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 Paolo Pasquariello, Professor of Finance for the Stephen M. Ross School of Business at the University of Michigan, who spoke with InvestorPlace via email about financial advice for recent graduates.
As students move into the next phase of their lives and start saving, the most important word for them to remember is “diversification.”
Meaning, “never put all of your eggs in one basket, since if that basket breaks you will break all the eggs.” Most first-time employees will be offered a chance to build a retirement portfolio; they should jump at the opportunity and diversify the resulting portfolio to the largest extent possible.
That means having a significant portion of their investments in foreign assets; that means especially having a significant portion of their investments in bonds, especially government bonds but also corporate bonds. Especially the first, government bonds, are virtually the only form of cheap insurance available against recession risk. Government bonds do well during recessions because interest rates go down to stimulate the economy and so bond prices go up.
Likely, unscrupulous people will advise you to invest most of your money in stocks because you are young and retirement is decades away. Your answer should be that being young does not mean being stupid; no less than 35% of your money should be invested in (government) bonds.
It is possible that going forward the government will come around to organize some form of financial support / rescue package for the millions of indebted college students in the country. In the meanwhile, my suggestion is for students to try to repay their debt as soon as possible (not unlike credit card debt), or to try to restructure your various debts and loans by refinancing and collapsing them into one with lower monthly payments.
The coronavirus pandemic will hopefully teach many lessons to modern society. Among the most important ones is the need for risk management. It sounds like a complicated thing to do, yet the idea is pretty simple: you should always be prepared for the worst-case scenario.
Financially, that means maintaining a portion of your savings in liquid, near-cash securities worth at least six months of your monthly net salary. You may get sick, lose your job, decide to move, change your career, or be hit by a pandemic. In all of these circumstances, a cushion of cash or liquid securities will help you smooth your ride to the next step of your life.
The most important benefit that an employer can offer you is a retirement matching program. It sounds complicated, but it is not; it is “free” money that the company gives you by matching a fraction of your retirement contributions. Many companies offer a 1-to-1 match up to some limit, for instance 5% of your monthly salary.
Let’s say that you earn $5,000 per month; if you choose to automatically invest 5% of your monthly salary in the company-sponsored retirement plan [a “401(k) plan”], $250, your employer will also contribute $250 to that plan every month. In other words, your monthly retirement contributions will double “for free.”
Let me repeat: This is “free” money in the sense that it is part of your compensation and it is for you to take; but if you don’t contribute to your retirement, you will simply lose it. Thus, my suggestion for you is to contribute to your retirement the largest fraction of your monthly salary that your employer matches.