The coronavirus pandemic has had a huge impact on employment and personal finances, with one of the hardest hit demographics being young adults in their late 20s and early 30s.
A new study by renowned think tank the Institute for Fiscal Studies reveals that young adults who were already dealing with low incomes, high relative costs and low savings levels on the eve of the lockdown are bearing the brunt of its economic impact.
Here, Svenja Keller, Head of Wealth Planning at investment specialist Killik & Co, looks at the biggest money challenges facing young adults today and how they can get onto firm financial ground.
What are the biggest financial challenges facing young adults?
Even after the current crisis has subsided, I empathise with the pressures on them, which are huge. First off, there is the immediate challenge of having to juggle multiple calls on their time and money. These may include; finding and perhaps changing jobs, paying down student loans and other debt, saving for a house deposit and in many cases having children.
At the same time, they need to think about the long-term future and their life after work as they are constantly reminded that there is going to be little help available from the State or the old-style (and often generous) defined benefit pension.
Their challenge is balancing these immediate and future requirements. While information about all of this is available, there is often too much of it and some of it is conflicting – it’s very hard for anyone to know where to start and who to talk to when it comes to setting priorities and planning. Meanwhile, modern marketing solutions constantly tempt them into spending more, everything is just a click away.
As a result, years can whizz by before many young adults sit down properly and get themselves organised when it comes to their finances, though these years are some of the most important when it comes to harnessing the power of compounding to boost their long-term wealth. For this reason, some form of financial planning is important at any age.
What is compounding?
Albert Einstein is said to have called the power of compound interest “the most powerful force in the universe” and went on to say…”he who understands it earns it; he who doesn’t pays it.”
Whether you save a little or a lot, compounding will make your money grow significantly more over the long term. Compounding is where you earn interest on interest already earned. This creates a snowball effect for your money. The bigger your savings become, the more you will benefit from compounding. So the earlier you can start saving, the better.
When should someone start to plan?
The earlier, the better. Take basic budgeting – it’s a skill that we should ideally learn at school age, from the moment we start receiving pocket money. The faster people work out how to set priorities and understand the trade-offs when it comes to spending, the more disciplined they will be. It is vital to grasp the importance of saving early – even small amounts put away when someone is young can mushroom into meaningful sums later at little cost in terms of lifestyle.
Unfortunately, it is all too easy to fixate on the here and now – meeting the next rent or mortgage payment, or credit card bill. The result is too little attention being focused on how things will look 20, 30 or 40 years into the future. This “recency bias” leads many people to miss the opportunity to really give themselves an early financial leg-up for later life. That matters because compounding is so powerful over long periods.
What stops younger people from saving more?
Part of the problem is the messaging around saving, which can be quite depressing. A lot of the marketing out there tries to scare people with facts about quite how much they will need to save to achieve anything, whether getting onto the property ladder or funding life after work.
It can all seem a bit overwhelming, especially when people can get a quicker, albeit short-lived, buzz from spending money now. What we try to do is convince those in their twenties and early thirties that even small saving steps can lead to bigger things if they start early and harness compounding over time to do some of the hard work for them.
We also emphasise that our approach isn’t based on giving up the things that people love, but just making sure they can see the value in balancing priorities and planning for the future.
How should they go about it?
The approach featured in a lot of industry advertising is the idea that we can spend first and then find a way to save what is left over, whether that is a few pence or many pounds per month. However, the truth is that most people get through whatever is in their current accounts – the more they earn, the more they spend.
So, when looking at cash flow modelling – a tool used by financial planners to forecast how much money you could have in the future – a better approach is to set a goal, then work out the amount needed to be saved to achieve it and then set that aside systematically in a separate account.