Graduation can be one of the most exciting — and intimidating — times in your life.
You’re officially an adult, and with that new-found independence comes financial responsibilities. No pressure, but the decisions you make today about spending and saving can mean the difference between struggling for the rest of your life and building a solid financial future.
Here’s a list of important questions to ask yourself as you start your journey:
1. Where Should I Live?
Depending on where you want to live and how much you earn, you probably can’t move into your dream home right away. The cost of a studio in a big city could potentially get you a huge place out in the country. Your location of choice is tied to many variables — job, family and personal preferences.
To avoid overspending, be realistic about how much you can afford. As a rule of thumb, roughly one-third of your net monthly take-home pay should be used to finance the place you live. If your starting income is modest, you’ll likely pay a higher percentage for housing.
If you decide to rent, always read the entire lease before signing on the dotted line. Find out details such as how long the lease lasts, whether it includes utilities and if there are any fees for terminating the lease early.
If you’ve already saved up money for a down payment, consider buying a condo or single family home. As of this writing, interest rates remain relatively low. And the sooner you buy, the quicker you start building equity and claiming tax benefits that come with owning a home.
If you can find a roommate, you’ll have extra money for other living expenses, such as buying furniture and paying the bills for phone and Internet access. Also, don’t forget renter’s insurance to cover your personal belongings in the event of a theft, fire, flood or other disaster. Alternatively, consider the upsides of living with your parents for a little while longer. (See “The Boomerang Generation” at right.)
2. How Much Should I Save Each Month?
No one wants to live paycheck to paycheck. Doing so can lead to significant stress if you lose your job, become disabled or incur a major expense such as a large medical bill or costly car repair. That’s why it’s smart to set aside a predetermined amount from each paycheck that goes directly into savings. This amount should be separate from your retirement savings. (See “Why Should I Begin Saving for Retirement Now?” below.)
Keeping a separate savings account will help prevent you from thinking that this amount is part of your disposable income. As a rule of thumb, you should try to build a “rainy day fund” that equals three to six months of net monthly take-home pay. When the unexpected strikes, you’ll be glad you saved.
3. Why Should I Begin Saving for Retirement Now?
It may seem premature to think about retirement when you’re just starting your first “real” job. But you can amass a bigger nest egg by saving small amounts when you’re young, because your contributions have time to compound. Plus, any money you put into tax-deferred accounts lowers your taxes in the year you contribute. (Income taxes will be due when you eventually withdraw funds from these accounts, however.)
If your employer offers a retirement plan, such as a 401(k), sign up as soon as possible. Also, find out whether your employer makes “matching contributions.” This means the employer adds in a percentage, say 25% or 50%, for every dollar you contribute. Besides employer-provided plans, there are many other retirement planning tools. For example, traditional and Roth IRAs may be beneficial, depending on your personal situation.
As an added bonus, you may be able to borrow from a 401(k) account or take money from an IRA — without paying an early withdrawal penalty — for several reasons, including the purchase of a first home.
4. Do I Need to Buy (or Finance) a Car?
After putting money toward living expenses, savings and retirement, new graduates need to budget for another essential: transportation. Again, you might not be able to afford your dream car right away. Moreover, a car may not be a necessity — especially if you live and work in an area with reliable public transportation.
If you decide to buy a car, consider saving money with a used car. Another way to save money is to look for a car loan with the lowest possible interest rate by:
- Checking your credit. Consider a co-signer if your credit rating is poor or you haven’t established a credit rating yet.
- Shopping around for interest rates at your bank, credit union and various car dealerships. Try to get quotes from at least three different sources.
If you finance a vehicle through the dealership (because it’s convenient) and later find a lower rate elsewhere, you can pay off the original loan with the lower rate loan. Just make sure the original loan doesn’t include any prepayment penalties. Some homeowners even use home equity loans to finance their vehicles, because the interest is generally tax deductible.
5. What Types of Insurance Do I Need?
Graduation is a good time to make critical decisions about auto, health and life insurance coverage.
Most new graduates get their health insurance coverage through an employer. If you’re unemployed or your employer doesn’t provide coverage, you may be allowed to stay on your parents’ policy for a few more years (until you turn 26).
If you can’t get coverage through a parent’s health insurance provider, look for other affordable options. Coverage options for the unemployed include:
- Certain government sponsored programs (such as Medicare, Medicaid, and the Children’s Health Insurance Program),
- Plans obtained via a Health Insurance Marketplace, under the Affordable Care Act,
- Certain grandfathered group health plans, and
- Certain other coverage specified by the U.S. Department of Health and Human Services in coordination with the IRS.
The Affordable Care Act’s individual mandate was repealed, so there’s no longer a penalty for failing to procure health insurance. Nonetheless, it’s still important to have coverage in case you experience a costly medical crisis. Also, the greater the number of insured people, the lower the financial strain on the U.S. health care system, which helps tamp down massive price escalations in medical care.
6. How Can Discretionary Spending Help Me Build Credit?
Any money that’s left over from your paycheck is available for discretionary items, such as vacations, dining out, pets, clothing and personal pampering. Credit cards can be a convenient way to pay for discretionary items, and, as an added bonus, they often accrue rewards points that can be redeemed in the future. However, high interest rates and undisciplined use of credit cards can lead directly to suffocating debt.
If you don’t already have a credit card, sign up for one to help build credit. But resist the temptation to spend beyond your means. Pay off your credit cards in full every month — or, as mentioned, you’ll likely incur high interest rates on unpaid balances. Interest-free financing offers (for, say, a mattress or an appliance) can be another way to save money and build credit, but you must pay off the balance in full before the deal expires — or once again you’ll incur high interest charges from the original purchase date.
7. Who Can Help Me?
As soon as possible after you graduate, and certainly when you start earning significant income, establish a relationship with a tax professional. During your career, you’ll likely need help from this person, as well as other experienced professionals (such as an attorney), as your financial and legal needs evolve.
The Boomerang Generation
Even if they already have a full-time job, recent graduates are increasingly choosing to live with their parent(s) or grandparent(s) to save money. But financial dependence is rarely the sole reason for “boomeranging” back home. Instead:
- Young people are waiting longer to get married compared to previous generations. Without a fiancé or spouse to encourage independent living arrangements, many graduates return home, until they finally tie the knot.
- Many empty nesters miss their children and ask them to return, at least temporarily, to help with companionship, medical care and security, financial obligations, and day-to-day chores. Parents often mutually benefit from living with their adult children.
Could this option work for you? The negative stigma associated with living in a family member’s spare bedroom or basement isn’t what it used to be.
One Pew Research survey reported that roughly 75% of young adults who live with their parents are satisfied with their living situation and upbeat about their future finances. That’s about the same satisfaction level as young adults who live on their own. Parents are often just as happy about their adult kids living with them — at least for a while.
Please contact Judith Barnhard via our online contact form for more information.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.