Managing your personal finances after college can be one of the biggest stresses for college graduates. Whether due to parental contributions or financial aid, many traditional undergraduates don’t have to manage a full-time income and living expenses while in school. But for most of us, graduation brings a real wake-up call in having to handle your finances.
These 6 steps can help get you set on a great track, for now, and in the future.
(This post is written for informational and educational purposes and is not professional financial advice. If you are looking for advice suited to your particular situation, seek out a financial professional such as a certified financial planner or CPA).
Table of Contents
Step 1: Lay it all out–understand the current state of your personal finances after college
Before you can make a financial plan of attack, you need to know your money landscape. Pull together all of the pieces to look at your assets and debts and your monthly cash flow.
Calculate your net worth
Set up an initial net worth calculation by identifying your assets (bank account balances, vehicles, or other physical assets), and your liabilities (student loans, vehicle loans, or credit card debt). While there are different ways to decide what should “count” in the calculation, ultimately your net worth should reflect your assets minus your liabilities.
Once you’ve calculated your net worth, you have an idea of your starting point. For our purposes, it doesn’t matter whether you have a net worth of $50,000 or -$100,000. What does matter is that you know what it is and can look to improve from wherever your starting point is.
Calculate your cash flow
Calculate your monthly cash flow by identifying your monthly income–what’s in your paycheck after taxes–and your expenses. On the expense side, you’ll be making distinctions between essential expenses (such as rent, student loan payments, and minimum amounts needed for a month’s groceries, for instance), and discretionary expenses (streaming services, going out, travel, etc.).
This cashflow worksheet from FINRA can help you run the numbers. Calculating your cash flow will tell you whether you have additional funds that can be used toward your financial goals, or if you’re currently making choices that you’ll need to adjust in order to make those goals happen.
Find ways to save
You may be the rare person that has plenty of excess cash in your monthly calculation. If so, awesome! Now’s the time to start putting that money to work, by building your emergency fund, paying off debt, and starting to build assets.
If your calculation showed negative cash flow, though, you’ll need to make some immediate changes to either cut expenses (the most effective cuts come in food, transportation, and housing) or grow income–hello, side hustles!
Big Ticket Savings: Look for ways to save in the big three spending categories: housing, transportation, and food:
- Invite friends to a home-cooked dinner rather than going out to the bar.
- Evaluate your current living situation. Can you comfortably afford your rent, or do you need to consider something smaller, less convenient, or with more roommates?
- Figure out whether you can afford the car you’re driving. Would a less-expensive car, bike, or public transportation be good options while you get your finances in control?
Recurring Expenses: You can also look at your streaming services and other subscriptions for places to cut recurring expenses. Do you really need Hulu and Netflix and Disney+ and HBOMax, or can you pick one to watch for the next three months, then switch and binge watch shows on another one? While these monthly charges are often small, $10 here and $20 there start to accumulate. And when you multiply by 12 months, the costs can really start to pile up.
Step 2: Open a high-yield savings account and save up an initial emergency fund
If you don’t already have a savings account, now is the time to open one. The difference between a checking account and a savings account is that the first is designed to be used frequently, typically with a debit card. A savings account is meant to hold money that won’t immediately cycle through it.
Where should I open a savings account?
You’ll want your savings account to be a little inconvenient. That way, you won’t be tempted to tap into it for everyday expenses if your checking account is running low. To create distance, try opening a savings account with a different bank than your checking account is in. It typically takes about 2-3 days to electronically transfer funds between banks.That little bit of friction can help slow down any non-urgent purchases from becoming opportunities to raid savings.
Many online banks are great options for high-yield savings accounts, as they frequently offer higher interest rates (.30% or higher) compared to big banks like Wells Fargo which feature interest rates more like .02%. I have had good experiences with Capital One Bank, which offers fee-free online savings accounts with a current interest rate around .5%.
Credit unions are another good option. Unlike banks, credit unions are member-owned, rather than a company trying to turn a profit. Credit unions can often offer higher interest rates for savings accounts, as well as lower interest rates for loans.
How much should I save?
$400. When discussing savings rates, researchers often ask whether people or households could handle a $400 emergency with savings. So $400 would get you there.
$1,000. A thousand dollars is a nice round number. It’s also substantial enough to emergencies cover minor car repairs, or an emergency flight home.
$2,467. In 2019, two researchers calculated the minimum for a healthy emergency fund, and they came up with $2,467. Now, this may vary depending on the cost of living in your area. But it’s an option.
3, 6, or 12 months of necessities (think rent, utilities, insurance, minimum debt payments, basic needs). This is the gold standard for an emergency savings account. If you were laid off from your job, what would you need to survive?
My recommendation? In this action step, save until you have a $400 or $1000 balance in your emergency savings. Then, as you complete the next steps, revisit and bump up the savings to the next level of the options above.
Step 3: Make sure you’re saving enough in your employer-sponsored retirement plan to get a company match.
If your company offers matching contributions to your 401k (or 403b or TSP) plan, be sure that you are enrolled and making enough of a contribution to qualify for that match. By skipping the matching contributions, you’re essentially giving up part of your compensation from your employer. If you can avoid it, don’t leave that money on the table.
Taking advantage of employer contributions also ensures you’re getting the benefit of compound interest. As you’re early in your career, even a small employer contribution of $2,000 at age 24 could grow to $30,000 or more by age 65.
Don’t believe me? Check the math on this compound interest calculator from the SEC.
Related: What you need to know about 401ks, IRAs, and saving for retirement
Step 4: Stop adding to debt, and pay off your high-interest debts
If you’re carrying a balance in high-interest debt (anything over 5%), this step is critical. Paying off the balances on these debts should be a top priority after a basic emergency fund and getting an employer match. (Some people suggest it before the 401k match. But unless your debt is in seriously bad shape, the long-term benefits of investing early may win out).
First, stop adding more debt. If your monthly cash flow is negative, stop or significantly limit your discretionary spending, such as shopping or entertainment. Find big-ticket savings opportunities, rather than focusing first on little expenses like the famous lattes or avocado toast.
If you’re drowning in debt, the worst thing you can do is to pile more debt on top of it. I tried that for a few years in my 20s, and it wasn’t fun.
The debt snowball
When it comes to paying off multiple debts, the debt snowball approach is a time-tested approach. This approach takes advantage of psychology to build a sense of momentum
- List out all of your debts and order them from lowest to highest
- Pay the minimum monthly payment on all debts (while not adding debts)
- Make an effort to put extra toward the smallest debt, each month, until the balance on that smallest debt is fully paid off.
- Once the smallest debt is paid off, roll the money you were putting into that debt each month (the extra payments, plus the minimum payment) into the next smallest debt.
- Repeat until you’ve retired all of your debts.
The debt avalanche
While the debt snowball approach uses the psychological benefits of momentum to help you get out of debt, the debt avalanche uses math. In the debt avalanche method, instead of ordering debts from lowest to highest balance, you order them from highest to lowest interest rate. Otherwise, it follows the same steps.
There are pros and cons to each method. While the debt avalanche may reduce the overall interest you pay during your payoff journey, the best approach is the one that you will actually use.
Should I pay off student loans faster?
It depends. In most cases, student loan debt–especially federal student loans–has pretty low interest rates. For example, federal Stafford loans are currently under 5% interest. For many people, this means that after paying off higher-interest debt, e.g., it’s a good time to pivot to investing and growing assets.
The stock market has averaged a return of 10% over the last 30 years–8% when adjusting for inflation. Given that rate, many people decide that some student loan interest is fine to hold onto while establishing a better rate of return. And a number of federal student loan repayment options can also help reduce your balances over time.
Step 5: Build your emergency fund higher.
In the previous emergency fund step, you may have chosen a smaller amount ($400 or $1,000) to get started. If so, now that you’ve put yourself on the debt payoff track, try to bump that emergency fund up to the next level.
This bigger emergency fund provides an additional cash cushion in case you face medical emergencies, layoffs. A larger fun also helps in the future, if you decide you want the ability to leave a bad job situation without having another one immediately lined up.
As you’ve hit the other steps in this post, try to get your emergency savings to at least 3-6 months of your necessary expenses, saved in a high-yield savings account.
Step 6: Put funds into a Roth IRA
If you’re already contributing to your 401k up to the maximum match from your employer, an IRA is often the best next step for saving/investing.
Why an IRA? Because unlike a 401k, where you can only choose from the providers and plans offered by an employer, in an IRA you can choose from hundreds of providers and any investments that a provider offers. And many providers now provide fee-free transactions and minimal to no annual fees.
Why Roth? As long as you make less than the income limit ($140,000 in 2021), you can contribute to a Roth IRA. In a Roth IRA, you invest “post-tax” money, instead of the “pre-tax” contributions in a traditional IRA or 401k. In other words, you’ll pay the taxes on the income you invest now, but then your invested funds will be able to grow for decades and you will never have to pay tax on the earnings. With the power of compound interest, that could be a big tax savings, especially if you assume your future tax rate will be higher than your current one.
Not sure where to start? Check out a discount broker like Vanguard, Fidelity, Charles Schwab, or TD Ameritrade. Each have a process that walks you through how to set up and fund an account.
Related: How to Set Up an IRA
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