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 David M. Cordell, PhD, Clinical Professor of Finance at The University of Texas at Dallas, who spoke with InvestorPlace via email about financial advice for recent graduates.
Create a lifetime plan for investing, and commit to it. Establish quantitative goals like, “I will have a securities portfolio worth X dollars by the time I am 30.”
Avoid “keep up with the Joneses” syndrome, in which you attempt to establish and maintain a lifestyle that you can’t afford, the result of which is typically accumulation of high-interest-rate debt instead of an investment portfolio. You will always have friends who have more “stuff” than you do. Get over it.
Pay yourself first. In other words, have money taken out of your paycheck and deposited and/or invested directly. First, establish an emergency fund of at least three and preferably six months of expenses in case of job loss or unexpected major expenditure. These accounts should be liquid, like a savings account or money market account, not something volatile like stocks.
Save also for planned expenditures, like an automobile, a vacation, a down payment on a home, or a child’s education. The longer the time period, the more risk you can take in search of higher returns. Stick with diversified mutual funds and exchange traded funds rather than individual stocks. They may not provide the same excitement, but you’ll have plenty of opportunities to make individual stock investments as your portfolio and investment knowledge grow.
It is likely that you will have friends who brag about how well their investment in XYZ company turned out. Be very, very cautious in allowing their experiences, real or exaggerated, to influence your plans.
Saving 15% of your compensation is a realistic goal, even if it is unrealistic when you are starting out. Whenever you receive a raise, commit to allocating 25-50% of the raise to savings. If you receive a bonus, do the same. This will increase your total savings percentage over time.
Save for retirement even though it seems to be a century away. Building a retirement fund gives you security and could allow you to retire at an earlier age if you choose. It also provides some flexibility since you can tap those funds if absolutely necessary.
Don’t be discouraged when your stock market investments decline in value. Keep investing. Follow the concept of dollar-cost-averaging — when the market is lower, your monthly contribution buys more shares. Thus, in the long run, the dips in the market allow you to have more shares and more wealth.
Aside from the obvious benefit of the education that college provides — knowledge for its own sake –college is an investment in your future as higher earning capacity. Don’t allow yourself to resent the payments you must make. They aren’t much different than having to make payments on an automobile loan, and the average amount of student debt is about the cost of an automobile. Both the automobile and the education provide ongoing benefits.
The good news is that education keeps providing benefits long after the loan is retired, whereas the automobile declines in value with every passing year. Still, making minimum payments stretches out the education loan period seemingly interminably. Don’t be a slave to the debt. As you get raises on the job, commit to increasing your loan payments significantly. You will feel the burden lifting as your loan balance declines.
The COVID-19 outbreak is a stark reminder that we are all subject to events that are beyond our control. Many very successful individuals and businesses are under great financial stress, and some have declared bankruptcy. But many have survived the crisis because they had adequate financial reserves. There can be no more clear example of the importance of establishing a significant emergency fund.
Considering employment benefits, medical insurance is an absolute necessity. Consider dental and vision insurance if they are available, but watch out for the maximum insurance benefits, the deductibles and co-pays. It may be better financially to establish a fund to pay out-of-pocket for expenses associated with these insurance coverages.
Most corporations have 401(k) plans and not-for-profit entities have 403(b) plans. Both of these retirement savings plans allow you to set aside money for retirement and reduce your taxable income by that amount. The earnings grow tax-deferred, then you pay tax on the funds when you begin withdrawing them at retirement. These plans usually offer an employer match. For example, the company might match the first three percent of your compensation that you contribute. If you don’t take advantage of the match, you are leaving money on the table. That’s like turning down a raise.
A Roth 401(k) or Roth IRA retirement savings plan may be available to you. With these plans, the money invested is not tax deductible, however, the distributions at retirement are not taxed. Because of the progressive nature of the federal income tax system (higher rates for higher incomes), Roth programs can be especially beneficial for people who are in a low tax bracket now but will be in a high tax bracket at retirement. You should seek professional advice to determine whether a Roth is a good choice in your situation.
Another employee benefit is a supplement to the typical medical insurance benefit — the flexible spending account (FSA). You can have money deducted from your paycheck on a pre-tax basis to be added to your FSA, and those funds can be drawn from to pay for health care expenses that are not covered by insurance. Essentially, the FSA amounts to a discount on your medical expenses by allowing you to pay for them with pre-tax dollars.
A similar benefit is available for child care expenses.
Some companies have education benefits that help pay for the pursuit of graduate degrees.
Many companies offer a modest amount of life insurance at no cost, and they often offer optional life insurance in larger amounts. Because there is typically little or no medical underwriting, this latter benefit is more valuable for people who may have health issues that would make purchase of individual life insurance more costly. People in good health can typically find individual life insurance at lower rates.
Short-term disability insurance and long-term disability insurance may also be available from employers. Although young adults often think they are invincible, bad things do happen. These policies are typically not too expensive, but you need to understand the limitations such as the elimination period, which is the amount of time of disability before benefits begin being paid.
Long-term care coverage may also be available, but most experts think that it should be considered much later in life.
You can read the next installment of “Money Moves for Recent Grads” here, and find the entire collection here.