Advice for New-Found Financial Freedom (College Grads)

So you’re a college graduate that just secured a full-time job and now more money is rolling in than you’ve ever been responsible for.  You’ve heard horror stories about how new-found financial freedom can suddenly turn into a nightmare with just a couple of wrong decisions.  This blog post doesn’t cover obvious problems like driving up credit card debt but instead describes some fundamental principles to guide you.

Warning:  I am not a certified financial advisor/planner.  I’m just a guy that has done well with my own personal investments and has had the benefit of passing advice to two daughters when they graduated from college and got their first job.

Know where your money is going

At least at a category level you should know where your money is going.  Review your budget and expenditures every 2-3 months for the first year, then every 6-9 months after that.  If you think your budget is solid, yet you end up short more than 25% of the time before pay periods, you must find out the reason.  Often times, it’s the “miscellaneous” category.  Keep increasing it until you come to a balance.

Also, any specific category in which you’re spending $50 or more per month should be a line item in your budget rather than lumped into “miscellaneous”.

Maintain at least 6 weeks worth of living expenses in savings in case of job loss

8-12 weeks is even better as those that lived through the 8-10% unemployment rates of 2011 and 2012 can attest.  Your budget should tell you how much you need to span this period.

The way to think about it is what would happen if you suddenly lost your job and had to immediately start looking for a new one?  How long would it take (best case, worst case, most likely)?  How much will health insurance cost until you can get covered under a new employer’s plan (remember, you have to pay the whole policy, even if you elect what’s called COBRA coverage from your prior employer)?

Plan for financial surprises, they will happen more often than you think

Miscellaneous needs that are less than $50 each should be covered under your monthly “miscellaneous” budget.  But beyond that, you will likely find that every few months something in the $250+ range comes up.  So plan for it by having it set aside.  If this takes your job loss safety net below where it should be, start building it back up as soon as possible.

In the extreme case, think about a car wreck that causes you to have to pay a $1,000 deductible to your insurance company in order to get your car fixed.  You would want to be able to get your hands on this amount of money immediately, otherwise go without your car for a while.

Invest 10% of your income into a regular investment account (not your retirement account)

This is the account that you will probably draw from if/when your kids go to college and is also what you would use when you first retire, before drawing from your retirement account.  Have this deposited directly from your paycheck rather than manually transferred each month.  If you have your full paycheck deposited into your checking account, it’s amazing how often you’ll either forget or will convince yourself to transfer less than 10% to your investment account.

This account should probably be invested in something like an allocation fund, which has a mix of investment types and typically has a name that describes how conservative or aggressive it is.

With every pay raise, add 1-2% to your 401K contribution – until you are contributing 12%

This is your retirement account and it will grow tax-free.  If you can start out contributing at least 5%, that’s a decent start.  And it’s not actually that unreasonable if you’re just coming off of a very low budget and feeling like you’ve suddenly got so much extra income.   And if you can start out at 8-10% contributions, that’s even better.  The cool thing is that most employers allow you to change your contribution on a quarterly basis, so dial it up to start and you can always dial back if you realize you got overly aggressive.

It will seem like it grows very slowly at first but once the balance increases to something more substantial, the gains on your base amount will really start to compound.

  • If your employer doesn’t offer a 401K plan, then put this money into your own personal Individual Retirement Account (IRA), which also grows tax-free and your contributions might be tax-deductible until you reach higher income levels (educate yourself on Roth versus traditional IRAs).
  • The best way to make an IRA contribution is via direct deposit from your payroll.  If you’re just starting your first salaried job and haven’t yet gotten used to various luxuries, experiment with starting at a 10% contribution.  If you later discover you don’t have enough left over in your paycheck to make ends meet, then back off some.  But I’ll warn you now that once you get a taste of even a couple of paychecks, it’s hard to deduct more for retirement.  So try to get aggressive at the very start.
  • Realize that your IRA and 401K accounts are something that you won’t want to touch until you’re at least 60 years old.  Otherwise, you’ll incur a 10% early withdrawal penalty.  Most 401K plans allow taking a loan against your balance at a very favorable interest rate and when you make payments you are essentially paying yourself back.

Here’s an example of how regular deposits into an investment account can grow over a 20 year period.  Down the left side are different monthly deposit amounts and across the top are different returns you might expect to get in the market.  In a practical example, you might start by depositing $50 per month and then increasing it by however much you can with each pay raise you get.

Monthly Deposit

6% Return

8% Return

10% Return

$100

$46,435

$59,294

$76,570

$200

$92,870

$118,589

$153,139

$500

$232,176

$296,474

$382,848

$1,000

$464,351

$592,947

$765,697

In order to retire and live for 20 years from your retirement account, you will need a lot more money than most people think.  In fact, having $1 Million in your retirement account will only allow you to draw $86,000 per year, assuming you can continue to get a 6% return on your investments during retirement.  I know, that might sound like a lot of money to you today.  But 40 years from now when you’re ready to retire, inflation will cause that to only be equivalent to $26,000 in today’s dollars (assuming 3% inflation).  You might be able to count on Social Security to add to the amount and you might inherit something from a family member, but be very careful about counting on either of those scenarios.

Disability Benefits

If you’re employer offers a benefits plan, check to see if long-term disability is included.  And even if it is, it’s probably very basic.  What would happen if you were to be disabled from an accident or illness to such an extent that you couldn’t continue working a job that pays enough to be self-sufficient?  Long-term disability benefits provide you income for a long time (varies depending on the plan) and the cost for young professionals is VERY inexpensive (think $5-10 per month).  I personally believe this is MUCH more important than life insurance, which becomes really important if you later have children that are dependent on your income.

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Author: Gordon Daugherty

Over the past 15 years Gordon has seen more than 1,500 startup pitches, given personal advice to more than 500 entrepreneurs and been involved with raising over $45M in growth and venture capital. Throughout his 28 year career in high tech, Gordon has two IPO’s and a $200M acquisition exit under his belt. Now, through his advisory practice called Shockwave Innovations and as Managing Director for Austin’s Capital Factory startup accelerator, Gordon’s focus is purely on educating, advising and investing in tech startups.

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