Todd Christensen, Education Manager
Debt Reduction Services, Inc.
Each spring, we see arenas and grandstands full of families and friends gathered to celebrate the group of college students about to receive their associates, bachelors, or masters degrees, or even their Ph.D.s. After years of enduring long nights of study and the stresses of projects, research, and finals, these graduates now face their next major life obstacle: financial independence often without any formal personal finance training or coursework. Simple rules of thumb can help during such busy and demanding times.
What are some financial rules of thumb college graduates should keep in mind?
From preparing for their first student loan statement to preparing for tough economic times, financial rules of thumb can help college students assess and organize their personal finances to make their transition to financial independence as smooth as possible.
That said, some rules of thumb make more sense (and cents) than others, so read on to see which can help, which need adjustments, and which might be ignored.
Rules of Thumb to Keep in Mind
- You have seven months after graduation before you need to make a student loan payment. If you have a student loan, your first statement will arrive about six months after your graduation date. You will then have approximately 30 days before your payment is due.
- Your student loan’s monthly payment will equal roughly 1% of your total balance. At the typical 4% to 5% APR, your monthly payment on $40,000 of student loan debt will be $400 and change.
- Live like a college student for your first 5 years after graduation. Don’t max out your new paycheck by dining out every meal, getting some new wheels, or moving into the fanciest apartment you can find. Instead, max out your 401(k) contributions. Open an Individual Retirement Account and max out your contributions there too. You will NEVER regret having a large nest egg to start off your career. Just ask any 50- and 60-year-old you meet.
- Pay yourself FIRST! Make your savings account contribution your first bill of the month. Build a cushion for emergencies and for future plans like vacations, vehicle repairs (and replacement), gift-giving, and a down payment on a home.
Rules of Thumb to Modify
- College graduates earn an average of $50,000 their first year after graduation. Salaries vary by the school you graduate from, the area you choose to live in, but mostly by the field of study you get your degree in. Those with degrees in education and child development will earn significantly less than those graduating with a degree in engineering, accounting, or information technology.
- For every $10,000 a year you expect to earn, it will take you a month to find your first job. If you expect to earn $50,000 a year out of college, you may be looking for five months. Of course, graduates with some degrees will be hired even before graduation (sometimes even before their final year), such as IT.
Live one paycheck behind. Live below your means to such an extent that you can pay your bills one paycheck ahead of time. That means the rent you pay, the food you eat, and the gas you pump were paid for with your paycheck a month ago. Early on, though, it may be difficult to live this way until you’ve built up enough of a cushion in your checking account.
- Try the 50/30/20 budget. This simple percentage-based budget suggests you use 50% of your net monthly income to pay your living expenses (housing, food, utilities, transportation, cell phone, Internet, etc.), use 30% for dining out, entertainment, splurges, and shopping, and invest and save the remaining 20%. For a more nuanced percentage-based budget, try our Money Pie budget.
- Use the Rule of 72 to Predict Your Future Investment Value. Divide 72 by the return you expect on an investment to determine how long it will take for it to double. If you think you’ll earn the historical average of 9% returns in the stock market, it will take 72÷9, or 8 years for your investment to double. However, take into account that the stock market is volatile. Some years you may earn 9%, others lose 15% and still others earn 40%. Also, keep in mind that putting money into your savings is meant to prepare you for emergencies, not to build wealth. After all, at 0.5% APR, it will take you 72÷0.5, or 144 years to double that deposit.
- Pay off your highest interest rate loan first. This rule (known as the debt avalanche) will save you the most money in interest paid and have your debts paid off fastest. However, if you want to build or rebuild your credit rating fastest in the process, consider the debt landslide that has you pay off your newest account first. Only use the debt snowball method (focusing on the lowest balance first) initially and temporarily until you have sufficient motivation to stick with your plan.
Rules of Thumb to Disregard
Spend 35% on your rent or mortgage. Where you live will greatly influence how much you spend on housing. However, if you can live with roommates to cut your housing costs, you’ll be better prepared to buy a home later.
Get a credit card for emergencies. Credit cards are not for emergencies. An emergency savings fund is for emergencies. Credit cards are for convenience and for security in making purchases. Changing your mindset in this regard will likely save you years of heartache and tens of thousands of dollars in credit card interest.
Get a whole life insurance policy while you’re young. About the only people recommending anyone get a whole life insurance policy nowadays are those selling the policies and earning commissions. Term life policies are so affordable that most people will do better to use the difference and invest it in their 401K or an IRA.
Start saving now for your own child’s education. Beyond the fact that you may not even have a child yet, you should understand the human nature rule that stipulates that we value what we work and sacrifice for. Students who pay for or work their own way through college are much more likely to graduate than those who have their entire college experience paid for by their families. That doesn’t mean you should not save, but you might strongly consider encouraging your child to put a little of her or his own skin in the game.