Financial Planning for the Recent College Graduate

Last year, you were playing beer pong and sleeping until noon. These days it’s coffee (strong and black, please!) and conference calls by nine. While recent college graduates don’t often think about financial planning, learning and practicing good financial behavior now can set you up for financial freedom much sooner than 65, the age we typically associate with retirement.

Take it from me, a recent college graduate who has successfully saved almost $30,000 for retirement in just four short years – on a modest salary, while enjoying life, using simple principles, and without relying on the “next hot stock tip.”

1. Create a Budget
It sounds simple, but the first step to financial freedom is to create a budget. Doing so will allow you to set realistic goals and reign in excess spending. Budgeting may not have been an issue during college, but now that you’re paying the bills, you’ll want to know exactly where the money is going.

Tip: Use a money management program such as Quicken or MS Money, an Excel spreadsheet, or a simple pen and notepad to track your spending. First, write down all of your “fixed” expenses such as rent, car insurance, and certain utility bills. Then, keep a strict log of your flexible spending for the next week. Be extra careful to track the amount you spend on meals or out at the bar. Extrapolate this amount over a month, adjusting as necessary. Finally, and add the fixed and flexible spending. Subtract this from your net (take home) pay. Hopefully you’ll have something left over!

2. Pay Off Credit Card Debt
If you have something left over from step one, that’s a good sign. Use it to pay off high-interest credit card debt. In my opinion, carrying a large amount of high-interest credit card debt is to be avoided like the plague. It means I’m living outside my means. Granted, all credit card debt is not bad – who knows when the car will break down or you ruin a pair of pants – but that is different than going on a shopping spree at Bloomingdales.

Tip: Add “credit card payment” as a fixed expense each month. Knowing that the money is “already spent” will keep you from splurging when you get your paycheck! Paying off credit card debt should be a high priority.

3. Invest up to the Match in a Company 401k or Retirement Plan
After you pay off your high-interest credit card debt (student loan debt doesn’t count, as it is low-interest), begin investing in your company’s 401k, assuming they offer one. Many companies will match whatever you contribute to your account, up to a certain percentage. For example, if you make $30,000 and your company matches up to 5%, invest that much yourself. You’ll end up investing $1,500 and your company will kick in another $1,500, bringing your total savings to $3,000. Even better, your contribution is tax deferred, meaning your taxable income for the year is only $28,500!

Tip: Diversify your investments if you can. My favorite is an S&P 500 index fund, which has historically returned around 11% over the long-haul (remember – you’re in this for the long haul!) Don’t invest it all in the company stock if you have that option – if the company tanks, so will your retirement dreams!

4. Open a Roth IRA (Individual Retirement Account)
If your company doesn’t offer a retirement plan, or you’ve maxed your contribution to your employer’s match, open a Roth IRA. The money invested in a Roth IRA comes after you’ve paid taxes on it. However, that will be the last time you ever pay taxes on it. It will grow tax-free, and remain untaxed when you withdraw it years later. The current yearly contribution is maxed out at $4,000, but this will increase in the coming years. I have invested the maximum for the past four years. With decent returns, my IRA account now stands at almost $20,000.

Tip: Find a low-cost broker such as Ameritrade or E*Trade to open up your retirement account. Shop around for the best deal. Again, I recommend investing in broad indexes instead of individual stocks – you are in this for the long haul!

5. Envision Your Future
Money is only a tool to achieve your dreams. By setting your sights on what you want to accomplish, you can plan to have enough assets to enjoy your time when you finally do retire. You may not need a large sum of money to live happily and comfortably.

Tip: Set a goal and save accordingly. If you plan to stop working early and travel, you will need to save more now. If you plan to continue working long into the future, you can get away with saving less.

6. Have fun and use time to your advantage!
Have fun with retirement savings. There is nothing more rewarding (to me at least) than watching my nest egg grow. Don’t necessarily deprive yourself, but be aware of the great power that you have by starting young.

Tip: A little goes a long way! Even if you can only invest $10 or $20 a month, compounding interest and time are in your favor. See the power of compounding for yourself – experiment with the compound interest calculator found at http://smartmoney.com/compoundcalc to see how the effects of starting amount, rate of return, and time effect your final return – you may be pleasantly surprised!

If my advice hasn’t quite sunk in, I’ll give it one final try. Look at the final return if you investing $10,000 with an 8% return (which is conservative), at different ages, assuming you want to retire at 65:

$10,000 invested at age 25 – $217,245
$10,000 invested at age 35 – $100,627
$10,000 invested at age 45 – $46,610
$10,000 invested at age 55 – $21,589

As you can see, it pays to invest early. Even though you may think you have more in common with the students in the dining hall than the old-timers getting the early-bird special at the diner, the numbers don’t lie. Good financial planning for the recent college graduates makes sense!

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