With graduation behind you, no more college tuition bills, and a new job that probably pays way more than minimum wage, you might have your eye on a graduation present to yourself: that MacBook you’ve been wanting, a plasma TV for all the NFL games you’ll be watching, or an upgrade to your 10-year-old hand-me-down hatchback. And after four-plus years of putting up with other people’s weird tendencies and annoying living habits, you might be tempted to kiss roommates goodbye and splurge a little on rent to get an apartment all to yourself.
But before you start breaking out the credit cards or making any financial decisions that spend paychecks you haven’t earned yet, ask yourself what your financial plan is: What are your short-term and long-term financial goals? Where do you want to be financially five years from now? 10 years? 20? What are you doing about retirement? If you were to lose your job, how much of an emergency savings fund would you need to be able to live for six months, and what are your plans to get there?
As much as you may want to start living, furnishing, eating out, and buying things like a real person, now that you’re out of school and have a job, experts say the key to your financial freedom is to stick with the starving student lifestyle for a few more years. That way, you can put your newfound money to work for you, pay off your debt, and start saving now so that you have the cash for all those trips, purchases, and big plans.
Here’s how to start:
1) Get a Beat on Your Debts
Before signing off on an apartment, car loan, or new surround-sound system, get the full picture on how much you already owe. Add up all of your debts and monthly bills — student loans, credit cards, car insurance, cell phone, etc. For loans and credit cards, make a note of your minimum monthly payments, your repayment terms (how long you’re being given to pay off each debt), and your current interest rates, along with which of your rates are fixed and which are variable and subject to change. Remember that variable rates usually mean variable monthly payments: If your variable rate goes up, your required minimum monthly will also generally go up.
Total up your monthly bills and minimum payments, then deduct this amount from your monthly income to determine how much money you have left over for other spending. Make sure you leave yourself a cushion for variable monthly payments that may get higher, and don’t forget to allow for necessary living expenses like gas and groceries. If you’re not planning on living with your parents, you’ll also need to take into account monthly costs for things like electricity and cable.
You may find, after you’ve figured just how much your monthly expenses will eat into your brand new paycheck, that a new car or your very own apartment will just have to wait.
2) Give Higher-Interest Debt Top Billing
Not all debt is created equal. Your federal student loans, which tend to have lower interest rates than credit cards or private student loans, are OK to pay off more slowly, says Elaine Bedel, president of Bedel Financial Consulting, Inc. Federal student loans also feature extended and income-sensitive repayment options that may allow you to lower your monthly payments, as well as forbearance and deferment benefits that could let you postpone your monthly payments temporarily if you lose your job or run into other financial trouble. Car loans, credit cards, and even many private student loans won’t give you this luxury.
Take the interest rates you made note of in step 1, and list your debts in order from the highest interest rate to the lowest. Make paying off your debts with the highest interest rates your top priority. If you can, make bigger payments on these debts, paying more than the minimum each month until you pay them off. Then work your way down the list until everything is paid off.
3) Sign Up for Your Company’s 401(k)
Retirement may be the last thing on your mind when you’re not even 25 yet, but signing up for your company’s 401(k) now will give your money more time to go to work for you. Many companies will match employee contributions to a 401(k) up to a certain amount. Employer matching is basically free money for you. And you don’t have to pay any taxes on the money you contribute to a 401(k) until you withdraw it decades down the road.
We know you probably feel like you still have forever to save for retirement. And taking any money out of your paycheck right now for something that still seems so far away can be hard to bring yourself to do. But when you’re tempted to put off setting that money aside so you can spend it instead, think about this: Your 401(k) earns interest, so every year that you put off saving is one less year that your money is earning money.
To put it in perspective, say your goal is to retire with $1 million: Assuming an 8-percent rate of return, if you start now and save for 25 years, you’d need to invest a little over $1,000 a month, writes Chuck Saletta of financial services company The Motley Fool. If you wait until your 30s to start thinking about retirement and only save for 15 years, you’d need to invest almost $3,000 a month to reach that $1 million goal. Only give yourself 10 years to save, and you’d need to invest $5,500 a month.
Committing to a smaller paycheck just when you’ve really started earning one can be tough, so start easy. Take just $5 from each paycheck to get your 401(k) rolling. You likely won’t even notice an amount that small. Every couple months, keep nudging up your contribution by either $5 or $10 until you reach a point where you can feel the squeeze of your deductions on your monthly budget. Keep your monthly contributions at that amount until you get a raise or pay off a debt that gives you more room in your monthly budget. Then bump your contribution up by $5 a paycheck and start the process over again.
Before you know it, you’ll have a 401(k) with a significant amount of cash that’s earning you even more money, so that down the road, you won’t be struggling financially — you’ll be set.