It's difficult to match the intensity and excitement of graduating from college and setting out on life's journey. Personal finance certainly doesn't hold a candle to it, but careful planning can help smooth the way for those just starting out after college.
Whether you are a beneficiary of a trust, continue to receive financial support from your parents, or have to earn your own way, there are a few considerations you need to make to put yourself on a solid path to building and preserving your own wealth.
You’ll need to figure out a budget that allows you to enjoy your leisure time while saving for the long term, you’ll need to start saving now rather than procrastinating, and you’ll need a system to help you keep on track.
What you will quickly realize is that you need a lot of planning to set up your life. You’ve already taken steps to building a career by graduating from college, but there are still decisions to be made: do you continue in school and get a professional degree? Do you find work for a company or for yourself? What passions do you have that can help guide these transitions, and how much money do you need to get started? After all, it’s easy to get caught short on money even if you had a lot to begin with. You’ll want to identify spending categories and compartmentalize your income, including setting aside money for fun.
It is also an exercise in setting priorities and working toward bigger and bigger goals, such as a dream vacation, a new car or a first-time home. While room after room of high-quality designer furniture would be a nice way to start out your first apartment, your immediate needs are a couch, a bed, and some lighting. Over time, you will be able to adjust your spending to reach for those larger purchases.
Starting out with a plan also helps avoid problems shared by a lot of newly independent young adults: cash crunches and credit trouble because they don’t adequately match their income with their expenses. In a survey this year by the financial industry’s main regulator, 26% of 18-34 year olds said they regularly overdrew their checking accounts compared to 19% for all age groups. More than half of respondents aged 18-34 said they used credit cards in a way that incurred higher fees and interest rate charges.
Understanding your credit and using it wisely can save you big money over the long term in interest alone. On a $500,000 30-year mortgage, the difference between a 3% interest rate and a 4% interest rate is about $100,000. To qualify for the best terms on a mortgage, you need solid credit scores, and those can easily be damaged early on by mismanaged spending.
Credit scores are also used to set interest rates on revolving credit lines, car loans, credit cards, and business loans and they aren’t based on income or inherited wealth. They are based on how well a person services their debt and manages their finances. And apart from saving money, good credit — at least 700 on the FICO scale — is what landlords and even employers use to judge whether you are responsible.
Wealthy people don’t always have the highest scores, either because they avoid using credit or they are sloppy with managing their accounts, either running high balances or failing to pay the bill on time every month. But using credit wisely builds in flexibility and security, especially when making big-ticket purchases or traveling.
Don’t underestimate the value of a financial plan to help sort out some of these issues. It may sound mundane, but mapping out your saving, spending, borrowing and investing strategies will help you reach your goals and minimize stress.
A plan can help you decide whether to buy a first home or continue to rent while you save for bigger goals, for example. It can help you evaluate your credit options and make sure you have enough set aside to fund both an emergency stash and your charitable causes.
Discipline can also help you prioritize what to do with a bonus from your job. A $10,000 windfall, from a bonus or a gift, could fund a vacation or help save for the future purchase of a car or a condo.
Apart from budgeting and using credit wisely, saving is a top priority for building wealth, and postponing it can cost dearly. As illustrated in the graph above that assumes a 7% annual return, Susan who saves $5,000 a year starting at age 25 and ending at age 35 (10 years) will invest $50,000 in total and have $602,000 at age 65. Bill who invests three times as much money over 30 years but doesn’t begin saving until age 35 ends up with less wealth. By starting early, Susan accumulated more wealth because of compounding interest. Chris who contributed steadily for his entire career ended up with the most wealth with $1,142,811 at age 65.
It may be difficult to find extra money when you are just starting out, but that is where discipline comes in. Savings can be automatically deducted from your paycheck and put into a company retirement plan — all the better if the company offers matching funds — an outside individual retirement account you set up, or even a regular savings or investment account. If you don’t see it, you won’t feel it “missing” from your paycheck.
Small amounts add up over time without you realizing it, but where you put your money is also important. Savings of $166 to a basic money market account, the account could be worth $20,000 in 10 years.
Remember that wealth isn’t accumulated overnight, at least for most, and it takes vigilance to maintain and preserve it over time. A strong advisor can help you overcome human tendencies that often undercut financial goals. We often put short-term interests over longterm ambitions, or we panic and sell when we should buy, or we spend when we should save. For more information, talk to your family’s Boston Private advisor.
For more information on how to get going, download a free workbook filled with games and activities to help initiate discussions about money with children of all ages.
* Investment returns and interest rates may vary; the projected returns in the examples above are presented simply as an illustration.
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