So you’re starting your career, a new chapter in your life. You are on your own with no classes, exams, or papers in your future. You may be in your first apartment, likely accountable to no one, except yourself.
But you do have bills to pay, friends to see, big purchases to plan for. You also have to think about life — not just for today but tomorrow. Retirement can seem like a lifetime away (and it is!) but in order to enjoy life both today and in the future, you need to take some financial actions.
It goes without saying that you need a checking and/or savings account into which your paycheck is deposited and from which you pay your bills. But to best prepare yourself for financial stability, here are five actions you can take that will make the most of your life right now and in the future.
1. A budget
To achieve financial independence and security, you need a budget. Put every dollar you earn to work for you: Pay current bills. Pay down debt. Save for future plans. Quantify your budget, whether that be digitally or written out the old fashioned way. It will make your finances seem more real and give you a sense of ownership.
Budgets can take many forms. Some people want to track every single cent they earn and spend. This is a great tactic if you want to see exactly where your money goes, but it can be frustrating to see exactly how much you spend and how little you think you can save. It can be especially disheartening if you make minimum wage or are paying down student debt.
The 50-20-30 Rule is not a one-size-fits-all budgeting technique — it may not fit for those working for minimum wage — but it is commonly recommended. According to this concept, 50 percent of your take-home pay covers essentials (housing, food, transportation, utilities, groceries, etc.), 20 percent goes toward retirement and savings, and 30 percent covers everything else including student debt repayments above the minimum, entertainment, non-recurring expenses like new clothes and shoes, etc.
Oh, and about debt…I would advise against taking on (more) debt for anything other than a house or a car. You don’t want to take out loans unless you are acquiring a tangible asset in return.
2. Emergency fund
Experts advise that you have at least six months of essential expenses saved in an emergency fund. If you lose your job or a semi-catastrophic event occurs in your life, having this money set aside will reduce your stress.
If your car dies on the freeway, your emergency fund is available for a down payment on another car. If you lose your job, you will still be able to pay your bills, including student loans.
While the prospect of saving money can be daunting, remember you only need to consider your essential expenses which you listed when you prepared your budget. Save every month until you have fully funded your emergency fund.
Be careful to replenish your emergency fund if you use it and get it back to your established level as soon as you can.
3. Employer-sponsored 401(k)
Most employers provide a retirement savings vehicle called a 401(k). This enables you to put aside a percentage of your paycheck into a tax-deferred account each month or pay period. Key advantages to this account are tax deferral of current income and “free money” from your employer.
Any money you put into the account is tax deferred, which means you don’t need to pay taxes currently on this money you just earned, until you take it out. For example, if you make $40,000 a year and put 10 percent of your salary into your 401(k) account ($4,000), your overall taxable salary this year becomes $36,000 ($40,000 less $4,000).
Many employers will match either dollar for dollar or a percentage of what you deposit into this account. The range varies by employer — most common is 1-6 percent of your annual salary — so check with your Human Resources department to understand your employer’s 401(k) policy. Continuing with our example, if your employer provides for 5 percent of your salary, then your employer would contribute $2,000 into your 401(k) account (your $40,000 salary times 5 percent).
You now will have invested a total of $6,000 ($4,000 you deposited and $2,000 your employer deposited) into your retirement account. This $2,000 is, in essence, “free money” for your retirement. By taking full advantage of your employer’s contributions, you could build your retirement nest egg by hundreds of thousands of dollars.
4. Roth IRA
In addition to an employer sponsored 401(k), you could establish a Roth IRA. This account is self-directed; you select a mutual fund or other investment vehicle in which you will deposit after tax earnings. You may deposit up to $5,500 per year in a Roth IRA. Once you reach age 59 ½ you may take the money out without penalty. But do not take any of it out before age 59½, otherwise there is a significant tax penalty for doing so.
The advantage to this account is that all the earnings will be taken out tax free; you will not pay any taxes on the money you withdraw during your retirement. So, let’s assume you are 30 years old and will not retire until the age of 70. (I know difficult to imagine, but bear with me.) Let’s also assume you put $5,500 into this account each year for 40 years which earns 6 percent per year (a conservative estimate).
When you are age 70, you will have deposited $165,000 ($5,500 x 30 years), but due to the magic of time and compounding of interest, you will have an account balance of over $900,000 which will be entirely tax free when you withdraw the money during your retirement. Cha-ching!
Even if you cannot deposit the full $5,500 each year, any amount you can put into this account is a good idea because of the tax advantages upon retirement.
5. Goal Fund
Everyone has goals. Most cost money — think: vacation, buying a house, backpacking around Europe.
Maybe you have heard of SMART goals (Specific, Measurable, Achievable, Realistic, and Time-bound). In terms of money, you would save to achieve the goals. Determine a specific dollar amount of savings to put into your goal fund every month, then you will have the money when you need it.
By planning ahead, making goals and sticking with a savings plan, you can enjoy the life plan you have made for yourself and savor the accomplishment of meeting your goals.
These accounts and ideas are just the tip of the iceberg, but a very good starting point to securing your financial future, and present.
So go ahead, have fun with your friends, take a vacation and plan for your future goals and retirement. With a little planning and discipline all you want to do and who you want to become is within your reach!