Personal Finance: The Basics
Because copious note-taking didn't prepare you for responsible money management.
Somehow, mastering the art of filling a blue book with fertile blather during exams didn't prepare you for the basics of personal finance.
Here's what you need to know to get started in handling your money: Keep your finances simple, use credit wisely, budget, start a savings plan - and stick to it. Smart use of your money requires you to balance short- and long-term goals.
"Live within your means," says Stuart Ritter, a certified financial planner for T. Rowe Price, who also teaches a class in personal finance at Johns Hopkins University. "If you don't have the cash right now to pay for a vacation, stay home. Every dollar of debt you take on now is more than a dollar you won't have to spend in the future. Current debt means you're constraining your future lifestyle."
With careful planning, there's no reason you can't go on that dream vacation - just don't do it at the expense of your immediate goals or saving for a future down payment on a house. This will require you to make tradeoffs. It can be as simple as brown-bagging it at work two or three days a week instead of eating out with friends or sitting in the cheap seats at the ballpark or concert.
Here are some basic personal finance tips your classes in chemistry and Chaucer didn't teach you:
Pay Yourself First
Contribute a fixed amount each month to a savings or investment account by setting up an automatic transfer from your paycheck. If you try to save what's left over at the end of the month, you'll find that routine expenses expand to gobble up your take-home pay and you won't set aside a nickel. So, take the savings off the top each month. Put your savings on autopilot and your nest egg will grow quickly thanks to the wonders of compound interest.
Open an IRA
A Roth Individual Retirement Account is built with after-tax dollars. Contributions aren't tax deductible, but this isn't a major problem for most because the money grows tax-deferred and distributions at retirement are tax-free. A traditional IRA comes with a tax break on current contributions, but the money is taxed when withdrawn. You probably don't need the tax benefit as you begin your career, but it will be important when you retire. For most, this makes a Roth IRA a better choice.
Grab Free Money
When weighing a job offer, be sure to ask about the company's match to a 401(k) retirement program. This is free money. Grab it with both hands. Not all employers make a matching contribution and those that do will contribute at different rates - generally 25% to 50% up to a pre-determined percentage of your salary. You can transfer the money to another retirement plan if you change jobs. Nail this down with human resources before you take the job.
Early in your career, invest in equities because you're after long-term growth. If you're just out of school, you may want to devote as much as 90% of your retirement portfolio to stock. This requires a strong stomach, or as they say on Wall Street, the "risk tolerance" required to ride out market downturns. Over the long haul, stocks have provided greater long-term growth than bonds. When you get married and start a family, reduce the percentage of equities in your portfolio to limit risk and move into bonds and CDs. Work with a financial planner as your portfolio grows to get the right mix of holdings to meet your needs.
Unanticipated Territory Ahead
You can't anticipate major car repairs and your best friend's wedding may catch you by surprise. Unexpected expenses can dent your financial plan. What about a major health problem or a decision to go back to school and change careers? That takes real money. Many young adults spend right up to the last nickel and are forced to borrow when hit with major unanticipated expenses - or ditch plans for advanced study. A little planning now can avoid economic Armageddon later.
Pay On Time
Be sure to pay your credit cards in full each month. This will help build a solid credit history that will come in handy when you want to buy a house. It also saves you money. Better yet, paying the bill in full allows you to use the bank's money interest free for a month. The flip side: The Stupidity Tax - late payments on movie rentals, library books and credit card payments. The Stupidity Tax is money out of your pocket and easily avoidable with half an ounce of planning.
Buy Basic Insurance
You wouldn't drive without car insurance, but many recent graduates don't get renter's insurance. In most cases, it's affordable. Add up the replacement cost of your stereo, laptop, digital camera, TV, clothes, kitchen junk and other household items. Chances are low that your stuff will be stolen, vandalized or destroyed by fire, but why take the risk as you begin to acquire stuff that you didn't buy at a garage sale? Medical insurance is generally cheap because you're young and healthy. If you're not covered by your employer's group plan, consider getting catastrophic coverage. If you're covered by your employer, consider paying a little extra each month to upgrade the coverage.
Once you learn the terms and get the hang of the basics, handling your money wisely is no more difficult than filling a blue book.
The Web sites of major brokerage houses and banks offer solid financial tips to grads, including T. Rowe Price (TROW), Merrill Lynch (MER), JP Morgan Chase (JPM), Wells Fargo Bank (WFC) and Wachovia (WB).
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