Money Guide for 20-Somethings

Manwill saves by living with her parents.

When you don't have a lot of money, what to do with it might seem like a silly question. But the high price of college, pressure to start saving for retirement at an early age, and pricey urban housing markets mean today's 20-somethings face tough financial decisions, with little room for error. It's not easy being young.

Take Rachel Manwill, a 24-year-old assistant editor who is trying to pay off $6,000 in credit card debt while earning around $34,000 a year. "After I'm done paying my bills, there's not a whole lot left beyond what I know I'm going to need for gas and food," she says. In an effort to save money, she still lives with her parents in Upper Marlboro, Md., and, even so, feels that she's living paycheck to paycheck. "It just never seems like there's enough," she says.

Many in Manwill's generation share her frustration. According to the latest numbers from the Bureau of Labor Statistics, consumers between the ages of 16 and 25 report household spending of just $282 less per year than their pretax income of $28,258. (Housing and transportation alone account for more than half of those expenditures.) Consumers between ages 25 and 34 fare better, spending almost $10,000 less than their average pretax household income of $56,149, but still devote 57 percent of their take-home pay to the basics—food, housing, and transportation.

So, what is a strapped 20-something to do? The key, say personal finance experts, lies in prioritizing all of those competing demands for money. Here's a road map to help sort it all out:

Spending. First jobs come with some unavoidable start-up costs, such as a new suit and possibly wheels to match. Those expenses can easily outweigh first paychecks. That's why Liz Pulliam Weston, author of Easy Money, recommends pretending that your new salary doesn't exist. "Most people would be better off if they continued to live like broke college students for a few years, until they get a handle on expenses," she says. "You will get approved for a monstrous car loan. There is no relationship between what you can afford and what you can get," she adds, which means those getting started on their careers have to exercise self-discipline and sometimes self-denial. If you need a car for work, buy a two-year-old used one, Weston says.

"Diminish your expectations," advises Tamara Draut, author of Strapped. Small habits such as bringing lunch, buying coffee at a deli instead of a coffeehouse, and waiting to buy a new car can make a big difference, she says. Living at home, which 1 in 7 adults between the ages of 25 and 29 does, can also provide financial breathing room, Draut adds.

All this scrimping need not mean living on bread and water. "You do need little luxuries, and you can fit them in no matter how small [your income] is, but you can't have them all the time," says Carmen Wong Ulrich, author of Generation Debt.

Credit card debt. Entering the workforce with credit card debt is not necessarily a bad thing, Ulrich says. "There are times in your life when you use a credit card that you are using debt in a good, smart way," she says, such as buying a couple of work outfits and cheap furniture for a first apartment. As long as the purchases are necessary to one's new professional life and paid off quickly, she adds, then it's not a problem.

But when debt accumulates, especially on multiple cards, it's time to crack down by paying as close as possible to the full balance each month. To decide which card to pay off first, check the credit limits, says Bill Hardekopf, chief executive of LowCards.com. Going over the limit can mean an additional fee of around $30. Even getting close to credit limits can trigger credit card providers to increase interest rates, which will make it that much harder to pay off the debt. The next priority should be paying off the cards with the highest interest rates to minimize interest payments.

Student loans. "Don't worry about student loan debt too much," says Weston, unless it's dominated by high-interest private loans. As long as most of it is locked in at lower rates, 20-somethings are better off putting their extra cash into high-yield savings accounts or retirement savings. The other advantage of student loans is that they tend to be flexible, with loan companies granting deferrals or forbearance to struggling borrowers going through temporary crunches, Weston adds. (Deferring doesn't stop interest from piling on more debt, so it's an option to be used only in emergencies.)

But paying late or missing payments altogether should be avoided at all costs, Draut cautions. Unless a borrower officially requests and receives a deferment or forbearance from the lender, missed payments can hurt credit scores.

Savings. Weston suggests a cushion of at least $500 to pay for emergency expenses, such as car repairs, to avoid racking up more credit card debt. Ideally, every worker should have up to six months of living costs stowed away in case of job loss, but Weston acknowledges that could take years and needn't be a top priority for younger workers.

Insurance. While skipping health insurance altogether is tempting, it's a bad idea, Ulrich warns. "Almost half of bankruptcies last year were caused by medical debt. It's a gamble with your financial future you shouldn't take," she says. Since just one accident or illness can cost thousands of dollars, passing on insurance is a big risk, even for the young and healthy.

Most people get health insurance through their employer. If that's not an option, Ulrich recommends looking for a high-deductible plan, sometimes known as catastrophic insurance, to guard against major unexpected expenses. (Trips to the doctor or emergency room will cost more, but there is a cap.)

Long-term goals. Financial dreams—such as taking early retirement, buying a house, or traveling around the world—need not be put on hold for decades. But to make them a reality before middle age, they may need to be slightly massaged. For example, workers in many urban areas may find that a home downtown is unaffordable but a place in the suburbs can be within reach, Ulrich says. "You have to alter your plan."

Retirement. Saving for retirement—another long-term goal—can also be temporarily deferred. While workers should try to take advantage of matching employer contributions to 401(k) and similar plans, saving above and beyond the level covered by the match can be nearly impossible for stretched entry-level workers. Still, Weston says young people should get in the habit of saving from their first paycheck: "You have the power of time behind you now."

Fidelity, which offers life-cycle, or target-date, funds that shift into less risky investments as workers grow older, recommends saving 12 to 15 percent of gross pretax pay each year. If employees start at age 25, they can replace 85 percent of their working income in retirement, the company estimates.

If that sounds daunting, consider Ulrich's view that today's youth may not be as financially well off as their parents' generation, but they're also living much fuller lives. "Not materially, but in terms of access to information, education, careers.... We have to hearten ourselves with that."