Money lessons every graduate should know
(MoneyWatch) After the last mortar board is thrown skyward and the final champagne cork popped, reality sets in. Sure, you graduates may get a little respite from the real world by moving back in with Mom and Dad for a time, but soon enough, you'll need to get a job and start your own life.
Which makes it imperative that you learn all you can about personal finance. Here are six lessons that will allow you to live a rich life -- without making millions of dollars.
Loans are both an obligation and opportunity
If you borrowed to finance your education, as have about 60 percent of U.S. graduates, loan payments begin six months after graduation. At first blush, that may seem daunting, but federal student loans are the most flexible debt you'll ever owe. That's because payments on these loans can be deferred if you don't have a job. Or you can pay off your debt through income-based or pay-as-you-earn programs, which allow for payments based on your financial circumstances. (See our related story: "Student debt repayment options offer hope" for details on how the plans work and how to sign up.) There is no reason to default on federal loans, and yet roughly 9% of students do. The consequences of default are harsh, ranging from high penalty fees to a ruined credit rating. And you should know that student loan debt is generally not dischargeable even in bankruptcy. If unpaid, it can pose problems for a lifetime.
If, on the other hand, you pay your student loans on time, you boost your credit, making it easier to qualify for low-rate auto loans, credit cards and, eventually, a mortgage, says Adam Levin, co-founder of Credit.com.
So formulate a plan so you can make good on these obligations. Gather together information on all your student debts and go to the Department of Education's website to calculate your monthly payments under various repayment plans so that your options are clear. Then, set up an alert that will sound two months before the first payment comes due. By then, you'll know whether your job will allow you to pay the loans off quickly -- the most cost-effective option -- or whether it's necessary to sign up for a flexible plan, such as the pay-as-you-go option mentioned above. Two months advance notice should be adequate time to consolidate all your student loans (if appropriate) and set up the repayment option that best suits your circumstances.
Prioritize your debts
If you have credit card debt, remember that it is costly and does not offer flexible payment like student loans. If necessary, spread your student loan repayment out over a longer period (which lowers monthly payments) so that you can afford to pay off the balance owed on credit cards as soon as you can. Once you have done so, make it a point to never charge more on a credit card (outside a true emergency) than you can pay each month. By avoiding interest payments on yesterday's spending, you'll have more money to spend on the things you want today.
Compound interest: The most powerful force in personal finance
When you get your first job, there's a good chance you'll be eligible to put aside money for retirement through your employer's 401(k) plan. Take advantage. You may think you can't afford it, but do it anyway. In fact, do it now.
Here's why: Every dollar contributed to a traditional 401(k) plan reduces the income subject to federal and state income tax. Assuming you'll pay 20 percent of your income in combined taxes, for instance, that means a monthly contribution of $200 to the plan reduces your taxable income by $160. Most employers match employee contributions of up to 6 percent of pay. The match rates vary, but it's common to match up to 50 percent on the dollar. So the $200 that you contributed becomes $300 -- and that's before the money is invested.
Compound interest has a greater impact when contributions are made early and continued consistently. Let's assume that you earn an average of 9% per year (that's roughly the long-term average return of a diversified portfolio, according to the market researchers at Ibbotson & Associates in Chicago). If you continue your $200 monthly contributions until you retire at age 67, you'll wind up with an astounding $2.2 million. Notably, you'll have contributed only $108,000 of your own money. The bulk of the remaining $2.1 million comes from compound interest and your employer.
It never gets easier
You may say that compound interest sounds like a great thing, but you're poor now and figure you'll start contributing when you have more disposable income. That sounds like a reasonable plan, but the fact is that it will never be easier than it is today. By the time you're 35, you will probably be earning considerably more. But you'll also have far more financial obligations. By then, you're likely to have a spouse, a car and maybe kids and a mortgage too. If you think it's tough to economize now, just wait until you've got diapers and day care to worry about.
Worse, waiting just a few years costs you a fortune. If you start saving your $200 a month ($300 with employer contributions) when you're 27 instead of 22, you give up a whopping $800,000. That's right. Your retirement nest egg at age 67 will amount to $1.4 million instead of $2.2 million, assuming you start contributing just five years later and all other factors remain the same. If you don't contribute until you're age 32, you give up $1.4 million, leaving you with just about $880,000 at retirement. To be sure, you can catch up by contributing much more later, but don't fool yourself. It will be just as hard then as it is today -- and maybe much harder.
Motivation is everything
The hardest part about saving for tomorrow is that there are all sorts of things that you want today: the fire-engine-red BMW; the luxury apartment on the beach; cool clothes, shoes, expensive dinners.
Saving for tomorrow doesn't offer such glitzy images. It's hard to define its purpose unless you consider your long-term goals and what it will take to finance them. Whatever these may be, it's a lot easier to say no to spending today when you can picture in your mind's eye what you want and you know how much you want it. Jot down your goals -- and make them as unique as you are. A long-term goal for some is a comfortable retirement, but that may not be what moves you. If you like to travel, consider your savings getaway money. If freedom is what matters most to you, set aside enough to tell your boss to get lost when you've had enough of him. Just be sure to set down your goals, figure out their cost (there are calculators on the Web for this) and visualize them whenever you're tempted by something you could have this very moment. Keep annual tabs on your progress. Know, too, that the first $100,000 saved is the toughest. After that, compound interest is likely to contribute as much as you do each year.
Investing is simple -- and necessary
You may not have a finance degree, but today's world requires you to be conversant with the world of investing. You will have to make choices about how to invest your 401(k) dollars, and, if you're able to save outside of that plan for other goals -- a home or college for your kids -- you'll have to invest that money too.
Ethically challenged financial professionals prey on potential clients by taking advantage of their the confusion or ignorance. But investing wisely is simple, and you can do it yourself. If you choose to hire someone to do it for you, it is still necessary to understand the basics. There are dozens of quick-read investment primers that can do the job. My own "Investing 101," Mike Piper's "Investing Made Simple," Eric Tyson's "Investing for Dummies" -- these are all straightforward lessons on how to invest wisely.
Notably, they all say pretty much the same things. Buy stocks (ideally, index funds) for long-term goals; buy bonds, CDs and other fixed-rate investments for midterm goals; and put your emergency money in bank accounts or money market funds, where it's accessible when you need it. You don't need to do anything fancy. You don't need to watch your investments on a daily basis. If you keep it simple, consistent and diversified, you'll do just fine.
Happy graduation. May you live a rich life -- however you define it.
