You just had a good run in your final year of college and it looks like you’ll be out in the real world soon enough. You may have mixed feelings at this point – most people are thrilled about not having to worry about doing assignments or a job on the side to keep up with expenses. On the other hand, you might be a little bummed about not living through that wonderful summer vacation phase again.
In any case, you need to have your priorities straight. You’re about to break into the professional world, and it pays to learn a thing or two about investments and financial planning.
Take compounding interest for instance; it can greatly help you in the long run if you’re looking to make some wise investments. However, it can also be a complete buzz-kill if you go over the budget and pile up credit card debt.
As a fresh college grad, you need to take into account some basic financial considerations.
It’s certainly very exciting to finally have your own place. Here’s an acceptable housing affordability standard: your housing expenses should not exceed 30% of your annual earnings.
Here’s how you can project your monthly expense: divide your net salary by 40. So let’s say you’re making $40,000 annually after deductions, the best you can afford is a place with a roommate, probably in a city like New York or San Francisco.
High rent and tax figures means living a tough life in the more attractive communities, unless you have a high-paying job. You might be tempted to save money by living further away from the workplace; however, the benefits almost never outweigh the cons of a long and tiring commute.
So, if you decide to live in more expensive cities, you may need to settle for a trade-off by spending less on entertainment or other non-housing expenses. This can be a tricky proposition as people love moving to places like NY City and San Francisco to take in the sights and what they offer outside of the office. It is important to acknowledge early on that you’re going to need a lot of discipline and careful financial planning in order to continue living decently on a budget.
Savings and Investments
It might be okay to stretch the budget every now and then to enjoy living in the more lavish cities; it is an absolute must that you also stretch out your 401k contributions and take advantage if your employer matches.
You see, an employer match is like money in the bank that grows over time. You might be able to eventually use that money to make a down payment on a house, a nice car, or college education for your kids-to-be. Maximizing your 401k contributions is always good practice.
It doesn’t end here though: making the right investments will let you take full advantage of your 401k contributions. You don’t want to be in a situation where you end up with mutual funds having high fees as your only investment option. It’s a known fact how these funds can mean bad business in the long haul – the high fee structures lead to a sizable gap between your returns and what you get to keep. In addition, their trading costs are usually not taken into account and a high turnover leads to an inflated tax bill.
As you hunt for funds to invest in, keep an eye out for low-cost index funds. Your best bets are Spartan and Vanguard ETFs – low cost, wide market exposure. Since you’re a new college grad, your ‘investment shelf life’ is quite long, around forty to fifty working years. Hence, you should be aggressive with risk tolerance: equity-driven primarily while having a little fixed-income exposure in order to diversify.
Strictly staying within the domestic equity scope, diverse exposure to large, mid and small-cap equities is recommended. Seek exposure to developed as well as emerging markets when it comes to international equities. Also, be on the lookout for Bond ETFs which invest in domestic as well as international corporate and government bonds, though this can vary according to your risk tolerance.
Compounding interest is a twin-edged sword: it can almost ruin you in the form of debt. Consider student loans; balancing student loan debt can be a tricky affair due to the associated opportunity costs. Not to mention how some federal loan plans have high interest rates, making it tough for you to pay down initially.
Dedicate a section in your monthly budget to taking care of student loan payments. When you make it a habit to make your payments on time, you are effectively leveraging yourself to clear all debt.
Another aspect to consider is credit-card debt. Credit cards are generally viewed as bad debts since they don’t return future dividends. Just know that failing to clear your monthly payments can get you in a tight spot fast – compounding interest on credit cards.
Credit cards are not a gateway to free money access. Get in the habit, and it can prove to be fatal. Instead, learn to build a firm financial foundation. Use them for rewards programs, spend only on what you can afford and make your monthly payments on time in order to generate a good credit score. That is the key.
Work Hard and Enjoy Your Life
We all love doing stuff in our down time, whether it’s kicking back with a friend and taking in a movie, playing video games, or hanging out at your favorite club. Make it a habit to reserve 10% of your after-tax earnings for “fun stuff” while maxing out your 401k. Always be mindful of your spending and keep a little something extra for the rainy days.