What Recent Grads Need to Know About Finances

Most people wonder at some point whether knowing what they know now, would they have done things differently coming out of college. Is there one decision we could change that might have sent us on a different, more prosperous trajectory?

I think we know the answer to that. While we cannot go back in time, we can provide new college grads with the benefit of our hindsight. Here are three critical concepts that, had I understood them way back then, would have changed my life considerably.

Embrace the Virtue of Living Beneath Your Means

The challenge for many new college grads is that when you have no real purpose for your money other than chasing a lifestyle, you end up using every extra dollar you earn in the pursuit of more. So, you find yourself at the end of the month having to start from zero again. Any emergency or an opportunity for a fun splurge that arises forces you into a mad scramble to come up with funds. If you must resort to using a credit card, you will be making minimum payments for several years. It is a vicious cycle that can only be broken when you start spending less than you earn.

Instead of succumbing to the dangerous pursuit of more, learn to embrace the freedom of living beneath your means. Develop a serious budget that keeps your spending level to a minimum of 10 percent below your take-home pay. Use the frugality that was forced on you in college to your advantage in real life until you achieve some financial stability. And just know it will not always be that way.

Discover the Power of Compound Interest

The biggest mistake young adults make is to think they have plenty of time to start saving for their financial goals. While it is true you have decades to save for retirement and other goals, what you are not considering is the high cost of waiting to save. Through the magic of compound interest, when interest is earned on interest, your money’s growth is exponential. But, you need time to maximize the benefits.

Consider the following scenario of two recent college grads:

Recent grad Jonathan starts contributing $800 a month, about $10,000 a year, to his retirement plan at age 25, but he stops saving at age 45.

After graduating, Katy enjoys the good life and waits until she turns 45 to start saving. She starts contributing $800 monthly to her retirement plan and continues until age 65.

Assuming both grades earned a 6 percent annual return on their money, Jonathan’s account will grow to nearly $360,000 at age 45. Even though he stopped contributing after 20 years, his account ballooned to more than $1.1 million by the time he turned 65.

In the twenty years Kary contributed to her account, it grew to $360,000, the same amount as Jonathan’s when he turned 45.

Both Jonathan and Katy contributed the same amount of money but, because Jonathan’s money had an extra 20 years to compound, his account grew exponentially larger. Katy experienced the true cost of waiting.

Do Not Underestimate the Overbearing Power of Debt

When you go into debt, you experience the power of compounding interest in reverse. It is what leads to the debt spiral that keeps millions of people from achieving their financial goals. Especially if you are carrying student loan debt out of college, you need to quickly learn how interest works and its effect on your finances. If you are carrying student loan debt, you need to have a plan to pay it down as quickly as you can. That goes back to Tip #1 – Living Beneath Your Means – and using the excess cash flow you generate each month to pay off debt.

More than half of recent grads will have to postpone major life events and purchases, such as buying a house or car, getting married and starting a family, and even delaying retirement. If you’re beholden to the loan servicer, that debt can be a dream killer. An essential rule of thumb to follow right out of the gate is, if you do not have the cash to pay for it, you cannot afford it, and you certainly cannot afford the debt.

Develop a Purpose for Your Money

People who do not have any real purpose for their money—or a life ambition—are destined to spend their money on anything they think will bring them happiness. But that happiness is often fleeting, evaporating until you spend your money again. Establish serious, achievable goals. If a decision to spend any money does not get you closer to those goals, think twice before spending it.