Money is funny. It’s also complicated, uncomfortable, and confusing. Along with sex, religion, and politics, money has been deemed too taboo for the dinner table. Ironically, that’s exactly where it should be talked about the most.
The neglect of financial education has resulted in a generation of perplexed people frightened by the recession and unsure of the financial future ahead of them.
When considering financial planning, City Magazine consulted a variety of financial professionals on what new graduates entering the workforce should be doing with their money.
Money is a highly individualized matter. The advice given in this article is general. Before taking action, one should consult a certified financial planner for their best financial options.
Starting Behind
Student loans, a thorn in the side of roughly three-fifths of Missouri college students, can be one of the most daunting financial burdens facing new graduates already struggling to adjust to the new world of adult life.
Hope Gerdes, a financial advisor at Edward Jones, advises to pay loans off as soon as possible. There are too many stories recounting a graduate’s $20,000 loan ballooning to a $60,000 loan due to missed payments.
“Live below your means,” says Gerdes. “If you can sacrifice for, depending how big your loans are, the first two to five years after college, and you sock every dime into your student loans, you could potentially get them paid off within five years.”
Kevin Callaway, vice president, financial advisor, LPL of Central Investment Trust Co., suggests three questions to ask when looking at student loans: How many loans are out there? What’s the amount? What’s the highest interest rate?
From there, Callaway suggests paying a little more on a smaller, lower interest loan to free up cash flow. One could consider combining the loans or paying the minimum payment on the loan with the smallest interest rate while paying more on the loan with the higher interest rate.
These strategies could be applied to any debt, whether education or credit card related. However, nothing would compare to meeting with a certified financial planner, or CFP, and sorting out an individualized plan of attack.
Investing for the Future: Retirement
“Today, the universe of investment options seems endless. It can be overwhelming to decide which investments are best for you,” says Jill Dobbs, vice president and CFP at Central Trust Company. “My advice is to keep it simple.”
Often, one of the benefits of a job is a 401(k) plan. A 401(k) is a contribution plan, set up by your employer, with both tax and savings advantages. One of the most common 401(k) plans offered is employee matching. This plan involves your employer contributing a certain amount to your retirement savings based on the amount of your own contribution. The general employer contribution is between three to six percent of an employee’s pay.
All of our experts cited that one of the biggest mistakes that young people make is not taking advantage of their company’s 401(k) options.
Among advisors, the rule of thumb is to save 10 to 15 percent of your monthly income for retirement. But this doesn’t mean you have to put the entire 10 percent away yourself. This is where employer matching comes in.
“Aim for 10 to 15 percent of salary away,” says Gerdes. “If the match is three percent, and you want to reach at least 10 percent, you should be putting in at least seven percent.”
Any 401(k) contribution is tax deductible, meaning one would only be taxed on the remaining income after their contribution. However, when the money is withdrawn at retirement, taxes will be applied on the whole sum. The advice across the board was to cash in on the maximum match.
Another common way of saving for retirement are individual retirement arrangements, or IRAs.
The two most common IRAs are traditional IRAs and Roth IRAs. The biggest difference between the two are taxes.
Roth IRAs are taxed the day you deposit your money, making them a great option for the beginning stages of a career, when one’s tax bracket is usually lower. While traditional IRAs are not taxed during deposit, the amount is taxed upon withdrawal. Often, individuals will switch to a traditional IRA when their tax bracket increases.
“Little known fact — you can use Roth IRAs as your first home savings account,” says Gerdes. “You can withdraw the money without any penalties for the purpose of your first home.”
Otherwise, one must wait until they’re 59 and half or older to withdraw from their IRAs.
IRAs have higher yield potential compared to a 401(k). The accounts are handled by banks or brokerages that allow account holders to move their money around through stocks, bonds, and real estate.
“You can choose how aggressive to be in your IRA,” says Callaway. “It’s a bucket and you can do whatever you want in it.”
The Big Bad Budget
“How much money is coming in every month,” asks Callaway, “and, of that money, are you making the best use of it?”
One’s monthly budget is a reflection of what is happening in their life. It includes how they spend their time, where they put their money, and their financial goals.
A huge mistake young people can make is putting off dealing with their financial plans. Delay could be the cost of the difference between a beachside bungalow and a basement apartment.
“They kick the can down the road, and they don’t understand the power of money,” says Dan Renfrow, vice president and senior trust officer at Hawthorn Bank. “Time is really more important than money. If you take someone and you give them $1,000, they want to take care of it. But if you give them $10, they’ll go blow it at Starbucks. Every dollar has value, even if there aren’t a bunch of zeros behind it.”
Renfrow advises to revisit a financial plan every year to revise your budget and account for any big life changes.
Bank and budget apps can be a great tool for those breaking into the budgeted lifestyle.
“Having all of your finances consolidated at one financial institution makes it much easier to look at your big picture,” says Gerdes. “There is value in having the ability to see your checking, savings, mortgage, and credit card information in one easy website or app. It makes managing your financial life less time consuming and allows you to maximize technology to your advantage.”
Both Dobbs and Gerdes emphasized the benefits of automation. If you don’t see the amount in your account, you won’t miss it and you’ll learn to live without it.
Shorter Term Savings and Investments
There are other things, such as a home or children, that need more short-term planning compared to the long road to retirement.
Money markets combine the benefits of both a checking and savings account and make a great emergency fund hideout. The account accumulates a higher interest rate compared to a regular savings account. Additionally, account owners have an option to withdraw money without penalty. Money markets are another option for a house down payment.
Mutual funds can be a first step into longer-term investments in the stock exchange. “For people who don’t understand that much about investing, mutual funds are a great option,” says Gerdes. “They’re well diversified. They’re professionally managed for you. The expenses are low.”
The idea is that one mutually agrees with a group of other people to combine your financial force to buy into a variety of companies.
“A mutual fund has an active manager that is picking and choosing securities based on their expertise. Part of your investment is paying for that expertise,” says Callaway.
The minimum amount to invest depends on where one goes to invest. No one needs to come up with $10,000 to invest in financial growth.
“Many investment companies offer mutual funds with small minimum investment amounts and allow investors to make monthly additions as little as $50 per month,” says Dobbs.
As the investor, one would have a singular share of many companies, which, as a 20-something, one may not be able to afford. A mutual fund’s internal diversification solves a potential diversification issue.
Diversification maximizes return while minimizing risk by investing in multiple areas that would react differently to world events or changes. However, it’s vital to remember that risk is still involved even with the most diverse financial portfolios.
“Your 20s are where you can make the biggest impact on your retirement,” says Callaway.
Compound interest is the secret to a 20-something’s breezy financial freedom. Compound interest grows on the initial principal and all accumulated interest. Basically, the account holder earns interest on top of their previous interest.
“Compare investing $100 per month beginning today for 20 years versus starting 10 years from now,” says Dobbs. “Assuming a 5 percent average rate of return, waiting 10 years to start investing results in having a total of $15,000 versus $40,000 if you begin today. It’s not always easy to find an extra $100 in the budget, especially when you’re just starting off, but the payoff is huge in the long run.”
“If you want to build wealth, you’re not going to do it in a short-term investment like a money market. If you’re looking at the stock market, it scares people, but it’s for long term money. It’s not for people who want to pull money out in a year or two,” says Renfrow.
Merging Finances for the Future
Are you financially compatible with someone? It’s probably not the first (or even 15th) date conversation we usually think of, but when it comes to a promising future with someone, finances are inevitable.
Many people meet their partner in their 20s and 30s when their finances are still growing. The financial presence of their partner could make a huge impact — positive or negative.
“Ask how their parents were with money, how they are with money, what debts they have,” says Callaway.
Trusts are usually needed down the line. Trusts are intended for higher net worth individuals or more complicated accounts. Trusts establish legal protection to the trustor’s assets. Trusts save time, reduce paperwork, and in some cases can return inheritance or estate taxes.
The main reason to consider instating a trust would be to avoid probate, when the court system controls who receives what due to lack of instruction prior to someone’s passing or whether there was a child with special needs involved.
However, one should probate-proof all their accounts, regardless of net worth, whenever opening an account or taking on a new financial asset.
The End in Mind
“Begin with the end in mind,” says Callaway.
Callaway defines financial freedom as a level of contentment. “You’re debt free, you have money coming in from other means that are outside your normal employment to do the things in life that you want to do that are important to you,” says Callaway. “The money is working for you instead of you working for your money.”
While financial plans and discipline are undoubtedly important, Renfrow makes the point for one to invest in themselves.
“The greatest asset one has is themselves. Never stop learning. Your job is going to constantly change,” says Renfrow. “The more you can stay up, the more valuable you become, then you become a higher earner in the future in whatever profession. The best investment anyone can make is within themselves. Things are changing faster and faster, and you need to stay on the forefront.”
The Vocab
401(k)
A contribution plan where an employee can make contributions from their paycheck either before or after tax, depending on the options offered in the plan. The contributions go into a 401(k) account, with the employee often choosing the investments based on options provided under the plan. In some plans, the employer also makes contributions, often matching the employee’s contributions up to a certain percentage. SIMPLE and safe harbor 401(k) plans have mandatory employer contributions.
Money Market
A money market account is an interest-bearing account that typically pays a higher interest rate than a savings account and provides the account holder with limited check-writing ability.
Mutual Fund
Type of financial vehicle made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments, and other assets.
Asset
A financial asset is a tangible liquid asset that gets its value from a contractual claim. Cash, stocks, bonds, bank deposits, and the like are examples of financial assets. Unlike land, property, commodities or other tangible physical assets, financial assets do not necessarily have inherent physical worth.
Traditional IRA
A traditional IRA is a way to save for retirement that gives you tax advantages. Contributions you make to a traditional IRA may be fully or partially deductible, depending on your circumstances. Generally, amounts in your traditional IRA (including earnings and gains) are not taxed until distributed.
Roth IRA
A Roth IRA is a special retirement account that you fund with post-tax income (you can’t deduct your contributions on your income taxes). Once you have done this, all future withdrawals that follow Roth IRA regulations are tax free.
