5 financial pitfalls to avoid in your 20s

Even if you’ve just entered the job market, it pays to be cautious, patient and financially literate. (Rawpixel pic)

Many millennials just starting their careers make decisions that could be detrimental to their long-term financial health. This article highlights five potential money traps to avoid when in your 20s.

1. Being financially illiterate

Financial literacy starts with the mastery of six accounting terms: assets, liabilities, equity, income, expenses and cash flow. Their relationship is key and is summarised in the diagram below.

Maintaining your financial report card will help steer you away from trouble.

Financial well-being can be assessed using these six accounting terms and understanding them helps in making wise financial decisions. Not doing so could cause the following financial calamities:

2. Credit card debt

Credit cards can be used to make cashless payments, get discounts and, most importantly, to build up a credit profile.

A good credit profile allows access to bank loans to invest in real estate, a common strategy to gain wealth and financial independence.

However, some use credit cards to cover shortfalls due to excessive spending. If you are in your 20s, you cannot afford this form of debt if you want to be financially solid.

Interest rates on credit card debt are 18% to 24%, the highest among all liabilities.

Interest rates on credit card debt are 18% to 24%, the highest among all liabilities. If you have credit card debt, prioritise clearing it off quickly.

If the debt is overwhelming, seek help from a financial planner or the Agensi Kaunseling & Pengurusan Kredit, an agency under Bank Negara Malaysia that helps individuals resolve debt issues.

3. Overpaying for a car

A car is a necessity. But, if everyone viewed their car solely as a necessity, there would be more Peroduas and Protons on the road. But it is a status symbol too that defines your social standing and level of affluence.

The cost of a car includes the down payment, instalments, servicing and maintenance, insurance and road tax. This excludes costs such as petrol, tolls and parking.

Are you spending 30% to 50% of your income on your car? If you are, and you feel the car is eating you up financially, it might be timely to reconsider owning one, or you could try to grow your income.

The cost of a car includes the down payment, instalments, servicing and maintenance, insurance and road tax as well as petrol, tolls and parking.

If you are just starting out and you need a car, opt for a second-hand car or a lower priced first-hand car. Why? The value of a car depreciates over time.

A RM50,000 car in the showroom today can be sold second hand for RM25,000 in 10 years’ time. This is a straight-line depreciation of 5% per annum. Not forgetting that your effective interest cost could be about 5% per year, thus costing you a negative 10% in your equity (net worth) per annum.

If you are spending 30% to 50% of your income on a car, you cannot save and invest for your future.

4. Buying a property you cannot afford

There are two parts to this issue: affordability and overpricing. One generally makes a 10% down payment for a property.

If it is priced at RM500,000, the buyer is required to make a RM50,000 down payment. In addition, there would be about RM20,000 in transaction costs, including the sale and purchase agreement, loan agreement, stamp duties for these agreements and the valuation report.

Ideally, a buyer should set aside RM125,000 cash to afford the property.

It is common for newly developed properties to be priced 20% to 40% above the value of those in the vicinity. Buyers are promised low down payments and savings on a couple of transaction costs.

However, the purchase is funded with substantially marked-up loans in order to avoid having to make the 10% down payment.

Newly developed properties are usually priced 20% to 40% above the value of those in the vicinity.

Issues arise after the buyers have collected the keys to their properties. Most would have been unable to sell at a profit for they need buyers willing to make a 10% down payment.

But if one has the cash to buy a property, why buy one at a higher price than it was originally bought for and at a 20% to 40% premium over the other properties in the vicinity?

As such, the sellers must lower their prices, which causes the property prices to fall 20% to 40% from the net purchase price.

If the initial buyers cannot sell their properties, they incur about 4% in interest and other property-related expenses, such as maintenance fees, sinking fund, utility bills, quit rent and assessment.

So, what is best if you are in your 20s today? Save for your down payment, which allows you ample time to prepare financially and emotionally to be a property owner.

5: Chasing quick gains

In today’s economy, investing is a life skill that determines your long-term financial survival and stability. Current fixed deposit rates are well below 3% per annum.

While there is a need to invest, the issue is often the investor’s desire for quick gains without taking the time to study and manage their investments properly.

What if you wish to invest but you have no clue where to start? Educate yourself. Understand the six accounting terms discussed earlier.

Formulate a financial plan and make a checklist to distinguish good deals from bad and take the time to assess them. If you are promised high, fast returns with hardly any effort, avoid the deal and you will do just fine.

How to get a financial head start in your 20s?

Here are nine things you can do now to build the foundations of financial independence.

1. Understand the basics of financial statements.
2. Learn how to draw up a financial plan.
3. Avoid credit card debt. If you have, settle it as soon as possible.
4. Use your credit cards to build your credit score.
5. Do not spend more than 25% of your income on car-related expenses.
6. Do not buy a property if you cannot afford it.
7. Do not buy a property just because you get cashbacks. It could be overpriced.
8. Don’t chase quick gains from investments.
9. Learn how to invest, be it in stocks or real estate.

This article first appeared in kclau.com

Ian Tai is the founder of Bursaking.com.my, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks. It is an essential tool that sifts out stocks that grow profits consistently from a database of over 900+ stocks listed mainly in Malaysia.