Great Suggestions on How to Handle Your Finances for College Graduates and the Rest of Us Too

The following is a guest post from Marotta Asset Management.

Last time we discussed the many ways you can save money as you learn to live on your own. Our suggestions included sharing housing costs, buying a previously owned car with cash, preparing meals instead of eating out, and eliminating the frills from services that are deducted automatically each month from your checking account. Here we offer some sound advice on how to put that money you've saved to work for you.

First, look carefully at your company's benefits plan. Disability insurance is probably the most neglected insurance. Consider signing up through a work plan. More employers are implementing health savings accounts, which allow you to pay for your medical expenses with pretax dollars. They are coupled with a high-deductible health insurance plan. If you are young and healthy, these provide you with disaster insurance as well as health-care insurance savings. If your employer has one, put the maximum away annually, and invest it if possible.

All the pundits say, "Save as much as you can," which is fine advice but not specific enough. You need to take a substantial chunk of change out of your discretionary money each month, some before it even makes it to your checking account and most of it after you deposit it. The amount, about half your take-home pay, may seem excessive at first, but remember, you are trying to grow rich, not live rich.

As your first priority, get the benefit from your company's 401(k), which usually amounts to contributing 5% of your salary while your employer matches with another 4%. This is the portion we mentioned that's deducted before you ever see a paycheck. If your employer has a health savings account, the money you contribute will also come out before your collect your paycheck.

After these deductions, you probably have the remainder of your paycheck deposited automatically into your checking account. You should then automate a transfer out of your checking account into an investment account to meet many of your long-term financial goals. Money in your investment account will appreciate. Always keep your goals in mind and stay on track.

For example, make a list of all the big-ticket items you will need to pay for over the next several years. You need to pay your car insurance. Transfer the appropriate monthly amount to your investment account. You should be saving for your next car. Transfer the appropriate monthly amount to your investment account. All of these significant purchases may comprise around 10% of your take-home pay.

You should be fully funding your Roth IRA while you are young and in a relatively low tax bracket. For 2008, to meet the $5,000 limit for your Roth IRA, you need to save $416 a month. Put this money into your investment account and then transfer it once a year to a Roth IRA account.

Save 5% of your take-home pay in a taxable account allocated for your retirement. This is after fully funding your 401(k) match and your Roth IRA. There are times in life when you will need taxable savings, and you should be saving and investing 5% of your take-home pay.

Save and invest 10% of your take-home pay for charitable giving. As your investments earn money for you, you will give appreciated assets to the charity and replace the same dollar amount from your take-home pay. Donating appreciated assets provides an additional 15% tax savings.

Finally, as a margin of safety, save and invest 10% of your take-home pay to help cover the cost of unknown unknowns. If your first response to this suggestion is to ask, "Like what?" the answer is "Exactly." Most people who run up credit card debit keep their regular spending within 100% of their take-home pay until some unexpected expense causes them to deficit spend. You can't anticipate unknown unknowns, so the best you can do is set aside some money to cover them when they arise

All of these expenses can easily comprise half of your take-home pay. Even if you've landed a good paying job straight out of school, don't spend over half of your take-home pay on daily expenses. Transfer half of your pay directly to an investment account and let it start growing. Cash in the bank is the best financial security. Cash doubling in an investment account is the best financial future. By the time you need money from your investment account for some of those long-range purchases, ideally it will have already started earning a nice return.

Saving and investing should be automatic. You won't miss what you don’t see. Have half your take-home pay transferred out of your checking account and into an investment account each month.

Live simply. Avoid buying items you have to store, repair and maintain. Produce twice what you consume. Be generous. Avoid liabilities you have to pay each month. Invest in assets that pay you instead. Do these things and you will have a peace of mind that your contemporaries may never find.

Comments

[Cully P]

Definitely some good points in here. Being a graduate 3 times over, and knowing how much I owe, is a killer. My road to glory is finally coming to some understanding that my student debt will take a while to eliminate, but i've finally gotten rid of my revolving debt, which had been a monkey on my back for the past 15 years or so--i.e., the beginning of my college career until now. Feels good to get rid of that monkey--but more education needs to happen so that young people understand how much of a burden credit cards, student loans, and any other debt weighs on you into adulthood.

[saria]

New hire and new college grad here.

Question about the disability insurance:
My employer offers long term disability insurance that will reimburse 60% of income if the disability lasts longer than 90 days. But it can be paid either by me or them. If I pay for it, the premium is paid with post-tax dollars and I get the advantage of having a tax free benefit in the event I become disabled. If my employer pays for it, the annual benefit gets taxed and therefore reduced.

So it appears more advantageous if I pay for it, but am I missing something? Is there a catch? Shelling out a few extra bucks a month (post-tax) initially doesn't seem like a big deal, but keep in mind I live in New York (high living costs) and I'm going to be making less than $50K, base salary. Every dollar counts.

Part of me also thinks that I'm still young and healthy so is it even worth shelling out for insurance I may never use? However I find this last one a less convincing argument...you never know what could happen.

Thoughts?

[Jake]

Saria --

Think about it this way. Your employer is offering you two options:
(1) Pay a basic cost each month for a basic disability benefit.
(2) Pay more each month for a higher disability benefit.

If your employer wasn't offering the second option, would you go try to buy extra disability coverage else where? If not, why would you buy it from your employer???

Also keep in mind that right now 60% of your income is $30,000. If you make $30,000 a year, your tax bill will be very low anyway, since a big chunk of your income will not be taxable once you consider exemptions and the standard deduction.

Overall I would not pay the extra few bucks a month for what amounts to a hundred bucks a month or so if I get disabled.

[Josh]

Very good advice for the new-to-the-workplace.

I would also add that if your company has a Stock Purchase Plan (SPP) to max it out.

I like your advice about automating savings and it's what I have done (been out of school <2 years). It makes things very easy. With my 401k, SPP, and automatic transfers to EmigrantDirect I save nearly 50% of what I make post-tax. The remaining I'm free to "go crazy" with.

One piece of advice for new college graduates from me. Don't but a new car or house within the first year or so. I know you want to feel grown up and you have the money but this is not the time. Please wait until you have more job security and you've decided that you're at the right place. You have no point of reference so just a few months is definitely not the time to decide you like where you work.

-Josh

[Sara]

This post is all well and wonderful, but honestly, pretty unrealistic. The writer advocates saving/giving away 15% of your pre-tax salary and 25% of your post-tax salary for various things, AND maxing out your Roth IRA. For the average starting grad, who is probably making 30K - 50K, this would be extremely difficult and take a lot of self-discipline.

If you were making 30K and followed this advice, you would have $8,387.50 left to live on for the year, and if you were making 50K (a pretty good starting salary for most college grads), you'd have $17,313 left.

[Jake]

I'll second Sara's post. I was going to post that, but I've said something negative about every Marotta post for the last month or so, so I was making an effort to be less critical. The average college grad makes something in the 30k-40k range, and saving/giving 40% of that plus $5000 leaves you with a tiny post tax budget -- think ~$500/month for rent, ~$35/week for groceries, $0 on entertainment, $0 on eating out, turn off your heat and AC etc.

Josh, how on earth do you save 50% of your income? If it's not too personal of a question, roughly how much are you making? I'm guessing you are bringing in more than a typical college grad.

[rwh]

Saving and investing regularly is very important. If you are just starting out work on an emergency fund for all those unexpected expenses, start an IRA, preferably a Roth IRA, and work on a diversified portfolio. Eventually start a non-retirement investment portfolio with regular (even if small) investments. Having money deducted from your checking account each pay period or each month is excellent advice because of the discipline it instills.

But saving 50% is not only unrealisitic, it can also be counter productive as it sets people up for failure. Young people (as well as old folks like me) need to have some of the immediate gratification that spending will bring. This kind of plan sounds like you won't even be able to go to the movies or buy a 6-pack of good beer. 10-20% is much more reasonable, attainable and will give people the results and positive reinforcement they need to keep it up, while also enabling people to enjoy the fruits of their labors and experience the thrill of finally being on their own.

I put advice advocating saving 50% in the same circular file as trying to pay off a mortgage in 5 years, especially for someone just starting out.

[FMF]

Saria --

I'll try and post your question in a couple weeks (I'm booked next week) and let readers take a shot at it.

[JACK]

Saria:

The other thing to check is to see whether if you pay it, it becomes portable (can be taken job to job) or not.

As to the post:

I think it is incredibly unrealistic. By all means, they should be saving, but 50% of take home pay should be saved? Great if you can do it, but I don't think this is realistic at all.

Giving away appreciated assets, in my view, is a dangerous suggestion for most people. The last thing someone who is giving a basic tithe to their local church wants to be doing is giving away his likely long-term asset gainers. You give away appreciated assets to charity when (a) you have a lot of appreciated assets and (b) after they have appreciated. In other words, unless this person is in his 50s and on and is facing some major tax management decisions, I wouldn't be recommending giving away that stock that just appreciated. Not when you are in the asset accumulation phase of life, which is what the post is meant to be addressing. You do that in the retirement phase where you are going to sell the asset anyway. There it makes sense to substitute giving it away rather than selling it to give the money away, etc. But not for a new person starting out.

[moneyandpf]

Ok I did some calculations so let's see how realistic this is.

So for instance let's take a 45k salary assuming someone single (Using Rounding):

401k pre tax 5% - $2,250
HSA maxed out contributions pre tax - $2,900
- Income Taxes - $6,310

=Take Home Pay $33,540 or $2,795/mth
Long Term Disability - $100/mth
Fully fund Roth - $415/mth
5% of take home pay to savings - $140/mth
Big ticket items 10% of take home - $280/mth
Unknown Unknowns 10% - $280/mth
Charity 10% - $280/mth (No tax savings unless you have more itemized deductions)

Let over money = $1,300

This would probably be very tight to really live off of for a graduate at this salary. Add to the fact this assumes you have no prior debt (Education loans, credit card balances, car payments). While I like the general idea of the post this would be hard to do for many IMO.

[Katrina W.]

Has anyone noticed that all of this discussion assumes that the graduate has no student loans? That alone can take a big chunk of your take home pay. In my case that adds up to 11% just to make minimum payments.

On a side note, what are people's opinions on whether to save money for an emergency fund versus paying extra off high interest private student loans? Three months expenses is the standard ideal, but unreasonable for someone who is losing out because it is sitting in a bank account instead of lowering their balance (and more importantly accumulating interest!) on their loans.