Thoughts On Money
This month, Summer officially begins. Isn’t it a wonderful time of the year! A time to enjoy the outdoors, a time for vacations, and a time for students to take a break from school. For some students, this Summer represents a graduation milestone from high school or college; truly one of those BIG life transitions.
Those transitioning from being a student to living in the “real world” will face one of the most difficult challenges – figuring out how to manage their personal finances. Over the years, I have had a lot of parents, grandparents, aunts, uncles, etc. ask me to provide their new graduate with some guidance and provide a simplified “how to” on managing their money.
Today on TOM, I bring you the first of a two-part series on the Graduate’s Guide to Personal Finance. I will lay out seven steps (three in this issue) that a graduate can take to get started on the right track with their finances. Because we all have diverse financial backgrounds, some of these steps will apply and some won’t, and some will be new and some won’t, but I am confident that the financial wisdom weaved throughout will be helpful. So off we go …
Step One – Build Awareness Around Your Spending
The primary objective for most young grads is to learn how to save more. Saving more is always a great goal, but in order to get there, you first need to know how much you spend. To keep it simple, let’s think of savings this way: What You Make – What You Spend = What You Save. Most people know exactly what they make each year; many know this number in hourly terms, annual terms, pre-tax, after-tax, etc. One’s income usually gets a lot of attention and rightfully so. The other part of the savings equation is what you spend, and most people really have no idea what that number is. They do their best to guestimate, but there is typically a wide gap between what people think they spend vs. what they actually spend.
So, what is a graduate to do? I would suggest that you record all of your expenses for three months. This means that each day or every couple days, you itemize each of your transactions to a spending category (i.e., food, rent, shopping, etc.) and at the end of the month you will have totals for each of these broad categories. Hopefully, since you are doing this over a three-month period, you will have a good idea of what your average spending is per month. Remember, spending can be lumpy, you might have a big auto repair bill one month and not have another until next year. By recording multiple months of spending, you will have a more reliable estimate for what your average monthly spending is.
To make this process easy for you, there are tons of apps, free software, and features within your mobile banking that will help to organize this information. Your daily routine should be simple as opening your phone or computer, spending 5 minutes recording your new transactions, and then the application should produce some general reports for you on your spending.
I would encourage you to make this a habit and continue beyond the three months, as this will help you to stay in tune with your finances. Just like you know exactly how much you make, you should always know exactly what you spend. Over time, you will begin to see the trends with your spending and be able to pivot and make adjustments along the way to meet your savings goals.
Step Two – Start Building an Emergency Savings
Now that you know how much you make and how much you spend, it’s time to start organizing your savings. The first box you want to check is to make sure you have an emergency savings account established. This is a pool of money set aside just in case things don’t go as planned. This could be a safety net for a job loss or job transition, an injury, or any other sort of curveball life throws your way.
You will want to find a savings account that provides an attractive interest rate. I would look for something that has a yield close to that of a 3-month government treasury bill. This account should have about three to six months worth of expenses in it. So, if your monthly spending is $7,000 a month, then you should work towards saving $21,000 – $42,000 in this account.
This account should be easily accessible, and the value of the account should be stable. Emergencies come without warning, and you don’t want any obstacles in your way when you need to access these funds.
Step Three – Understanding Annual Interest Expense
Now that your emergency savings account is up and running, you want to begin to review your debt obligations. I get this question a lot, “I have student loans and credit card debt, should I pay those off before I begin saving for retirement or buying a house?” My answer is, “It depends.”
Here’s what you need to do first, you need to understand what the cost of your debt is each year in dollar terms rather than percentage terms. Just ask your financial institution what the annual interest expense is in dollars. You can find this out for your car loan, student loan, etc. Most of the time, this exercise will help you to realize just how expensive debt can be, and it often will make sense to pay this debt off quickly before initiating other savings plans.
The reason I say “it depends” is because there are other factors to be considered. For some people, they might have a retirement plan at work that their employer will match their contributions dollar for dollar, and this might be a reason to create a hybrid save/pay-off-debt plan. Other folks might have access to really low-cost borrowing where it makes sense to pay the debt off over a long time, like a fixed rate mortgage. This is why it’s important to know your numbers and work to devise a strategy that best fits your situation.
Of the steps that we have discussed thus far, Step Three might be the most cerebral, which means it would be wise to loop in a financial professional to help you create this plan.
To Be Continued…
Ok, that covers our first three steps in the Graduate’s Guide to Personal Finance. Next week we will continue the discussion around these final four steps:
Step Four – Open Accounts That Match Your Goals
Step Five – Automate Your Savings
Step Six – Stay the Course
Step Seven – Invest in Yourself
I hope you found this to be a helpful reference for yourself or perhaps a good resource to share with a family member or friend. This is TOM signing off, until next week…
The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.
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