Start Early to Exit Young

I have long thought that schools should do much more to prepare students with personal finance education.  It should start early explaining concepts of limited resources and the importance of saving.  By high school students should have a basic understanding of credit scores, 401k plans, and loans (especially student loans and how compounding works).  College should reinforce and expand on these ideas.  Retirement planning could be a course on its own but it should be at least included in some personal finance prerequisite.

I recall learning how to write a check (I write 1 or 2 a year), that was about it.  I hope that home economics or whatever its called these days has evolved over the years.  I know for sure though, that too few graduates are prepared in these aspects.  Too many friends and family have waited too long to start investing for retirement.  Some don’t save at all, others save all cash at near 0% return.

I thought I would use this post to talk about my thoughts on how to invest right out of college.  Keep in mind, this is my opinion and my experience.  Everyone’s situation is different and you should consult financial advisors about your specific situation.  That said, lets begin at the beginning……

Congratulations!

You’ve recently graduated and have a job offer.  Likely you’ve been handed a packet an inch thick that has everything from health insurance information to a W-4.  Somewhere in there is information about your company’s 401k plan.  There is one section I want you to start with….  employer match.  Employer match = free money.  This is the most important concept of this post so remember it if nothing else.  There can be nuances to the match but what you need to figure out is how much you need to put in so that you get the full match amount.

Typically there is some ratio 1:1 or 2:1 that will be worded something like “we will match your contributions dollar for dollar up to 4%”.  That means if you contribute 4%, your company will as well.  In other words if you are paid $30k your first year and you contribute 4% to get the max match, you will have contributed $1,200 and your company will have contributed an additional $1,200.  You doubled your money!!

Student Loans =(

But I have student loans, how can I justify saving in a 401k until I pay those off?  Good question.  Lets look at the math on each path.  Lets assume an 8% rate of return in your 401k vs. an 8% student loan interest rate.  This should be conservative on each as your student loan interest rate should be much lower these days and the historic S&P500 rate of return is higher.  Anyway 8 and 8, I’m going to do a simple (Iess exact) calculation but it will illustrate the point well enough.  In 20 years, your $1,200 (plus match) is worth over $10k.  You didn’t pay income taxes on that contribution which also saved you money on the front end (more to compound over time).  If you instead put the $1,200 against your student loans you will have saved about ~$4k in compounded interest.  Also by paying off that debt you may be missing out on education tax deductions or credits.  The gist is that I have trouble making any case for forgoing your 401k company match.  Do not take that to mean you should stop at the match level, I think of that as the minimum.

Investment Selections

When you setup your 401k plan you will need to choose where you want to invest the money.  Typically there are 10-25 mutual funds available.  Most guidance says that investors with a long saving horizon should be heavy in stocks.  I’ll tell you that I’m about as close to 100% stocks as you can get.  For reference, a CNBC article that talks about allocation.  Then there’s the fees…. you are working hard to max your match, you don’t want to turn right around and give it back in fees.  The investment schedule for your 401k plan will show an annual fee expense percentage for each choice.  I try to keep my overall expense percentage as low as possible but definitely below 0.15%.  Every cent you save on fees is a gain that will compound over time.  I started my 401k by tossing 100% into the S&P500 index fund which had the lowest fees.  Over time as the pot grew, I diversified into other funds with small and midcap stocks and international and emerging markets funds.

My 401k plan has LOST money!

Oh the fun of investing in the stock market.  It will go up and down and sideways and occasionally upside down.  You need to be ready for this.  Its so difficult to watch as you’re loosing 10s, 100s, even 1,000s of dollars every time you hit refresh.  I know you’ve heard it but try to remember, BUY LOW SELL HIGH!  If you’re young try to think of every dip in the stock market is a potential buying opportunity where the stock market is on sale.  I also recommend reading The 9 Steps to Financial Freedom by Suze Orman.  Its one if the first personal finance books I ever read and talks a lot about the psychology of investing.  Worth a read.

Grow Your Contributions

Its up to you to find the balance between making student loan payments and 401k contributions but both are very important.  In order to really get to the next phase in your personal finance situation you need to grow the money you put into each.  The easiest way to do that is to make more money.  {Thank you Captain Obvious!!!}  Seriously though, every raise is a great opportunity to evaluate your budget.  Try to put all (as much as possible) of the new money toward your student loans and 401k and keep your other spending as is.  You probably can’t completely, but its a good goal that ends in good results over time.  Spending much less than you make is the key to early retirement.

 

Resources I recommend:

 

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