We all have decisions we make every day and we seem to survive just fine with the vast majority of them, even when we are young or inexperienced. We can usually decide how to spend our free time and what to have for lunch and dinner without much difficulty, despite the number of choices out there. There’s very little stress involved and any choice we make won’t affect our lives too much (barring some foolish behaviors like excess drinking or drug use).
But when it comes to financial matters and money choices, it’s a whole different ballgame. These decisions can be very tough, especially for new college graduates who have little or no experience in making them, and can cause heavy-duty, brain-busting stress. Especially because the money habits we start as young adults can have benefits, or consequences, far into our futures.
Ninety-nine percent of us have limits on the money that we have to use, so when it comes down to the nitty-gritty, how do you make a good decision? Here are five of the most common and difficult questions that young adults face and what I recommend that they consider:
1. Pay down your debt or save for emergencies?
Deciding which to focus on first can be tricky (of course you’ll need to pay the minimum due on any loans or credit cards, but focusing means more than the minimum). Saving for an emergency is generally the first priority for everyone. A fund with 3-6 months of expenses to cover things like job loss, medical expenses, car repairs, and the like is essential to peace of mind and facing the unknown. “Something can happen and it usually does” says the old expression, so being prepared is a huge priority.
While your debts like student loans are important, if the loan rates are low (like 1-3%), then they can be your second priority. When the interest rates are high, it may be moved up on the list once you have an initial small emergency fund saved, because saving that high interest is as good as investment incomes are in the market. In that scenario, your savings can be substantial and eventually help fund your emergency account.
2. 401k or Roth IRA?
The short answer is your probably need both. First, a 401k is a great way to maximize your money for retirement (yes, I did say retirement even though you’re 40-some years away from it, now is the time to start). You should enroll at work as soon as you are eligible.
401k monies are pre-tax dollars that you never see because they come directly from your paycheck and usually are matched by your employer (up to a certain percent of your pay, such as 3%). It’s literally free money and earns you 100% back on your matched contribution. There is no other investment that you can ever make that will guarantee you that kind of return, so it’s really a no-brainer. The compounded growth over the years will give you a pot of gold at retirement.
A Roth IRA is also important. It’s drawn from your taxable pay each pay period and is very flexible because you can withdraw with no penalties even if done before age 59½ (unlike a 401k). You don’t go through your employer to set it up, but it can be very cost effective to set it up through an e-trade broker like Fidelity or Vanguard to save on administrative fees.
3. Buy a home or rent?
Increasingly, renting has become the better options for Millennials and especially for new graduates. You always need to do what’s best for you. But the flexibility of renting is a major draw for young adults because of the many changes you may contemplate in those early years. You may have to consider relocation for your current job to advance, or you may want to return to school at some point. You won’t need a huge down payment to rent, and home improvements and real estate taxes aren’t necessary. Living space generally isn’t a priority, especially if you’re single and without children.
The “American dream” of home ownership can still be on your horizon when you come to that point in the road where you are set on your career path and location.
4. Credit or cash?
Believe it or not, credit may be your best choice here. It will be as long as your are paying your credit cards in full each month and avoiding annual and other fees. Why? Credit cards help you track your expenses and can protect your purchases through the card’s insurance, as well as make travelling and money easy to deal with.
It can help establish you so that when you buy a car, buy a home, rent an apartment, even apply for a job, your track record will show credit worthiness. And when you have any problems with your purchase, you can contact the card issuer for their help and protection.
There is one big caveat to this advice. If you’ve already dipped your toe into the credit card pool and ended up diving in full force by racking up a balance for a period of time, you might need to put yourself on a cash plan until you’ve paid off your debt and you’re sure you have the self-discipline to charge only what you need and pay it off each month.
5. Eat in or dine out?
Eat in to save money, of course! You do need to socialize and have time with friends and family, but you don’t need to eat out for 21 meals a week. For the culinarily impaired or the young, or worse yet the culinarily impaired young, do not sit at home and eat beans from the can and suffer nutritional deficiencies just to save a few dollars. Do yourself a favor and learn to cook if you haven’t already. There’s a ton of great resources on the internet, including how-to videos, to teach you everything you ever wanted to know about cooking.
Eating in and packing a lunch can easily save you hundreds of dollars a month and that money can be put towards your emergency fund, retirement plans, or other long-term goals. It’s ok to splurge occasionally with co-workers and friends, just don’t overdo it. Don’t do silly things, like drink $12 glasses of wine at the bar, when you buy the entire bottle for less and enjoy it with friends at home. When you do go out, be smart about it and save money whenever you can.
Well, there’s a start. It’s a simple guide to get some kind of handle on a few important decisions. Remember to track your expenses and make a budget so you know how much you have, need, and spend when you’re in the early stages of establishing your finances. Getting off on the right start will ease much of your stress and pressure.
So for our new graduates, how are you handling your financial decisions so far? For our not-so-new graduates, what was the best (or worst) decision you made when you were starting out?
Image courtesy of Stuart Miles on freedigitalphotos.net (with changes)