You’ve spent the last five years buried in books about ancient Chinese civilization, literary composition and the physical properties of the atom. And you’ve got the diploma to prove it.
No more finals or midterm exams.
As you celebrate your worthy achievement, be sure to keep your thinking cap close at hand—your biggest test is yet to come.
Indeed, recent college grads face a unique financial challenge.
The average graduate enters the workforce with nearly $24,000 in student loans,according to the nonprofit Project on Student Debt, an entry level salary that barely covers the bills, and a firestorm of immediate expenses, including a security deposit for an apartment, a car, furniture and a new professional wardrobe. (Hey, you can’t live in sweats forever.)
That doesn’t include the average $4,100 thee average graduate owes in credit card debt, according to SLM'sSallie Mae, the nation’s largest student lender, nor any big-ticket items for which degree-wielding young adults might need to begin saving—a wedding, mortgage down payment or graduate school down the road.
It’s a big challenge to say the least, doubly so for 20-somethings who haven’t had practice with money management skills.
“The biggest mistakes happen right out of college because that’s the time when they want the new car, the Pottery Barn furniture, the 2 bedroom apartment—all of those things that they’ve denied themselves for so long and now want to live the way they want to live,” says Pam Boyce, a financial planner with Garrett Financial Network and a professor of personal finance at Michigan State University in East Lansing. “They don’t realize that their money doesn’t go very far and it’s hard for them.”
Don't Just Sit There
First things first, though.
Before you can even think about managing your income, you need to get hired. In today’s tough job market, that can take months.
“If you can’t find a job right away, one way to differentiate yourself is to call the executive directors at the largest and most successful nonprofit organizations, which are all looking for help amid constrained budgets, and ask if you can volunteer for an unpaid internship,” says Larry Ginsburg, a certified financial planner with Ginsburg Financial Advisors in Oakland, Calif. “What you want in exchange for your contribution of time and skill is the professional reference and resources to help you get a job.”
Prospective employers who see volunteer work on your resume will be impressed that you took the opportunity while job hunting to contribute to your community rather than play the Wii.
“It won’t necessarily pay immediate dividends, but it will invariably become important capital over time,” says Ginsburg.
Time For A Budget
After you land a job and know what your take home pay will be, it’s time to develop a budget.
According to Boyce, standard income allocation models don’t resonate well with students, and for good reason.
“Their parents and grandparents are always saying, ‘Oh, you have to budget’ but they don’t know what that means,” she says. “Everyone is in a different boat with their debt and savings. How much they should pay for a car or an apartment is different for everyone depending on their values.”
A better strategy, says Boyce, is outlined in a book called “All Your Worth: The Ultimate Lifetime Money Plan,” by Elizabeth Warren, now acting director of the Consumer Financial Protection Bureau, and her daughter Amelia Warren Tyagi, which breaks out after-tax money out into three distinct buckets.
Fifty percent of one’s income gets allocated towards necessary expenses, like housing, car payments and student loans.
Another 30 percent goes to the “wants” category, like clothes and entertainment, while the remaining 20 percent goes to short- and long-term savings.
Debt And Saving
If you don’t have enough to cover your “needs” category, you’ll have to borrow from your wants category—or become more modest about your housing accommodations or car selection.
Just be sure to leave some disposable income for yourself.
An overly aggressive budget that leaves little room for entertainment is not sustainable, and a good way to derail your budget.
“Most of my students look at that 30-percent category and say, “Oh that’s plenty for me. I just want a pedicure and gym membership,’ but when they start doing the computation they realize it’s not very much,” says Boyce.
Using such a framework, says Boyce, grads are better able to prioritize.
“You can’t have everything. You have to decide what you want to splurge on,” she says. “If you have big students loans that take up a large portion of that needs category, then I’m sorry. You can’t also have a nice apartment and a nice car and nice furniture right away.”
Such a budget might also make recent grads realize (albeit begrudgingly) that the best solution is to move back home with mom and dad until they build a work-appropriate wardrobe, save for a down payment on a car or pay off credit card debt.
Pay Down Credit-Card Debt
Indeed, dealing with high-interest debt is a priority.
Conventional wisdom dictates that consumers should keep their debt-to-income ratio (excluding your mortgage or rent payment) to between 16 percent and 19 percent.
If you have multiple credit cards with a balance, start by paying as much as you can towards the account with the highest interest rate, making minimum monthly payments on the other cards to avoid any fees, says David Haugen, a certified financial planner with Ameriprise Financial in Tulsa, OK
When the first card is paid off, direct those dollars towards the second most costly card and so on until you’re debt free.
Then, continue paying off any balance you accrue monthly, which helps establish (or repair) your credit history—important in determining interest rates for future loans.
Paying off your student loans ahead of schedule is an admirable goal, but don’t be concerned if you’re not in a position to make extra payments right away.
Depending on how your job search goes, in fact, you may not be able to make the minimum monthly payment at all.
Fortunately, federal student loans are flexible.
Most have a standard ten-year repayment plan, but if you borrowed under the federal Stafford Loan program (either the Direct or Federal Family Education Loan programs), you’ve got a six-month grace period after you graduate before you have to start paying it back.
You get nine months for federalPerkinsloans.
But you can lower your monthly payments by extending your payment plan with a fixed annual or graduated repayment amount over a period not to exceed 25 years—though you’ll ultimately pay more for your loan because of the interest that accumulates during the longer repayment period.
If that’s not enough, you may qualify for deferment, which allows you to temporarily suspend payments on your loan due to unemployment, economic hardship or re-enrollment in school.
Forbearance is also another option for those who qualify, which is a temporary postponement or reduction of payments for a period of time because of financial difficulty.
And finally, there’s the income-based repayment, IBR, plan, which sets payment caps based on your income and family size.
Each repayment plan has its own eligibility requirements.
Emergency Savings Fund?
As you dig your way out of debt, you should also start building an emergency fund for bouts of unemployment or unexpected medical expenses down the road.
But different schools of thought exist on how you should save.
Some financial planners suggest putting an immediate $1,000 away into an emergency fund to create a financial safety net and then paying off your credit card debt.
At that point, they suggest, you can refocus your efforts on building your emergency fund even higher.
Others, Boyce included, disagree.
“I say you’ve got to get out of credit card debt before you can start saving,” she says. “Technically, you are still a saver when you’re paying off debt. You’re saving yourself all those interest payments.”
Whatever approach you choose, your ultimate goal is to save three to six months worth of living expenses into a liquid (accessible) interest bearing account, like a money market fund, or CD – up to a year’s worth if your job security is in question.
While retirement may seem like a low priority, given your age and financial plight, it’s important to get into the habit of saving right away, notes Ginsburg.
At the very least, contribute enough to get the employer match if one is offered at your job – lest you leave free money on the table.
“They need to become accustomed to saving no less than 10 percent of their gross compensation and making sure their lifestyle is structured so they can live on 90 percent of their after tax compensation,” says Ginsburg. “Even with all the ups and downs of the financial market, the power of compounding is enormous when you start saving early.”
As you begin the next chapter of your life, remember, the goal is financial freedom.
By developing good spending habits now, you’ll be giving yourself the gift of an angst-free future—at least where money management is concerned.
“Consistency of financial behavior will enable these young people to move towards financial independence,” says Ginsburg.