As part the programming presented by the Young Professionals Advisory Board (YPAB) at this year's Student Conference, Billy Novak and I spoke about personal finance. Following are a few financial basics and tips to help students better plan their financial future.
Familiar Financial Traps
Some recent graduates fall into a trap of spending more than they can afford and not saving enough. Often this is a result of buying too many non-necessities and making other expensive choices, such as choosing to live by oneself in an expensive apartment instead of sharing rent and utility costs with roommates, buying a massive brand new flat screen TV, buying a sports car, or visiting Starbucks every morning. The presentation showed the basic budget calculations for a thrifty person and one who has fallen into the trap giving a framework of understanding for the students. It is important to understand the monthly expenses and budgeting for those. Writing down every purchase may seem excessive but it builds an understanding of spending habits and available cash. You can't manage what you don't measure.
Tools for Long-term Savings
We presented the basics on 401k and Roth IRA plans. A 401k is a retirement fund run by an employer for their employees. In a 401k, money is taken out of an employee's paycheck before taxes and invested in a fund or funds. The percentage to invest and the investment mix is determined by the employee.
Since the money is taken out and invested before taxation, a tax is applied when the money is removed from the 401k fund. This is good because generally when someone retires, they are in a lower tax bracket than when they were working (they will only take what they need out of their 401k plan, which is likely less than their usual salary). Basically, less taxes, more savings.
Additionally, some companies have matching programs. For example, an employer will match $0.25 for every dollar the employee contributes to their 401k up to 6% of their salary. This is free money and signing up for that minimum percentage is a must!
Roth IRA's are Individual Retirement Accounts and are after-tax funds. This is a fund set up by an individual (instead of a corporation) and the contributions are determined by the individual (up to a certain extent if the individual also has a 401k). It is never too early to start savings for retirement! (Check out companies like T. Rowe Price or Vanguard for more information)
Stocks, Bonds, and Other Investments
Billy and Elizabeth also spoke about other types of investments like stocks, bonds, mutual funds and money market accounts. Stocks can be tracked and traded from a smartphone, but they do require research and strategy. Riskier stocks (like those of startup companies) can bring large profits. Bonds are generally safer investments because the return is far more likely, but the payoff may not be as great as a wise stock strategy. Mutual funds are a group of stocks that a group of investors purchase and manage. They are offered by numerous companies, such as Franklin Templeton.
Money markets were once known for delivering significant returns and few losses. The returns has since dropped, but money markets can still be a good alternative to a regular savings account (though some accounts require minimum balances and minimum withdrawal quantities). Many firms, such as Vanguard, have a variety of money market accounts for investors.
Buy vs. Rent
The last topic that was discussed was the buy vs. rent issue. With the housing market as low as it is currently, many students may be wondering if they should just buy, since a mortgage is often lower than the cost of renting. Owning property is a great way to build equity and tends to retain its value better than things like cars. There are also tax incentives for homeowners. There are many buy vs. rent calculators online that can help students to make the decision. There are several items that new house hunters may not be aware of, like the costs of taxes and insurance in addition to the interest and principal, homeowners association fees, PMI, and home repairs. It is important for students considering buying a house to understand their goals and where they see themselves in the near future.
In summation, budgetary decisions can be as simple as the math - as engineers, this should be elementary. Do your homework and understand your expenses. Once you do, you'll be in a better position to make decisions to set you up for financial success in the future.