This advice is part of a series InvestorPlace.com has compiled, inviting academics from across the U.S. to share their thoughts on aspects of finance that new graduates should know. Their thoughts have been presented with little to no editing. Today’s entry comes to us from Robert R. Johnson, Ph.D, CFA, CAIA, Professor of Finance at the Heider College of Business, Creighton University, who spoke with InvestorPlace via email about financial advice for recent graduates.
While it may seem to be a lifetime away, new graduates need to be taught to invest for retirement and not to simply save for retirement. Most Americans reaching retirement age have extraordinarily little wealth accumulation. Estimates are that two-thirds of individuals approaching retirement will not be able to maintain their standard of living because they have so little accumulated for retirement. Solving the retirement income crisis is not difficult — one simply must invest early and often.
According to data compiled by Ibbotson Associates, large capitalization stocks (think S&P 500) returned 10.2% compounded annually from 1926-2019. Over that same time period long-term government bonds returned 5.5% annually and t-Bills returned 3.3% annually. The surest way to build true long-term wealth for retirement is to invest in the stock market.
Starting early is the key to successfully building wealth because of the effect of compound interest. Albert Einstein said that “compound interest is the greatest mathematical discovery of all time.” Time is the greatest ally of the investor because of the “magic” of compound interest.
Making a few good financial decisions early in life can make the difference between a secure retirement and one fraught with difficulties. Mistakes begin early in life and the biggest financial mistake people make is taking too little risk, not too much risk.
In fact, a recent UBS study showed that millennials and the World War II generation have similar asset allocations — low allocations to equities and inordinately high allocations to cash. Both generations were shaped by cataclysmic financial events in their formative years — the WWII Generation with the Great Depression and Millennials with the Financial Crisis. New graduates need to invest in stocks and begin compounding early, letting that compounding work its patient magic over decades.
New graduates should certainly place a priority on debt extinguishment. Einstein also said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” People can put their investment house in order by reducing debt and acquiring assets that grow in value over time. The fastest way to change one’s net worth for the positive is to obtain more assets that earn compound in value (like stocks or CDs) and reduce one’s debts and lower interest payments.
Ironically, one of the biggest mistakes people make when repaying student loans is placing too high a priority on the repayment. One of the most important financial decisions anyone makes in their life is the decision to participate in an employer sponsored retirement plan. Perhaps the worst financial mistake anyone can make is turning down free money. If one does not contribute enough in a 401k plan that has a company match to earn that match, one is basically turning down free money.
Many people put such a high priority on paying down student loans that they do not participate in their company 401k plan. Contributing the max to your 401K also reduces your tax bill. New graduates should do whatever it takes to participate in their company’s 401K plan to the level to get the full employer match.
And yes, even if that means a slower repayment of student loan debt. People should be lauded for paying down student loans. However, making that the only financial priority is misguided.
Company matching requirements vary considerably by company. For instance, some firms will match contributions dollar for dollar up to a certain maximum. On the other hand, some plans require the employee to invest a certain minimum percentage of salary before the firm will contribute any employer match.
New graduates should take the advice of Berkshire Hathaway Chairman Warren Buffett who said “If you want to make saving a priority, take a look at how you budget. Do not save what is left over after spending; instead spend what is left after saving.”
In particular, it is difficult for many people to imagine their future self and give up that vacation or new car today in lieu of having money to retire on in the distant future. University of Chicago Professor Richard Thaler received the Nobel Prize in economics for his work in behavioral finance. The premise of behavioral finance is that human beings are not rational profit maximizing machines, but often succumb to behavioral biases.
One of the biggest behavioral biases that humans succumb to is the bias toward immediate gratification over delayed gratification. That is, our present selves tend to win over our future selves. It is difficult for many people to imagine their future self and give up that vacation or new car today in lieu of having money to retire on in the distant future.
Making retirement and savings contributions the automatic, default option, so that we must actively opt out of saving is a wise approach. People need to predetermine savings for retirement instead of needing each month (or paycheck) whether to invest in retirement or not.
People should try and automate as many financial decisions as they can. One must make saving money a habit. And habits — good or bad —develop over time. A particularly sound way to do this is to agree to have a specific amount (or better yet, percentage) deducted from your paycheck every month and put into a retirement account.
If we are automatically enrolled in a retirement plan, inertia and the inherent laziness of people tend to work in our favor. That is, once enrolled in a retirement plan, people tend to stay enrolled. One of the best ways to save money is to make it automatic.
As discussed above, perhaps the most important employee-sponsored benefit that graduates must consider is an employee retirement plan. Particularly important is the amount of the company contribution to that retirement program.
While new graduates may not be immediately planning to continue their education, they should consider a potential employer’s educational assistance program. Many employers offer generous tuition reimbursement programs for employees. Building one’s human capital is one of the best investments one can make.
Providing educational assistance is a strong signal of a good company culture. I am reminded of the anecdote where the CFO asks the CEO: What happens if we invest in developing people and they leave us? The CEO answers: What happens if we don’t and they stay? New graduates should want to work for an organization that values education.
For example, Intel’s tuition assistance program offers 100% of reimbursable costs ($50,000/program with no annual limit) including tuition, books, and fees. Raytheon provides full-time employees reimbursement for up to $10,000 for approved courses and accredited certificate/degree programs. Target will pay up to $5,250 for MBA coursework.
You can read the next installment of “Money Moves for Recent Grads” here, and find the entire collection here.
