When it comes to managing your money there are a seemingly endless number of tips and mantras people will throw your way: “pay yourself first,” “don’t ignore your money troubles,” “pay off your credit card in full,” “save at least 6-months’ worth of living expense,” “always max out your 401(k) contributions,” “don’t live beyond your means,” etc.
And while these are valid tips, they can quickly become overwhelming – especially if you recently graduated college and are still relatively new at managing your own money. That’s why we’ve pulled together three key money management rules that every college graduate should know.
We’re not saying all those individual financial planning tips won’t help (because more than likely they will); these are simply the 3 key rules we feel you should stick to for a sound financial future.
Rule #1: Never stop thinking about your retirement.
When you’re launching your career it will seem completely counter intuitive to think about how you will pay for your retirement. Trust us – starting to save for your retirement early can make a huge difference. Why? The answer is simple – compound interest. To explain how compound interest works, let’s take a look at the two types of interest:
- Simple interest – simple interest only charges based on principle value. Say, for example, you lend someone $100 on a 5% per year simple interest rate. That person would owe you $5 each year until he or she pay you back.
- Compound interest – this type of interest charges rate on the principle value as well as the value of any interest accrued. So if you charged your friend 5% compounding interest, the person would owe $5 the first year, and then 5% of $105 the second year – $5.25 – and so on.
As you can see, this is great for a young investor because you essentially earn interest on your interest!
That’s why it’s so important you start saving for retirement as soon as possible. Compounding will definitely work in your favor and help you achieve some exponential gains. Start contributing to your 401(k). Max out your employers match. And if your employer doesn’t offer a retirement package, look into Roth IRAs and other investment tools.
Rule #2: Create a budget and stick to it.
Knowing how much money you have coming in, and how much money you have going out is critical to successfully managing your money.
Quite simply, a budget is a realistic financial plan, which you put together based on your income, expenses and goals. Here’s how you set one up:
- Determine your income.
- Determine your fixed expenses.
- Determine your variable expenses.
- Compare your income to your expenses.
- Track your expenses.
- Adjust as needed.
- Evaluate your budget.
Keep in mind that creating a budget doesn’t mean that all of your problems are going to be solved. Nonetheless, it is an important step to determining your financial health and creating financial stability. It won’t be too difficult to create a budget, but you may find it difficult to stick with one. Just remember, you can do it!
Rule #3: Establish an emergency fund.
You never know when life is going to throw you a curve ball. It’s impossible to predict when you may get laid off, get in a car accident or face other financial troubles. That’s why it’s so important to establish an emergency fund.
An emergency fund is an easily accessible chunk of money you can fall back on when you are faced with an unexpected expenditure. Most financial experts recommend 3-6 months’ worth of living expenses. In most cases this will give you enough money to address the issue and develop a new long-term financial plan.
Since you will need to access your emergency fund on short notice, it’s important you allocate the money where you are able to withdraw it without facing any penalties. Many people will set up a separate savings or higher-earning checking account for their emergency fund. With some added planning you could also allocate it in a series of 3-, 6-, 9- and 12-month CDs. This would likely give you a higher interest rate and allow you to have access to the funds every three months.