Topics
Starting Out
Congratulations! You've graduated from school and
landed a job. Your salary, however, is limited, and you don't have much money
(if any) left at the end of the month. So where can you find money to save?
And, once you find it, where should this cash go?
Here are some ways to help free up the money you
need for current expenses, financial protection, and future investments --
all without pushing the panic button.
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Get Out From Under
For most young adults, paying down debt is the first
step toward freeing up cash for the financial protection they need. If you're
spending more than you make, think about areas where you can cut back. Don't
rule out getting a less expensive apartment, roommates, or trading in a more
expensive car for a secondhand model. Other expenses that could be trimmed include
dining out, entertainment, and vacations.
If you owe balances on high-rate credit cards, look into
obtaining a low-interest credit card or bank loan and transferring your existing
balances. Then plan to pay as much as you can each month to reduce the total
balance, and try to avoid adding new charges.
If you have student loans, there's also help to
make paying them back easier. You may be eligible to reduce these payments if
you qualify for the Federal Direct Consolidation Loan program. Though the program
would lengthen the payment time somewhat, it could also free up extra cash each
month to apply to your higher-interest consumer debt. The program can be reached
at (800) 557-7392.
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What You Should Buy
How would you pay the bills if your paychecks suddenly
stopped? That's when you turn to insurance and personal savings -- two items you
should "buy" before considering future big-ticket purchases.
Health insurance is your first priority, as hospital
stays can be extremely costly. If you're not covered under a group plan, see
if you can join any trade associations, which often offer group-rate policies.
Otherwise, start obtaining quotes on individual policies by calling the major
insurers in your state.
Life insurance is the next logical step, but may
only be a concern if you have dependents. In fact, at the age of 25 you're statistically more
likely to become disabled than to die prematurely, according to a 2004 report funded by the nonprofit Actuarial Foundation. Disability insurance will
replace a portion of your income if you can't work for an extended period due
to illness or injury. If you can't get this through your employer, call individual
insurance companies to compare rates.
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Build a Cash Reserve
If you should ever become disabled or lose your job,
you'll also need savings to fall back on until paychecks start up again. Try
to save at least three months' worth of living expenses in an easy-to-access
"liquid" account, which includes a checking or savings account. Saving up emergency
cash is easier if your financial institution has an automatic payroll savings
plan. These plans automatically transfer a designated amount of your salary
each pay period -- before you see your paycheck -- directly into your
account.
To get the best rate on your liquid savings, look into
putting part of this nest egg into money-market funds. Money-market funds invest
in Treasury bills, short-term corporate loans, and other low-risk instruments
that typically pay higher returns than savings accounts. These funds strive
to maintain a stable $1 per share value, but unlike FDIC-insured bank accounts,
can't guarantee they won't lose money.
Some money-market funds may require a minimum initial
investment of $1,000 or more. If so, you'll need to build some savings first.
Once you do, you can get an idea of what the top-earning money market funds are paying
by referring to imoneynet.com, which publishes current yields. Many newspapers also publish yields on a regular basis.
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Shopping for the Best Credit Card
In addition to looking at fees and the interest that you will be charged (also known as the annual percentage rate or APR), consider your lifestyle and past payment history when shopping for a credit card. Factors you may want to consider include:
- A fixed vs. a variable rate of interest. Most cards assess a variable rate, which can be reset monthly. In most cases, the rate of interest will not be less than a floor established by the card issuer.
- Minimum payment you are required to make.
- Maximum you can borrow without incurring an over-the-limit fee.
- Fees such as an annual fee, late payment charges, and interest rates on cash advances.
- Circumstances when the credit provider can change provisions of the agreement.
- How the company calculates the finance charge. Is it based on the average daily balance, the balance at the beginning of the billing cycle, or another amount?
- A low introductory interest rate, if offered (extensive lists of the latest low-interest-rate cards in the United States are available at www.bankrate.com and www.cardtrak.com). When is the rate likely to increase? What is the new rate likely to be?
- Incentives such as cash rebates on purchases, purchase protection, and frequent flyer miles.
- Your prior payment history. If you typically pay off your balance every month, the APR may be less of an issue than getting cash back with a purchase.
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Build Your Financial Future
Some long-term financial opportunities are too good
to put off, even if you are still building a cache for current living expenses.
One of the best deals is an employer-sponsored retirement
plan such as a 401(k) plan, if available. These tax-advantaged plans allow you
to make pretax contributions, and taxes aren't owed on any earnings until they're
withdrawn. What's more, new Roth-style plans allow for after-tax contributions and tax-free withdrawals in retirement, provided certain eligibility requirements are met. Another big plus is direct contributions from each paycheck so you
won't miss the money as well as possible employer matches on a portion of your
contributions.
Don't underestimate the potential power of tax savings. If you invested $100 per month into one of these accounts and it earned an 8% return compounded annually, you would have $146,815 in 30 years -- nearly $50,000 more than if the money were taxed annually at 25%. Bear in mind, however, that you will have to pay taxes on the retirement plan savings when you take withdrawals. If you took a lump-sum withdrawal and paid a 25% tax rate, you'd have $110,111, which is still more than the balance you'd have in a taxable account.
If you're already participating, think about either increasing
contributions now or with each raise and promotion.
If a 401(k) isn't available to you, shop around for individual retirement accounts (IRAs), both traditional and Roth, at banks or mutual fund firms. In 2007, you can contribute up to $4,000 to traditional IRAs or Roth IRAs. Generally, contributions to and income earned on traditional IRAs are tax deferred until retirement; Roth IRA contributions are made after taxes, but earnings thereon can be withdrawn tax-free upon retirement. Note that certain eligibility requirements apply and nonqualified taxable withdrawals made before age 59 1/2 are subject to a 10% penalty.
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Stop Waiting for the Next Paycheck
Beginning your working life with good financial decisions
doesn't call for complex moves. It does require discipline and a long-term outlook.
This commitment can help get you out of debt and keep you from a paycheck-to-paycheck
lifestyle.
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Summary
- Outstanding debt is one of the biggest obstacles to saving.
- Disability insurance is a major safeguard against financial trouble if you're out of work for an extended period.
- Most experts recommend saving at least three months' worth of living expenses in case income stops. An easy and painless way to fund an emergency cash account is through an automatic savings plan.
- Money-market funds are a potentially higher-earning alternative to bank savings accounts. But money-market finds can technically lose money (though they have met their financial obligations), and yields will fluctuate, unlike savings accounts. Also, savings accounts are FDIC-insured.
- Tax-advantaged retirement plans are a terrific way to help build long-term financial security.
Checklist
- Buy additional insurance coverage if necessary.
- Use savings from your newly revised budget to pay off debt ahead of schedule and accumulate enough money for your emergency savings account.
- Consolidate high-interest debt in a single low-rate account.
- Consider scheduling a meeting with a financial professional to review your plans for pursuing your entire range of goals.
