Our three children have now all graduated from college, started their chosen careers, and moved away from home. They are all in their 20’s and their lives have just begun! Each is excited, eager, and admittedly, a bit scared as they embark on their new journey outside the safety net of home and campus. Now that I’ve watched each one graduate, with pride in my heart, it’s time to sit down with each one and have a talk about retirement with them. Yes, you’ve read correctly. Retirement. It’s time. Amidst all the emotions of new beginnings, following their dreams, reaching for the stars, etc., NOW is THE time to think about their retirement, although I know that none of them have given any thought to this. Saving and investing is crucial to their financial well-being, and the time to start is NOW.
Sadly, I don’t think most college graduates have the knowledge to effectively manage their money, especially since it is the first time they are seeing healthy—or perhaps not-so-healthy— paychecks. Most have been financially reliant on their parents throughout their college years. And now, they have found jobs and need to start supporting themselves. Their spending, saving, and overall lifestyle habits must change. Not an easy task, especially for those who have been financially dependent and haven’t had to previously worry about finances. It can be a rude awakening! Many have never had to worry about saving, as any part-time job earnings were considered “spending money”. All necessities, such as tuition, housing, and food, were paid for by their parents. So ‘saving’ could be considered an ‘alien’ concept to them! What about investing and retirement? At such a young and vulnerable age, it’s not easy for most young adults to be thinking forward to retirement and saving for that time way ahead on the horizon of their young lives. Especially since many of them, for the first time in their lives, are earning a paycheck and enjoying reaping the benefits of that paycheck!
There are exceptions…. as some college students work full-time, are financially independent, and pay their own expenses. But for those who have been financially independent, my own children included, this is meant for them. It’s written for my own children, and for all soon-to-be-college-graduates. This is for all of you.
Remember to SAVE. To prepare for retirement, you must save for your entire life!
Live Within Your Means. This is, perhaps, the most vital lesson: You absolutely MUST NOT spend more money than what you earn. If you are like many young adults, you will spend money as soon as you get it. Our culture tends to be that of instant gratification. Clothes, movies, nights out with friends, whatever!! While in college, parents tend to pay for housing, groceries, utilities, THE CELL PHONE!!, etc., and most importantly, they paid the tuition bill. So, anything made by you was, by definition, your spending money. But no more! After graduation, you must realize that you will be responsible for all of these expenses, and that these essentials must be paid before you can think about buying new clothes, or another video game, or going out to dinner with your friends, no matter what the celebration or reason may be. You will have to learn that all the fun things you are used to buying or paying for will have to take a back seat to paying for all the essential things you need to live. And that brings is to the second lesson….
Delay Gratification. There is nothing wrong with wanting to buy something that you desire. But with the change in your financial situation, you are going to need the discipline to postpone that purchase. If it is something you really feel is worth having, then you should start saving money, and when you have enough saved, then you can go out and buy it. But under no circumstances should you put anything on your credit card that is not absolutely necessary. A credit card is for establishing credit, for NEEDS, not wants. And that leads us to point number 3……
Minimize Debt. Getting into debt leads to trouble. Some debt is good. A mortgage, a car loan, or maybe even a business loan are good types of debt. All are responsible uses of debt. And having a credit card and using it responsibly is a great way to establish a good credit score. But piling debt on your credit card just to buy things you really don’t need is a recipe for disaster. The late fees and interest charges will add up very quickly and cost you far more than the original cost of the product you bought. If you can’t afford to pay off your credit card at the end of each month, then you are taking on way too much credit card debt.
Keep Your Costs Low. The best way to live within your means is to keep your expenses low. Rent an affordable apartment. Buy a certified, pre-owned car. Shop at the discount stores for your clothes, or at the more expensive stores only if there are deep mark-downs, sales, or the end-of-season sales (and look at the clearance rack!). Buy groceries and household goods in bulk, shop at local farmers’ markets (which are usually very reasonably priced and supports the local farmer) and prepare your own food. Eating out is very expensive, and a bar tab can set your bill soaring. Use coupons! Cut down on fuel by doing multiple tasks in one trip. Save money any way you can. By following these tips, you can still get all the things you need while also keeping your expenses as low as possible.
Make a Budget. This is probably the most essential step. Calculate what your monthly income is and then figure out what all your fixed costs are. (Fixed costs include rent, utilities, car payment, student loan payments, etc. These are things that cost the same every month, and that you must pay for month after month.) Once you have subtracted these fixed costs from your take-home pay, the amount you have left can be used for your non-fixed costs. Non-fixed costs can be fluid from month to month, but they are still expenses that must be paid every month. They include things such as groceries, gas money and clothes. Figure out how much you need to spend on non-fixed costs and add it to your budget. Make sure you stick to that amount. Finally, after subtracting all these necessary items from your take-home pay, what you have left is what can be spent on the unnecessary things. By making a budget beforehand and knowing what you expect to spend on each category, you will have a better chance of not over-spending, and not having to use your credit card to incur unnecessary debt.
Save Your Receipts! This is a really great habit. When you first graduate from college and secure an entry level job, you will most likely fill out the 1040-ez form when calculating your taxes. You will take the standard deduction. Receipts won’t help you. But when you start earning enough to begin itemizing your deductions, saving your receipts in an organized fashion will be a big help. Get into that habit early!
Investing – Now that you know how to save, here is how to invest for retirement.
Find an advisor and make an investment plan. You probably won’t know very much about investing, even if you think you do, so find someone you trust who has a lot of experience (it could even be a parent!) and learn about investing. Read. Educate yourself. There are so many books and online resources! Once you are ready to start, make a plan about exactly how you are going to invest. What will you invest in? How often? How much? What are your long-term goals? Consider all these factors before you start and set your plan up in such a way that you can easily follow the progress and determine whether you are meeting your goals. Keep active in your portfolio and be vigilant with the person who is managing your account. As time goes on, you can alter the plan if it is not working or if your situation changes. And keep an eye on the percentage your advisor is charging you….
Pay yourself first. Initially, you may have a relatively low paying job, and for the first time in your life you will be responsible for all your expenses. So where will your investment monies come from? From yourself. You are going to pay yourself. By this I mean you are going to set aside (SAVE!) at least 10% of every paycheck and put it into a bank account. This 10% must be part of your budget so that it is just as much of a priority as any other of your fixed expenses. Once you have enough saved to cover about 2 months’ worth of your expenses, you can start putting money into a retirement account and begin investing.
Open a Roth IRA. Use a discount broker and open a Roth IRA in which to put your investment funds. This will be funded with after-tax money, so when you retire and withdraw the funds you will not have to pay any taxes on it. You can check with a trusted accountant to see how much you can put into the Roth IRA. Maximize this as much as possible.
Invest regularly. Once your investing account is set up, and you have your investing plan set, you can start investing. Your plan should include regular purchases at a set time period. It’s up to you what time period you pick. Quarterly or yearly is probably best. Don’t skip any investments. Make sure your quarterly or yearly investment is in your budget and execute it.
Diversify. You don’t want to put ‘all your eggs in one basket’. If you own too much of one type of investment, one stock, one ETF, or only owning technology stocks, etc. and it goes against you, your portfolio can take a big loss. When you first start, with the low amount of funds you will have, it’s probably best to start with an index ETF. These are naturally diversified, have low fees, and pay a decent dividend. Once you have enough to start buying individual stocks, you can begin building a portfolio of 20-30 stocks, in different sectors, to make sure you maintain diversity.
Buy dividend stocks and use the miracle of compounding. There are two reasons to buy stocks. One is for capital appreciation, which means that the stock rises in price and you can sell it for more than what you bought it. The other reason is to collect dividends, which is cash a company pays you just for owning its stock. I suggest buying dividend stocks. No one knows what will happen in the future with stock prices. If the stock you own does not go up in price you gain nothing. But with a dividend paying stock, you keep collecting cash, quarter after quarter, year after year. Even if the stock price doesn’t go up, you still get a return. And don’t just buy stocks that pay a dividend. Buy stocks that pay a dividend that rises YEAR AFTER YEAR! And once you have that dividend, reinvest it. This is how compounding will kick in. With compounding, when you reinvest your dividends, now those reinvested dividends will pay even MORE dividends next quarter. This causes your dividend returns to grow exponentially. A stock like Coke (KO) has been paying a higher dividend, year after year, for the past 50 years. Every year you get more money. Over a 50-year period, this can lead to great wealth.
For example, let’s say you put $1000 into a stock that pays a 3% yield. In the first year you will collect $30. But now let’s assume that the dividend rises by 10% every year. After 40 years you will collect $1,357.80 every year! In cash! And over the whole 40 years you would have collected $14,636, on an investment of only $1000. And this, of course, doesn’t even include any rise in the stock price. If you include an average rise in the stock price of 8% a year, the stock will be worth $23,462 after 40 years. Add in the dividends you were paid, and that $1000 investment will have turned into over $38,000. And that is with a single, one-time $1000 investment. That doesn’t even take into account that you will be investing more and more each year. Over a 40 years period, if you continue to add new funds and reinvest the dividends, compounding will make you very wealthy.
Stay 100% invested. The market will go up and the market will go down. But no one can predict when either will happen. If you are going to use a dividend growth plan, then you must actually own the stocks to collect the dividends. If you are out of the market for any reason you cannot collect dividends. So, it is my advice to stay 100% invested. You may reconsider this as you get closer to retirement, but while you’re young you should stay fully invested. Every quarter take all the money you have deposited in your account (and collected from dividends) and use it to buy dividend paying stocks. This will maximize the amount of dividends you will collect, and over time, with compounding, your returns will skyrocket.
Keep costs low. Although most online brokers have gone to zero commission trades, you can still be charged fees for certain transactions. ETFs and mutual funds still have management fees, and if they are high enough they can affect your over-all returns. And some places still charge for dividend reinvestment. Make sure you know all your costs and minimize them as much as possible. Over the long-term, 30-40 years, even just a 1% management fee can cost you thousands of dollars. Stay vigilant!
Summary: Plan, plan, plan. If you follow these guidelines and have clear goals, you may not live the high life in your twenties, but you will be comfortable and financially secure. As you get closer to retirement, you will find that you won’t have to worry about money. You will have plenty. You will be financially secure. And who knows, you may even be able to retire early!
While writing this, it occurred to me that the lessons I want to teach my children are the same lessons people discuss and learn about every single day. And the lessons I want to teach my children, I’m sure, are the same lessons other parents will be trying to teach their children. I hope that by reading this article, people become inspired and approach this topic with their college-age children, relatives, and friends. And as I put this article together, I came to realize that the lessons I will be trying to teach my children are applicable to all of us. College students, young adults, couples just starting out in their married life, couples with a new family, middle-age people edging closer to retirement, and people already in retirement should all try to live by these principles. There is never a time in your life when you should not try to be financially responsible.