This is Part 2 of our series on post-graduation financial wellness. In Part 1 we tackled goal-setting and understanding your debt and cash flow. Now we can move on to budgeting and organization. When you set goals, understand your cash flow, and prioritize your spending so that you take care of your most important goals and responsibilities first, you are in control of your money and not the other way around.
Here’s a reminder of your Road Map:
Road Map
1. Set goals
2. Understand your debt
3. Understand your cash flow
4. Establish a budget for living below your means
5. Organize your accounts
Step 4: Establish a budget for living below your means
The right budget can relieve stress and even create freedom in your finances. The most important aspect of budgeting is to not overextend yourself. Living at the top end of your means is risky and, to be honest, generally not necessary or all that satisfying. Give yourself some financial freedom and hold back. This is especially important when your income is in constant flux.
Considerations as you create your budget
Getting started: If you followed my advice and started tracking your expenses in step 3, you can use that information as a starting point for a realistic budget.
Decide to live below your means: What does this look like? You pay your credit card off every single month in full AND you save something every single month.
Prioritize your debt payments
Aim to save 10% of your income: It’s quite understandable that this might not be practical right away – especially if you have debt – but this is your goal and can be a mix of emergency and long-term savings. Ultimately, aim to increase this to 20% of your income.
Taxes: If you won’t receive a paycheck for a few months and are trying to plan ahead, don’t forget about taxes. Ballpark it and subtract about 15-20% of your income for taxes.
Monitor spending: Plug your budget into an expense-tracking tool like Mint and review your spending monthly. Review, learn, adjust, and repeat.
For detailed budgeting guidance, I’ve created a budgeting toolkit which includes a how-to article and accompanying spreadsheet, which you can download for free.
Step 5: Organize Your Accounts
Aside from your checking account and possibly a credit card (which should be giving you some sort of rewards), here are my recommendations on the additional savings and investment accounts you’ll want in your financial world.
In order of priority….
Emergency Savings Account
Where? These funds should be in their own dedicated high-yield savings account. I like Ally and Capital One 360, but there are other great options. Check out NerdWallet or Bankrate for the latest reviews. You don’t want this money to be super easy to access so that you see it as strictly for emergencies.
How Much? The goal is 3 months of essential living expenses (e.g., rent, groceries, health insurance, basic bills). This will likely take you some time, but relax. Be somewhat aggressive in your efforts to save at least $1,000. Then you can work toward your end goal of 3 months of savings at a slower pace. If you receive any money for graduation, use some of these funds to help jumpstart your emergency savings.
Retirement: Employer Sponsored (e.g., 401k)
Where? Your employer decides this for you. Your employer will have have a relationship with a financial institution that is in charge of holding all employee retirement accounts for the plan. If your employer offers a retirement plan, this might be a great place for your longer-term savings. If your employer offers any kind of match, this is a no brainer and your first priority behind debt payments and at least $1,000 in your emergency savings.
How Much? Contribute enough to your 401k to max out your employer’s match (this is probably around 3-6% of your salary). If this stretches you too much, contribute as much as you can and work toward the max percentage. In 2016, most employer-sponsored retirement plans allow you to put away $18,000 into your account.
Don’t get hung up on investments. Keep it simple. If you have no idea what you’re doing, look for a target date fund which most plans offer. This is a mutual fund that will invest in a variety of ways for an appropriate level of risk given your age and expected retirement date. The fund will automatically move into less risky investments as you approach retirement.
Retirement: Individual Retirement Accounts
How Much? The short answer is up to $5,500 a year.
If your employer doesn’t offer a retirement plan (or they do and you simply want to save more), you should open a Traditional IRA or Roth IRA. Both have great tax advantages and you can contribute $5,500 a year to either of these accounts. For those also participating in an employer’s plan, this is an additional $5,000 that does not count toward whatever annual contribution limit is set on your employer’s plan.
If you qualify for a Roth IRA (there are income restrictions), I’d start with this and open up a Traditional IRA once you no longer qualify for Roth contributions. You put after-tax dollars into a Roth account and when you take money out after age 59 ½, you pay zero taxes on withdrawals (that includes the growth on investments). With a traditional IRA you do pay tax on the earnings and pre-tax contributions when withdrawn.
Where? This depends on how involved you want to be with choosing and managing your investments.
Do you prefer to DIY? If so, choose a low cost brokerage firm like Fidelity or Schwab and buy ETFs. Use a simple allocation like 70% equity and 30% bonds.
ETF stands for exchange traded fund and they are low cost and associated with “passive investing” which is what I recommend for graduates. Most ETFs are index funds which means that the underlying securities held by an ETF attempt to mirror a broader market index, for example the S&P 500, so you can expect returns that closely mirror that index.
Do you prefer to outsource your investing? For those with little interest in investments or just too nervous to DIY, I recommend picking a robo advisor such as Betterment, which is the most cost effective way to smartly manage and automate your investing. NerdWallet has a helpful review of robo advisors, and you can check out our recommendations here.
Balancing Student Debt With Saving
Your first priority is to make the required payment on your loans each month. Your second priority is to establish an emergency savings fund. Save at least $1,000 in emergency savings as quickly as you can. From there, you need to consider the interest rate on your loans when deciding how to balance debt and savings. Paying off debt with an interest rate is a guaranteed return on your money. Despite what you might earn investing in the market long-term, you can’t deny how awesome you’ll feel when you finally pay off your student loans. If your employer offers a match on its retirement plan and your loan interest rates are around or less than 5%, I’m comfortable with you contributing enough to get the match and then putting any extra cash toward the debt payment.
We’re at the end of our road map and I hope this information gives you confidences and sets you up for success. Before I turn you loose, here are some suggestions for staying financially healthy.
Healthy Money Habits
- Continue tracking and reviewing expenses (monthly review of spending that is monthly and recurring in nature and quarterly for spending that is more annual in nature)
- Review bills, savings and debt and make sure as much as possible is automated
- Review goals annually
- Check credit report and score at least annually (quarterly is ideal)
- Free credit report: www.annualcreditreport.com
- Free score: www.credit.com
And please, don’t open up a new retail credit card just to save a whopping 15% on a one-time purchase. There’s a time and place for a retail credit card but definitely no need for more than one. You want to be smart about your credit. Read these two prior articles about credit to get up to speed on what you need to know about credit reports and scores.
Please reach out to me if you want more one-on-one help preparing for financial independence post-college. You can also join my newsletter where readers and I engage in healthy reflections and conversations about money. A great deal of value can come from talking about money and asking questions, so find someone - a professional, family member, friend or mentor - with whom you are comfortable talking about money.
You’ve got this.