by Brian Fung
You don’t have to be an economics major to know that achieving financial independence takes hard work and discipline, particularly if you find yourself living in a city with few support networks after graduation. In these situations, even a little advance prep can help. Here’s how to get on the road to financial security when you’re just starting out.
Get everything on the table
Before making any big decisions, it’s helpful to assemble the bits and pieces of your financial life into a single picture. Last week, I mentioned Mint.com — a free online tool that tastefully displays, among other things, how much you have in your checking and savings accounts, the balance on your credit card, and any other debts you hold. Once you sign up with Mint and populate the app with your financial information, new transactions get added and categorized automatically. Mint helps you track where your money is coming from, where it goes and, most importantly, how your spending patterns change over time — all with snazzy charts and graphs to help you understand.
If giving up your personal data makes you skittish, Mint is owned and operated by Intuit, the tax-prep company behind programs like Quicken. Mint can’t make transactions on your behalf, and only reads back to you what you’d find on your various bank websites if you were to log in there separately. Still, whether you should sign up depends on how highly you trust companies like these in the first place, and that’s something for you to decide.
Take willpower out of the equation
The biggest obstacle to saving is often our own selves. Putting cash under the mattress is a struggle — it’s inconvenient, there are bills to be paid now, there are things I want now, and so on. But saving doesn’t have to be an uphill battle.
Instead, consider automating your personal finances. That means setting up a system of rules with your bank(s) to manage your money — like a computer program for your income that you can set and forget. Not only does this system help you save cash by setting aside some of your paycheck before you have a chance to spend it all, but it also saves you valuable time and stress. If you’re feeling ambitious, you can even use this system to automatically pay your bills, which vendors appreciate and sometimes results in a little discount for you. And the best part? Automating your savings means you can spend whatever’s left with minimal guilt.
To see how such a system works, watch this explainer by Ramit Sethi, one of a growing number of smart personal finance bloggers.
Help! What’s a 401(k)/403(b)/IRA?
Retirement seems like a long way off when you’re in college. But people are living longer these days even as the future of Social Security grows less certain, which makes it important to plan ahead so that you have enough to live on after you stop drawing a salary. You probably don’t need to start saving until after you leave Middlebury, but the longer you wait, the steeper your climb will be. Someone who starts investing at age 25 will need to put away much less each month and will still end up having more in the long run than someone who didn’t start saving until 35 or 45.
There are different ways to get started. Unless you work part-time or are self-employed, most traditional employers will offer you a 401(k) retirement account. (A 403(b) is basically the equivalent of a 401(k) for teachers and some non-profits.) Any money you put in there comes out of your paycheck before taxes, which incidentally reduces the taxes you owe to Uncle Sam in a given year. Often, employers will also pay into your 401(k) if you contribute a certain amount yourself. Definitely take full advantage of this match, as it’s free money. Once it’s there, you can choose how to invest it. The only downsides are that you can’t touch what’s inside until you reach retirement age, and you’re taxed on what you withdraw, since you didn’t pay up before.
Another way to save for retirement is through an IRA, which is an investment account you fund with after-tax income. You’ll often hear about two types of IRAs — the traditional and the Roth. For young people, a Roth IRA is the better choice. It’s tax-exempt, meaning both your contributions and your investment earnings can be withdrawn tax-free at retirement age. (You can also withdraw early for a small penalty.)
What should you invest in? Index funds are one good choice. These are mutual funds that emulate the stock market instead of trying to beat it, and they come highly recommended for their low cost and slow-and-steady-wins-the-race philosophy. You might also look into lifecycle funds if you’d rather not think too much about it.
It’s a good idea to use both 401(k)s and IRAs, but how you strike a balance between the two is up to you. In short: you can either pay taxes on your retirement savings now, or later. If you think tax rates are going to rise later, consider taking the hit now.
Making sense of health insurance
Good news: there’s no need to worry about health insurance right away. Under the Affordable Care Act, Americans can keep their parents’ health insurance until they’re 26. This part of the law is already in effect.
That said, once you’ve been hired someplace and your employer starts subsidizing your health insurance, then you’ve got to worry about things like premiums and deductibles. (Again, if you’re self-employed or working part-time, it’s a different story.) A premium is essentially a payment you make regularly for the right to be covered by your insurance company. A deductible, meanwhile, is the amount of your healthcare costs that you have to pay before your insurer’s benefits start to kick in. When people complain about rising premiums and deductibles, it means that they’re (a) paying more every few weeks for the right to be covered even as (b) insurers scale back that coverage.
It’s also helpful to know the difference between an HMO and a PPO, which are two of the most common approaches to health insurance. There are a lot of details, but the bottom line is this: you get what you pay for. A PPO has higher premiums than an HMO, but the benefits are greater. You can see whatever health professional you like instead of being stuck with a list of pre-approved doctors, for example. Which you choose depends on your situation and your comfort with risk.
Need more help? The U.S. government has a handy online glossary.
The bright side of student debt
This is the big kahuna. If you’re drowning in student loans, it’ll be that much tougher to make everything else work. But there’s a silver lining: student debt is generally considered “good” debt because it helps build credit history and reflects an investment that pays itself off to society when you enter the workforce. And compared to riskier debt like the kind linked to credit cards, the interest rate on student loans is usually pretty low (for subsidized Stafford loans, it’s 3.4 percent; for unsubsidized Staffords, it’s double that).
There are other reasons for optimism. Students that go into the public sector after college can have their loans forgiven after ten years of service. If you go to grad school at any time, you can have your undergraduate debt temporarily deferred.
As with many of the issues covered here, what you do with your debt is an intensely personal choice. If the amount you owe is fairly small, you can probably afford to keep it around to help build your credit (once you pay off your loans, they disappear from your credit history). If what you owe is especially large and you have no other debt, you might consider making more than the minimum payment each month. If you’ve got a mountain of credit card debt at 15 percent interest, you might want to target that high-interest debt first.
Getting to a firm financial footing involves lots of complex decisions. Some of them call for deep reflection about your values and priorities. But none of it should be especially painful — and by thinking about some of this stuff now, you’re already ahead of the game.