Financial Advice For My 23 Year Old Self

My first job as a telecommunications engineer paid about MYR2,300 (~USD600) a month. That’s pretty reasonable for an entry level job in Malaysia but boy sometimes it seemed that I could never make any headway with my savings. If only I knew then what I know now about managing personal finances.

I didn’t really keep track of my savings. I had a stock trading account but it was just for the company’s restricted shares. I had bought too much life insurance coverage that also came with too many bells and whistles.

It’s no wonder that I wasn’t going anywhere with my savings. So this post contains advice that I would give to my 23 year old self (and others out there) about what to do with your hard earned money when you are just starting out with your career.

It doesn’t matter how much the starting salary is. The important thing is to build up some basic knowledge about personal finance and then put that into practice. Keep doing it until it becomes a habit, even when you earn more as you climb the corporate ladder.

When you are starting your first job, your salary is the main source of income. It can also be the only source of income. It’s fine as long as you are able to manage it wisely.

Chip Away The ‘Big Rocks’

You first start by identifying those big chunks of expenses that you have every month. At this stage of your life these expenses can be rent, student loans and car loans. These are the ‘big rocks’ but don’t let them weigh you down when you are young. Otherwise you will incur what’s called ‘opportunity costs’ for not saving and learning to invest instead.

Take car loans as an example. In the past, it’s quite impossible to hold a job and not own either a car or motorcycle that can get you to work. In the future perhaps owning one will not be necessary when you have driverless taxis with low fares or when pooled car ownership becomes practical.

Typically you’d buy a car with a hire purchase loan that’s stretched out 3, 5 or 7 years. That means you will commit a large and fixed chunk of your meagre monthly income to a bank for 3, 5 or 7 years. It’s therefore an expensive mistake if you buy a car that you can barely afford because that mistake will hang on your shoulders for that long.

The same goes for rent. I know it’s convenient to stay in a nice hip neighbourhood where you can easily get your cafe latte every morning. But just like car loan installment payments, rental amount is fixed every month (and can go up over time). Once you sign a tenancy agreement, you will commit a fixed chunk of our salary to the property owner throughout the duration of the tenancy. There is nothing that you can adjust or do during that period of time to reduce the rental.

At this young age, your life is pretty flexible and your body is full of energy. Take advantage of that and look for ways to reduce the weight of these ‘big rocks’. Take public transports, share your rented room with another roommate to halve the cost, stay with your parents, etc. But don’t forget to pay back your student loan.

At 23, you don’t really have dependants. There may be an urge to start paying a monthly ‘allowance’ to your parents but try to delay this. Honestly, your salary isn’t that much to begin with and you need it more than them at this stage. Give back to your parents in other ways by prioritising them during holidays or surprise them with simple gifts from time to time. When you eventually have kids that are starting to work, pass on the favour to them by not ‘taxing’ them of their minimal starting salary. There will come a stage in your life when you will regularly support your parents.

Prioritise Your ‘Variable Expenses’

Everything else should be pretty much ‘variable expenses’. Meaning they can be as high or as low as you want them to be. What are these things? They will be mainly food, clothing, entertainment, gadgets and travels. These expenses will correlate with your lifestyle. For example, if you love traveling you can prioritise your budget for traveling over all other ‘variable expenses’.

Speaking of budgets, now you have all the info needed to come up with one.

First, take your salary and subtract out the ‘big rock’ expenses. Hopefully you still have at least 60% of your salary left. Learning to limit your ‘big rock’ expenses to 40% or less of your income is essentially starting a habit to limit your debt commitments in the future. When you apply for a bigger loan such as a home loan in the future, banks will check your debt commitments to decide how much loan you are eligible to get. Typically your total debt commitment, including your monthly home loan payment, should not exceed 40% of your gross income.

Work out a reasonable budget for your ‘variable expenses’. Figure out what your lifestyle priorities are and budget realistically for them. Use your past spending amounts to decide if the budgets are realistic or not.

Now step back and check your budget. Is there anything left from your salary? If it’s zero or negative you have a big problem.

The next step is to adjust your ‘variable expenses’ so that you will get at least 10% left from your salary for savings. This can be the painful step because now you come face to face with your financial reality.

But you don’t have to sacrifice your lifestyle priorities as you do so. If you are a gadget freak, keep that budget for a new smartphone. Just consider aiming for a Xiaomi instead of an iPhone. Similarly if you love traveling, consider backpacking or local travels instead.

Life is all about making choices. Some choices can be hard to make but you cannot avoid them. You shouldn’t run away from making hard choices.

If you are able to get the 10% savings from your salary give yourself a big pat on your back. Well done.

What About Insurance?

Insurance is a pooling of money from people with different risk profiles so that when life deals a tough card on one of these people some of the money can be withdrawn.

You may think of getting a life insurance but again at 23 years old it’s likely that you do not have any dependents. Your first priority should be to stabilise your income and expenses and build up a bit of savings. It’s not buying life insurance. Don’t pay too much attention to words like:

  • ‘Buy life insurance early so that your premium is lower.’ Insurance premiums are similar to car loan installments and rents. It’s a ‘big rock’. Once you start, you cannot stop paying because that can cause your policy to lapse. Your priority at this point should be to build up your savings, not paying insurance premiums.
  • ‘Life insurance is like forced savings.’ In the first 2-3 years of your insurance policy, the majority of the premium that you pay to the insurance company will be used to pay a commission to the agent who sold you the insurance. So will you not have any meaningful ‘forced savings’ at least until 7 years down the road. Instead of using your meagre salary to pay the insurance company at this stage of your life, use your hard earned money to pay yourself first.

Your job will likely provide some sort of medical insurance as well, so you can give that a pass.

Building Up Savings For Day to Day Expenses

Layer 1: Savings for day to day stuff

If you are able to save 10% of your monthly income you will be on your way to slowly build up your day to day cash savings. The next question will be how much should you hold in your savings account?

Savings account typically hold next to zero interest rates so it’s not to your advantage to hold big sums in your savings account. Target about 2 months worth of your regular expenses to be kept in the savings account, ie just enough for the daily expenses.

Once you have your base savings of 2 months in your savings account, you should not worry too much about your normal daily expenses and bills. You have mastered your first level of what financial planners called an ‘asset allocation model’.

Emergency Savings for the Rainy Day

Layer 2: Emergency savings

Once you have your day to day cash savings take care of, the 10% monthly savings should now go towards creating an emergency savings fund. The emergency savings fund will be used when you have an unexpected big expense or if you suddenly lose your job. It’s a financial buffer to protect you during difficult times. If you have an emergency savings fund, you can then enjoy your life without looking back with worries.

In Malaysia, you can open a fixed deposits account for such an emergency account. The key thing is that the money should be easily accessible when needed. If you do use the fixed deposits account, split the money into chunks of say 1 month expense and then set the fixed deposit term to 1 month, auto-renewed. Whenever you need the emergency cash, simply uplift one of the 1 month expense fixed deposit 1 month at a time.

If you are in a country that has very low fixed deposit or certificate of deposit rates, then you could consider holding the emergency cash in a bond exchange traded fund (ETF) or money market fund. These are the least risky investments but keep in mind that when you need the cash it’ll take probably 5 or 6 business days for a sell trade to settle and the cash to be then moved out to your savings account. Also note that bonds and other investment funds can lose money so you’ll have to top them up from time to time. If the risks are too much, then just keep them in a separate savings account that is different from your regular savings account.

Start by aiming to save 3 months of your expenses in the emergency account. When you get to 3 months, give yourself a small celebration and then push it up to 6 months of expenses.

10% monthly savings alone will take 4-5 years to build up to an emergency savings of 6 months of expenses. That may seem like a very long time but you can shorten this duration by making sure that when your income eventually rises, your expenses rise slower than that. Additionally you can channel any additional income you may earn, such as bonuses and overtime pay, directly to the account. Challenge yourself to hit the 6 months emergency savings in 2 or 3 years instead.

Once you have built your personal financial safety net the next step is to take additional risks and build your investment plan. More on that in the next post.

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