Seven money mistakes to avoid in your 20s

Good money habits might not seem a priority when you are in your 20s. There are so many competing demands on your cash, and it’s important to enjoy some of the best years of your life. However, there are also some important traps to avoid, and if you do it will make things so much easier for your financial future.

Seven money mistakes to avoid in your 20s

1. Excessive debt

Debt is often necessary and it’s unusual for those in their 20s to be debt free. The trick is to differentiate between good debt – that ultimately puts you in a better financial position – and bad debt, which makes your position worse.

Good debt could include:

• A mortgage that enables you to live in and ultimately own a property
• Investing in yourself through a loan for education
• Borrowing to build a successful business

In the instances above the benefits can ultimately outweigh the cost of the debt. However, some debt is only bad, especially if it has a high interest rate attached:

• expensive personal loans
• overdrafts
• credit card balances where interest is paid

These higher cost debts should be cleared as quickly as possible as they represent a drain on your finances with no financial benefits. For other debts you should have a plan for managing them. Not only will you save on interest repayments, but you will also help to build a good credit rating which can mean lower interest rates when you come to take out a mortgage for a first home.

2. Getting caught short of cash

Establishing and keeping to a budget is important for anybody, but it’s particularly important in your 20s. When you are first getting to grips with managing your finances it is easy to underestimate your spending and fall behind on bills or debt repayments, which can mean you incur fees or penalties.

Not only can this be annoying and costly, but it can damage your credit rating. Having a comprehensive budget plan can help prevent these missteps and ensure you know how much you can afford and when.

Ideally, once debt is cleared, you’ll want to build an emergency fund to cover any unforeseen costs such as an urgent household or car repair. It can also be important to have some money put aside just in case your job circumstances change and you need to live off your savings for a short while. As a rule of thumb, an emergency fund should cover about three to six months of living expenses.

Getting the balance of spending and saving can be difficult, but it’s an essential part of managing finances in your 20s. One good framework to use is the 50/30/20 rule which suggests that when establishing a budget you allocate:

• 50% for needs (e.g., housing, bills, transport)
• 30% for wants (entertainment, etc.)
• 20% to debt repayment, savings and investments

These percentages aren’t set in stone. If you can allocate more than 20% of your income to savings, that’s great, and you’ll be better off over the long term. Meanwhile, some people will need to spend more on necessities.

3. Being too low risk for long term goals...

When it comes to investing risk can be a good thing, which to many people is counterintuitive. Look up synonyms for risk and you find: danger, jeopardy, peril, hazard, and threat. All words with negative connotations. No wonder that many of those new to investing start to hear alarm bells as soon as the concept of investment risk is introduced.

Yet not investing – leaving money in cash – is a high-risk approach in itself, at least in the long run. Cash does a poor job of growing your money, and it tends to shrink your wealth over time. One pound has lost half its spending power over the past thirty years (source: Bank of England Inflation Calculator). This means the goods and services that cost a pound thirty years ago will cost you two pounds today. You will have got some interest on your pounds in a decent savings account over the years, but it will have been hard to keep up with rises in the cost of living.

You won’t lose money on cash, the figure in pounds and pence won’t go down. That’s important, and it’s why you need to keep some on hand for life’s unexpected events. But having lots of your worth in cash is a missed opportunity over longer periods. Instead, investing in the stock market and other assets rather than saving cash may be right for goals which are still some years away.

4. ...but not taking too much risk either

If risk is a good thing, then why not pile into high-risk investments? Not so fast. Taken to the extreme, investment risk can be detrimental, and it can lead to financial ruin if you take a gambler’s approach.

Take investing in a single company. You are putting your capital in the hands of one business and one management team. That’s way too much risk for most people, though being an entrepreneur often means putting all your eggs in one basket. Elon Musk, founder of Tesla, famously gave the electric vehicle company a 10% chance of succeeding in its early life. It’s now one of the biggest auto manufacturers globally, but there are several points at which it could have failed along the way and become practically worthless.

You’ll also need to take a long-term view to ride out stock market ups and downs and allow the compounding of returns to do the hard work. While he’s been a great investor over the years, leading to fame as well as fortune, more than 90% of Warren Buffett's wealth has been accumulated after the age of 65. Time, and staying in the game through avoiding excessive risks, has been just as important to the world’s most renowned investor as stock picking. Keeping a cash reserve so you can leave investments untouched is part of this, and you should never borrow to invest. If you borrow, you may become a forced seller.

For most people, then, it’s a case of striking a happy medium. Taking enough risk to generate strong, long term returns ahead of inflation, but avoiding excessive risk that could wipe out a swathe of your wealth, leaving you with insufficient capital to recover. To thrive, you must survive, so while you need to take risk, room for error is essential. That’s why the concept of diversification – spreading your money around lots of different investments – is so important.

5. Disregarding tax

Commonly younger people don’t need to think as hard about tax. With earnings generally lower and less in savings and investments it can seem irrelevant. But it might be important in the future. You can only earn £1,000 a year in interest tax free from savings and after that you may have to pay tax on the amount received.

Similarly, with investments you must pay capital gains tax or income tax if profits taken, or dividend income exceeds certain limits. Although these used to be quite generous, for the 2024/25 tax year they are just £3,000 and £500 respectively. It doesn’t take much for a successful investment to become a tax liable one. It therefore makes sense to use your ISA allowance to house both savings and investments wherever possible. It’s like using sunscreen, there’s little effort involved and makes perfect sense as a precaution.

6. Missing out on the benefits of pension savings

If you are employed, ensuring you are paying into any pension plan at work should be a priority. You will be entitled to pension contributions made by your employer, as long as you keep opted into it and make the required level of contributions yourself. Although may not seem a near-term priority in your 20s, you should generally maintain this form of investing as far as possible as it is often the most efficient way to provide for retirement by some distance. You’ll also benefit from compounding returns over the very long term.

Your retirement can also get an extra boost from pension tax relief on your own payments into a pension. This contribution from the government can have a considerable impact on the size of your investment pot and the retirement income you can achieve. The government will automatically top up your contribution with 20% basic rate tax relief. Higher-rate and additional-rate taxpayers may claim up to a further 20% and 25% respectively back through their tax return. Consider a Self-Invested Personal Pension (SIPP) for making extra pension contributions with the ability to select from a very wide range of investments.

7. Not seeking help

Juggling different priorities can be tricky, and when you are just starting out putting the right plans in place can become overwhelming. Reaching out to friends or family with more experience can be helpful, but if you have a more complex question, or would like a professional opinion, then consider a speaking to a qualified financial coach.

Traditionally, Financial Planners work on an ongoing basis and charge annual fees to manage your money, but for many people this service and the associated costs are often beyond the scope of what is required. This is where financial coaches come in, and at Charles Stanley we can tailor coaching sessions to your needs and answer the financial questions you have personally.

Financial coach pricing is generally much more cost-friendly than formal financial advice or planning. For example, at Charles Stanley, we offer a free 15-minute consultation to have an open discussion about your finances and answer any questions - jargon free. Alternatively, book in for an hour-long financial coaching session (at the cost of £150) for an in-depth conversation and analysis, helping you establish goals and create a plan to help you achieve them.

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