For College Graduates: Learning to Live on Your Own, Part 1

The following is a guest post from Marotta Asset Management.

If you're like most of today's college graduates, you may find yourself ill prepared for the real world of financial responsibility. You never saw how your parents lived when they were first married and struggling. Consequently, you may be basing your after-school expectations on an upper-middle-class lifestyle. Here is my financial advice for those of you learning to live on your own.

My own financial education began when I was very young. My parents shared openly with us about the cost of running the household. I learned our home mortgage was $12,500, or about half the value of the house, and the interest rate on the loan was 4.5%. I knew my father's annual salary ($7,500) and that a week's worth of groceries cost $20 for a family of five.

Although you have to count on spending about 6.58 times more than that today, the principles of proportional living I learned are still the same: You can look like you are rich or you can actually become rich by saving and investing. Wealth is what you save, not what you spend. So be rich. Live frugally, and learn to save and invest.

The people who are struggling financially buy things and clutter their homes with them. The middle class buy liabilities such as boats and vacation homes and must spend money every month to maintain them. The rich, in contrast, buy investments. An investment is anything that pays you money.

Now that you are learning to live on your own, learn to live like the rich. The frugal millionaire enjoys both financial security and peace of mind. Living well within your means is a skill you may not have picked up from your parents or in school. Rather than learning from the so-called school of hard knocks, consider the following suggestions.

Rent is probably your biggest expense, but keep it well under 20% of your take-home pay. To lessen the impact, share your living quarters with roommates. If you learned nothing else in college, you at least found out how to share a room. Later on, when you get married and want your own place, you'll need the money you can save and invest now.

Whoever actually signs the rental agreement or lease and pledges to pay the rent on time each month deserves a better financial deal. That person should be able to charge his or her roommates more and also get first pick of the rooming options.

If you decide to live in a house or apartment and sublet, make sure to factor in the possibility that a roommate may leave without notice, owing you rent. Insist on a sublet agreement that requires the first and last month's rent to lessen the impact.

Your car ranks as your number-two expense. Again, keep total costs well under 18% of your take-home pay. With the salary at your first job after college, you probably can afford to make the payments on a trendy new car. Don't. Expensive cars increase both your insurance and your maintenance costs.

Be practical. Your car is a means of transportation, not a lifestyle. Buy a reliable car that has low maintenance costs. One that is at least a few years old will have already depreciated the most.

Only buy a car you can pay for with cash. Shun easy credit. The only decision that's worse than buying a depreciating asset is buying that depreciating asset on credit. Paying interest on an asset that going down in value may buy you a ticket to the poorhouse. Instead, start saving some of your monthly salary immediately for your next car.

After rent and transportation comes buying food. The average family spends 10% of their take-home pay on food. If you don't eat out, you should spend about 6%. When your earnings increase substantially, perhaps you'll be able to justify saving food preparation time and eating out. But until then, the time you spend cooking is well worth it. The calories you purchase at restaurants are about 2.5 times as expensive as those you prepare at home.

For example, if you brown bag your lunch all week, you can easily save $5.40 a day. Saving $27 each week adds up to $1,458 per year. After factoring in the rising costs of eating out and investing your savings in the stock market where they will grow and multiply, the difference to your net worth is amazing. Investing $27 each week will produce $100,000 in 20 years and $1 million in 40 years. Bring your lunch from home starting at age 20, and you'll have an extra million dollars at age 60!

Eating at home isn't the only way to save money. To extend your savings to the grocery store, here are a few commonsense rules that will lead to uncommon cents savings.

For dinners, master a dozen easy-to-prepare meals. If you can read, you can cook. Keep staples on hand to make these meals. Consider a bread machine and a slow cooker as essential purchases.

Plan your meals when you are hungry, but shop right after you have eaten. Shopping on a full stomach will help you limit impulse purchases. Make a shopping list. Buy staples in bulk at super discount stores.

Avoid convenience packaging and expensive processed foods. Try buying the generic store brand. If you don't like it as well as the leading advertised brand, many stores will refund your money. Actually compare the prices. Most stores make the bulk of their profit from products placed at eye level.

You don't have any extra in your budget for monthly services. You have only about 6% more to spend, and the remainder you should be saving and investing. You may tend to ignore the services that are billed automatically each month, but they will be the most serious drain on your finances. So consider getting the least expensive package of features or doing without entirely. These electronic transfers include phone service options, cable or satellite TV, high-speed Internet, and health club dues.

Comments

[Matt]

Very insightful article. I am a little interested by the fact that you left out building your credit while in,or shortly after graduating from college. As a senior in college myself, I have benefited immensely already from building credit by putting all the utilities for my apartment in my name. I recently qualified for a lower rate on a car loan because of this. Additionally, making sure that you do not open to many credit cards and that these bills are paid on time will also make post-graduate life, and ultimately purchasing a home that much easier.

[SM]

This article really has little to do with college grads. It's general PF advice that circulates in these environs on a daily basis. Beyond that, it's even a bit more generic than normal.

[Caleb]

Good article, but I would have to disagree with the comment on food savings, because this does not take consideration a person's time value. For example, if I know that it takes me a total of about an hour between shopping and preparation of food for each meal, and I only spend $5 per meal that I shop for, and my time is worth $80 per hour, I will actually save money by eating out if the meal cost is anything less that about $30. (I'm taking into account that I might wait half an hour or so for food when I eat out). Also, the type of restaurants that I like to dine at usually serve over-sized portion, so that $20 lunch actually becomes 2 or sometimes even 3 meals in one if I take it home.

[Minimum Wage]

Rent is probably your biggest expense, but keep it well under 20% of your take-home pay.

Who writes this stuff?

Caleb - That's assuming that you get paid hourly and work every hour of the day. If one is an exempt salaried employee, they get paid the same regardless of how many hours they work. In this situation, it would not be correct to use my standard hourly salary to calculate how one should spend their time.

[Margo]

^^I agree with the 20% benchmark for rent, if you want to get rich.

I am making 20% more than I was 3 years ago, but my rent went up $350 when I moved out on my own. If I could go back to having a roommate and get rent under the 20% mark, I'd have another $2K/year to either save or use to create a much "richer" life.

[Jake]

Overall a good article. However, when Marotta decides to tell you that brownbagging your lunch for 40 years will make you a millionaire, they should at least disclose that they're using a ~12% assumed rate of return to get to that number. A bit aggressive, even if you want to ignore the effects of taxes (and inflation).

When it comes to the rest of the advice, its all useful, if a bit generic.

[Dan]

The rent under 20% of your pay is absolutely unreasonable for some areas. Living in Washington DC as I do, I know you're lucky to find a place for less than $650/mth (and it's not going to be all that nice). Now considering an entry level salary might be $28k, that's roughly $1540 take home each month. $650 rent would be 42% of your take home. And that's doing well right out of college. Of course you can move to Duluth and probably get away with rent at 20% your monthly salary, but then you're making the decision at age 23 to give up opportunities to forge a career in a niche industry. You don't have a family, have no real responsibilities, and are young. Take a chance and go for a career that will make you happy. Just don't go into debt while doing it.

[Stephen]

I live in downtown Chicago (expensive area), graduated last May, make $55,000 a year, and spend $750/month on rent, plus about $50/month on utilities. That's about 22% of my take home pay, in an expensive area! I share my apartment with a friend, don't have cable, and keep our place at 62 degrees or less in the winter. Sure, I eat out lunch 2-3 times a week (Subway - $5 for me + the girlfriend) and dinner out maybe once a week ($35), but I've been able to pay off my consumer debt, and I just maxed out my Roth IRA for 2007 (as well as maxing out my company match for 401k), plus I have a few grand in the bank for a rainy day.

It can be done, so DO IT soon-to-be graduates!

[Ken]

"Overall a good article. However, when Marotta decides to tell you that brownbagging your lunch for 40 years will make you a millionaire, they should at least disclose that they're using a ~12% assumed rate of return to get to that number. A bit aggressive, even if you want to ignore the effects of taxes (and inflation).

When it comes to the rest of the advice, its all useful, if a bit generic."

I agree, the other problem with the food statement is, how much does it cost you to bring your food. When you pack your lunch it still has a cost. So really you can't save $27 a week. Maybe only like $15.

[Jennifer]

Very good article! I just hope people starting out will take the advice given them.

[Tex]

Brown bag every day for my entire life so that I have more dollars when I'm old and decrepit? No thanks. I like to have a break in my day and not seem like a damn anti-social hermit to my co-workers. Build those social bonds and it can help you build connections... i.e. better jobs at better pay in the future.

I save my food dollars at home. Granola with yogurt is cheap and tasty. So are noodles with parmesan cheese. Add rice to any meal as cheap filler.

Do note that when eating out fancy, you are already paying 15-20% more for tip, then ~8% more for tax. So that's 23-30% more you're paying, plus the basic cost of extra labor and silly upcharges ($1 for slice of cheese or bacon).

Also, "eating out" does not mean steak dinners as some of these PF bloggers seem to imply. I can get a filling sandwich made by someone else really quickly for $4.50. (No tip since you grab it at the counter.) I get variety and I don't have surplus unused meats, cheeses, vegetables, and condiments that no one ever calculates in the "savings of eating at home".

[Katrina W.]

There is no room in this plan for the payback of student loans. Mine eats up about 12% of my salary just for minimum payments. I'm assuming its much much more for graduates who weren't as fortunate to get as high of a starting salary as me.