rate of inflation. Inflation has averaged 3.13 percent over the past 70 years, according to Ibbotson Associates, a Chicago-based economic research and consulting firm. Stocks, on the other hand, have tended to rise by 10 percent per year, according to Ibbotson.
So, you find that Sally was wiser to rent. Her house, which she’d own outright after 30 years, would be worth $331,350. However, the mutual fund would be worth $763,495.
