Understand Your Finances
7 things you need to know about money before you graduate
Let's have some real talk for a minute.
Managing money can feel daunting: as you approach graduation, it might seem like a bunch of weird stuff like taxes and deductions, fees and interest rates, is rushing toward you. But you don't need to be the next Warren Buffett to put your best foot forward financially. In fact, some of the most important steps to financial success are super simple.
Here are seven things you should know about money as you contemplate your first steps into financial adulthood:
1. Learn how to make ends meet
The first thing you need to master is living within your means. After you land your first job, get a handle on your actual monthly take-home pay—the money you have after accounting for taxes, insurance, retirement, and other withholdings. Then, subtract your total monthly fixed costs, including rent, utilities, car payment or student loans. If you make an automatic contribution to a savings account, factor that in, too.
What's left after your set expenses is your discretionary income, and how you spend it—or save it—will influence your budgeting, savings, and investing. Love trying new restaurants? You may have to compromise by eating inexpensive meals at home, and packing lunches for school and work. That way, you can splurge a couple times a month.
2. Put time on your side
Saving may seem like a stretch when you first begin juggling the expenses of adult life, but even small contributions can add up over time. Generally, it's not recommended to start investing until you have about three to six months of living expenses saved, though this varies based on your own situation.
3. Keep it simple
David Hilty, 22, credits a high school internship with a financial advisor with helping him navigate the early stage of adulting. The internship, he says, was a crash course in money management, and how investing really works. "Before my internship, I had an interest in investing, but I didn't know where to start because it's such a complex world," David recalls.
You don't need to be a stock market expert to invest successfully. Warren Buffett, widely considered one of the world's most brilliant investors, has said the single best investment is a fund—or combination of stocks—that follows the Standard & Poor's 500 index, which tracks the 500 largest US stocks. The beauty of this sort of fund is that, since it's invested in hundreds of different stocks, you have an opportunity to get the safety of a diverse collection of stocks without having to invest in each one separately. While this is a good example of how you can diversify, it's important to keep in mind that there are more layers of diversification. For example, other diversification options include holding investments across stocks, bonds, and other asset classes and from different parts of the world.
4. Be consistent
When it comes to saving, slow and steady really does help win the race. Making monthly, automatic contributions to a savings account can put you on the path to long-term money growth—and economic security.
This approach can also work in long-term investing if you make consistent contributions. This strategy, known as "dollar-cost averaging," takes your emotions out of the equation. Regardless of whether you're nervous about market downturns or excited at upswings, you're investing more when prices are lower and getting the benefit of upturns.
5. Don't blow the big picture
Pay attention to fees. Overdrawing on your checking account or missing the due date on a credit card payment can easily cost you $30 a pop and also cause a ding to your credit score. Meanwhile, above-average investment fees can add up to a huge expense over time. Pay attention to how fees can impact the overall return of a mutual fund.
For most investors, the biggest cost is the fees charged by the funds they invest in. While these fees are often less than one percent, they can eat into your returns over time.
6. Get tax savvy
One of the more painful rites of passage into adulthood is the realization that a considerable chunk of your paycheck will go to taxes. Luckily, there are ways to cut the amount you give Uncle Sam. One of the best is a 401(k) or other tax-friendly retirement saving account.
When you opt for a traditional 401(k), your contributions are taken out of your salary before you pay taxes. Once that money is taken out, your take-home pay drops, which can put you into a lower tax bracket. That means you'll pay less taxes on all your income.
Of course, you'll eventually have to pay taxes on all those retirement contributions, but—on the bright side—you'll have years of collecting interest on money that would have gone to the IRS.
Another benefit is that many companies will match your 401(k) contributions, contributing money to your retirement. While it can vary widely, a typical program will match a percent of the employee's contribution, up to a certain amount of their salary, like 50 cents on every dollar contributed, up to 5 percent of their salary. For a recent grad who lands a job paying $50,000 a year with a dollar-for-dollar match of up to 3 percent, that amounts to an extra $1,500 a year for those who contribute enough to reach the full match .
7. Pay taxes on your retirement now...and save later
401(k)s aren't the only option for your retirement. You can also invest via a Roth IRA if you qualify or—if your employer offers it—a Roth 401(k). Unlike a standard IRA or 401(k), these plans require that you pay taxes today, which means that when you are eligible to start receiving distributions in retirement, you won't have to pay taxes on the money you receive. Since everyone's situation is different, you should speak to a tax advisor to help you decide which retirement account is right for you.
Like any stepping stone to adulthood, learning how to manage your money is a process. By developing some smart habits and a little knowledge today, you can set yourself up to be that much more ahead of the game tomorrow.
The information within this document is being provided for informational and educational purposes only. It is not intended to provide specific advice or recommendations for any individual. You should carefully consider your needs and objectives before making any decisions. For specific guidance on how this information should be applied to your situation, you should consult the appropriate financial professional.
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Sarah Max is a freelance writer. Her work has appeared in the New York Times, Time Magazine and Bloomberg News, among other outlets.