Money Start-Up Guide

Jul 5, 2016 by

graduation mortar boardsThe graduation ceremony is over, your diploma has been framed, and—yay!—you’re earning money. Congratulations! Now add this to your list: time to learn a bit about real world personal finance!

What Should Millennials Do With Their Money?

Newly employed after school, you’re earning real money maybe for the first time in your life. Spending it all is easy and tempting, but you’ve got a nagging feeling you should save some too. And of course those student loans aren’t going away by themselves.

How do you decide among and balance these competing demands for your cash:

  • Student loan payments—both minimum and extra
  • Maybe you left school with some credit card debt too
  • Savings: travel and vacations? a car? emergencies? retirement?
  • Lifestyle

As a young person, you might feel like you have loads of time to make choices about what to do with your income. That’s a feeling you need to get rid of! Actually the sooner you get on a sound financial track, the easier managing your money will be and the more success you’ll have, both short and long-term. Time alone works to your advantage.

Money Priorities for Millennials

Here’s how to think through allocating your cash:

1. Student Loans

At some point in time after finishing school and beginning work mandatory minimum payments on your student loans will kick in. It’s a good idea to investigate consolidation and income-driven repayment plans. With that done, you’ll know your minimum monthly payment(s). Making minimum loan payments has to be your first priority. But should you pay more than the minimum? Maybe—more about this later.

2. Emergency Fund

Everybody needs an emergency fund. Without one, you’re vulnerable to getting caught up in the high-interest debt trap because you may have to borrow money on a credit card to meet surprise expenses that outstrip your budget. All of the money you can set aside for savings should go to an emergency fund until the fund is enough. How much is enough? Read “How Much Emergency Savings?”, but in a nutshell, ignore all the rules of thumb about recommended emergency fund size and settle on a number that’s based on your unique situation.

Set up a money market account or the highest interest savings account your bank offers for your emergency fund. You want this cash to be easily accessible and without principal risk. is a good place to zero in quickly on the institution offering the highest interest rate on a money market account. Be careful of getting suckered by introductory teaser rates. Choose an institution offering a high rate (and favorable terms, such as no fees) after any introductory rate period expires.

3. Credit Cards

If you graduated with credit card debt, paying it off is right up there with building an emergency fund as a top priority. It’s simple: regularly paying interest to credit card companies will make financial success far tougher to achieve, if not impossible.

4. Planned Savings

Your emergency fund is for stuff you didn’t see coming, like a layoff or need to buy a short-notice airline ticket for a family emergency. Planned savings cover larger expenses that you can anticipate and save for—so you can pay cash instead of putting it on the credit card. A vacation, a car, a high-end bicycle, holiday spending, or a new MacBook are examples of the sorts of expenditures you should cover from planned savings.

Like emergency savings, accumulate planned savings in a money market account. You won’t earn much interest these days, but you’ll also never lose any of the money you deposit! An exception might be planned savings you don’t intend to tap for 5 or more years—say for a home down payment. You could take a bit more risk with these longer-term savings by, say, putting some of the money in a short-term bond fund. But I would strongly discourage any sort of stock investing with your planned savings fund, unless of course you’re okay running risk of being forced to change your vacation venue from Paris, France to Paris, Texas.

5. Retirement Savings

Does your employer offer a 401(k) plan or similar? At an absolute minimum, you’ve got to contribute enough to take full advantage of any match your employer offers. To do otherwise is tantamount to turning down a raise. It’s free money!

Okay, so you’re contributing enough to get your employer’s full match. Should you contribute more? Absolutely! If you feel like you can’t afford it, revisit your budget, and remember this: $1.00 contributed to your 401(k) will subtract only $0.80 or $0.85 from your take home pay.

It’s sooo much easier to reach your long term saving goals if you start early. That’s why I’m pressuring you on this one. Have a look at “Benefit of Saving $5,500” to see what I mean.

If your employer doesn’t offer a 401(k) then it’s time to open an IRA account. I recommend Vanguard. Fees are extremely low, and you won’t be swindled there into paying worthless active management fees. To see the huge effect of fees on the growth of your savings, read “Fund Fees: Nest Egg Killer”. If you’re self-employed, a SEP IRA may be the best fit, which Vanguard can also handle for you.

Balancing Priorities

Let’s say you’ve got your student loan minimum payments covered, but you’re thinking you don’t have enough extra cash after paying living expenses to build an emergency fund, contribute to planned savings, and contribute to a retirement account, all at the same time.

First, have another look at your budget and lifestyle. If you can’t do at least 2 of the Big 3 savings aims, then maybe you’re spending too much compared to your income. You could take on a side gig to earn more, or you could alter your lifestyle to cut your fixed expenses, or both. Might carsharing + biking + transit take the place of owning a car? Should you be sharing rent and utilities with a couple of roommates? Perhaps the best long-term decision you can make for your health and finances is to buy quality groceries and make your own meals. Think about it.

If you’ve scaled back your spending and boosted your income as much as you can, at least for now, then here are your saving priorities:

  1. Emergency Fund: build this first. And if you have any, pay off credit card debt at the same time.
  2. Necessary Planned Savings: save for any unavoidable big expenses you know are coming within the next year or two.
  3. Retirement: contribute to your 401(k) the max your plan allows, or make the maximum IRA contribution (currently $5,500 annually for traditional or Roth IRAs).
  4. Discretionary Planned Savings: save for big, discretionary expenses like trips and big screen televisions.

If you’re short of extra cash right now, start at the top of this list and work your way down until you run out of money. As your income grows and you finish off your emergency fund and credit card debt, keep working your way down the list.

Extra Loan Payments

If you’re keen to get those student loans paid off, good for you! But how do you balance extra loan payments and the three savings aims—emergency, planned, and retirement—described above?

First, I’d recommend making only the minimum payment on any student loan with an interest rate less than 3%. You can do better investing that cash in your retirement fund.

For loans with rates of 3% or more, making extra payments can make sense. Keep this in mind: paying an extra $100 toward a loan with a 3% interest rate is mathematically identical, before tax, to depositing $100 in a savings account with a 3% interest rate. After tax, the loan payment is actually better financially because part of the 3% you’d earn on the savings account would be taxed away! Of course no savings account pays anywhere near 3% today, but if you have student loans, think of them as risk-free investment opportunities with a guaranteed rate of return equal to the interest rate you’re paying. You may never have a better opportunity in your life to earn a solid, risk-free, guaranteed rate of return than paying extra on your student loans. That is, until you get a mortgage!

With that said, it’s more important that you at least build your emergency fund and pay off any credit card debt before you pay extra on any student loans. Again, no emergency fund means you could get sucked into the high-interest debt trap. That could be the beginning of real trouble. And your credit card APR is almost certainly much higher than your student loan interest rate.

Any questions? Write to me. My thoughts are free! And just because I’m old doesn’t mean I’m stupid. 🙂

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