Your 20s can be a very intense time full of transitions and opportunities.
You might be finishing or starting school; you might be beginning your first full-time job; you might be buying or renting your first house or apartment.
Needless to say, your budget will change quite a bit during this decade!
You're not alone if you've ever found yourself asking “how much should I save in my 20s?”
So, what's the answer to that question then?
Well, the short answer is…
…20 percent of your income.
Does that surprise you?
Let's talk about it.
The 50/20/30 Rule
One of the best budgeting methods out there today is known as the 50/20/30 rule.
The “50” part of the 50/20/30 rule means that no more than 50 percent of your income should be used for your essential expenses.
Essential expenses include things like your rent or mortgage payment, utility bills, groceries, insurance premiums, and copays for healthcare appointments.
Basically, we’re talking about anything that is necessary for your life and is not a personal or discretionary expense.
If your essential expenses are adding up to more than 50% of your total income, then it’s time to think about making a change.
The best way to reduce the amount of your essential expenses is usually to downsize your living space.
You might consider moving to a smaller, less expensive apartment or house and living with more roommates.
You could also renegotiate your rent when the time comes or make a commitment to using your utilities less, although these will likely be smaller changes.
The “20” means that you should be investing and saving 20 percent of your income.
If you have an employer that offers you a 401(k) and matches your contributions to it, then those matched contributions should be your first priority.
After that, you should focus on maxing out your Roth IRA. (This is usually $6000 per year.)
If you’ve taken advantage of your matched 401(k) contributions and maxed out your Roth IRA, then you can make deposits into a regular, taxable brokerage account and trade as you please!
When necessary, you can also use part of this 20 percent to put towards savings.
For example, if you haven’t built yourself an emergency fund yet, it would be wise to use all or part of your 20 percent to build up that emergency fund.
A good emergency fund should have enough money to cover four to six months of expenses in the event that you lose your job or have to pay a large, unexpected expense.
The “30” in the 50/20/30 rule is the best part: you get to spend it on yourself!
The remaining 30 percent goes towards personal, discretionary expenses such as restaurants, movies, video games, and beauty products.
What If I Can't Save 20 Percent?
Of course, you might not be able to have a perfectly balanced budget using the 50/20/30 rule while you’re in your 20s.
You might be in school and you don’t have time to hold down a full-time job.
You might be required to live in a certain location that doesn’t have a lot of flexibility on rent rates.
There is an infinite list of financial limitations that you might face while you’re young, so you just have to do the best you can!
If you’re working your hardest but you still can’t invest 20 percent of income, that’s okay. Invest what you can!
If you’ve made all the sacrifices you reasonably can but your essential expenses still represent more than 50% of your total income, that’s okay! Try to borrow some budget room from the personal expenses section.
If you’ve read our article on the top 1% at every age, then you know that the average income of a 25 year old is about $41,000.
If you make $41,000 per year, then you should be investing $8200 (20 percent).
Open a Roth IRA
If you haven’t opened a Roth IRA for yourself yet, the time to do so is NOW.
A Roth IRA, or individual retirement account, is a tax-advantaged retirement account that allows you to make contributions with after-tax dollars.
What does that mean?
Well, with a traditional IRA, you get a tax deduction for the contributions you make, meaning that your taxable income is reduced by the total amount of your contributions.
This is a great advantage for those who are in a higher tax bracket. If you can delay paying income taxes until you’re retired and in a lower tax bracket, why wouldn’t you?
But what about younger individuals who are just starting out in the workforce?
If you have an entry level job, you’re most likely in a lower tax bracket than you will be in retirement.
So you don’t necessarily need that tax deduction now; it would be a lot more useful to you down the road.
And that’s where the Roth IRA comes in!
When you contribute to a Roth IRA, you don’t get the same tax deduction you get from a traditional IRA.
Instead, you make your contribution with after-tax dollars, and then your money is allowed to grow completely TAX-FREE.
That’s right; you pay your income tax upfront and you won’t have to worry about any taxes when you withdraw the money in retirement.
It is incredibly important for young people to get started with a Roth IRA as soon as possible. The sooner you start investing, the longer your money will have to compound tax-free!
If you're looking to open your first Roth IRA, I highly recommend checking out Acorns. Acorns is a robo-advisor that does all the work for you by letting you round up your every day purchases!
IRAs do come with contribution limits, net income limitations, and other rules. You can learn more about those rules on the IRS website.
Invest In Index Funds
Once you have your Roth IRA all opened up, it’s time to invest in securities that will benefit you by growing steadily over the long term.
Index funds are a type of fund that track, or mimic, a specific index such as the S&P 500 or the Dow Jones Industrial Average.
You can easily buy into an index fund in the form of an ETF, or exchange-traded fund.
An ETF is a type of fund that trades just like a stock on the stock market.
Unlike a mutual fund, you can buy or sell an ETF at any time the stock market is open and with much less fees.
One of the biggest benefits of investing in ETFs is the natural diversification that comes with it.
When you buy an ETF, you are exposed to every single security inside of that fund.
So if you buy an S&P 500 ETF, that means that you have a diversified security filled with 500 different stocks!
At the end of the day, you shouldn't compare the dollar amount you're investing to the dollar amount that anyone else is investing.
Your goal should be to work hard, make sacrifices where you can, and invest as much as possible as early as possible.