You passed your finals, graduated from college with your diploma and just received your first paycheck. What’s next?
The most common question I get from my friends, my colleagues and our clients in their 20s is, “what should I do now that I have a job and have an income stream?”
That’s a great question, and the answer isn’t found in a textbook. I’ve found that the best strategy is to set up a financial game plan early and start having your assets work for you now. Like anything in life, building and establishing good habits early leads to long-term success.
Here are my top six tips for building a successful financial future:
Tip #1: Begin thinking about, and writing down, one-, five- and 10-year goals
I find this exercise to be a VERY helpful starting point. Ask yourself what you want to accomplish in the next year, next five years and over the next 10 years. Then think of a few specific/measurable goals to accomplish in the coming years, and write them down. Maybe it’s building a fund for a future house down payment or relocating to a new city. After you write down your goals, hang them up somewhere you’ll see them every day and then try and make progress toward them.
Tip #2: Establish your budget
The first play you should run from your playbook is to set up a savings game plan. This is one of the few things in the financial world that you have control over. You have the choice to spend your net paycheck on rent/mortgage, savings, groceries, entertainment and more. I recommend all young earners try to automatically set aside at least 15% of their gross income every paycheck to be put into your investment savings vehicles.
Automation is key! This practice will help you “pay yourself” before spending your money on wants, such as entertainment and vacations. Remember, while you are younger time is on your side; take advantage of time in the market rather than worrying about timing the market.
Additionally, I’ve had some colleagues find success by living at home for one or two years after college in order to save money before moving out. This strategy can help build your savings fund while you learn what it’s like to begin having everyday bills and expenses.
Tip #3: Set up your investment savings vehicles
Next, you should read into your employer benefits to see if they offer a retirement plan, such as a 401k, 403b or thrift savings plan (TSP). If they offer such a plan, you should enroll as soon as possible and elect to contribute a percentage of your paycheck to your new retirement plan. Often, employers provide a match up to a certain percentage of your contributions to your retirement plan; therefore, you should contribute enough to earn the total match.
Next, you should look to set up an individual retirement account (IRA) and taxable investment account. These will work alongside your employer-sponsored retirement plan. For those who play basketball, think of this as your triple threat. Your IRA will team up with your employer-sponsored retirement plan for retirement savings, while your taxable investment account will be available for those one-, five- and 10-year goals we talked about earlier.
Tip #4: Develop your tax plan
When you get your first paycheck, you’ll see deductions from your gross income, known as income taxes, that include federal, state, Social Security and Medicare. You won’t be able to avoid paying income tax, but you can lower the amount deducted from each paycheck depending on your withholdings and tax declarations. Be sure to talk with HR to ensure you’re withholding the appropriate amount from your paycheck to pay for your income taxes.
Additionally, when investing you can use tax-efficient assets, such as exchange-traded funds (ETFs), that have low expense ratios and avoid distributing large amounts of income. This practice will often lower your overall tax bill. TurboTax and H&R Block are great options for preparing and filing simple tax returns.
Tip #5: Use debt strategically
When it comes to applying for credit cards, student loans or a mortgage, be sure you have a repayment game plan in place beforehand.
I highly recommend that younger clients find the right credit card for their lifestyle and start building their credit score. This then lets them earn points/rewards that can be used for cash back, airline miles and more. I think this is better than paying in cash (so long as you pay off your entire credit card balance each month), as you earn free rewards. I recommend to always be sure that your monthly credit card balance is no more than 30% of your credit limit, you pay your bill in full every month and you never miss a payment.
If you already find yourself in debt, a great repayment strategy is to pay down the highest-interest loan first. This will result in you paying the least amount overall by reducing the amount you’ll owe in interest.
The ultimate goal is to not spend more than you make. If you have any credit card debt, that should be paid off before starting to save elsewhere. Other debt, such as student loans or mortgages, can be considered “good” debt and can be worked into your monthly budget.
Tip #6: Create your estate plan
It’s always good to have a plan in place in the event something should happen. If you had passed away last week, would your assets have been distributed how you would want? If you’re in the hospital and unable to make medical decisions on your own behalf, can someone make those decisions for you? The answer is probably no unless you have the proper estate documents in place.
For all our young clients, I recommend getting simple wills and financial/healthcare powers of attorney (FPOA and HCPOA) set up. This helps ensure your assets are passed on as you wish. It’s a legal document that coordinates the distribution of your assets after death and can appoint guardians for minor children. Your FPOA and HCPOA documents can allow someone to make major financial and medical decisions on your behalf. For example, if you’re incapacitated, the agent named in your FPOA has the power to make financial decisions on your behalf (such as paying your credit card bill).
Additionally, now that you’re an adult, you likely have assets/property in your own name (such as a car, investment vehicles, bank accounts and life insurance policies). You should make sure your beneficiaries are set up as you wish and do a periodic review to make any needed changes.
While it’s exciting to have your first job out of college, all the responsibilities that come with being an adult can be overwhelming. Hopefully the six steps above help as a starting point — however, it can make sense to talk to an advisor if the situation becomes too complex and you want professional guidance.
Your financial advisor can be a source of major stress relief and a coach for you when it comes to major life decisions, such as purchasing a home. Additionally, we have great intro guides for those trying to educate themselves about their finances.
Creative Planning is here for you. Our teams help ensure your entire financial life is working toward achieving your long-term goals. To discuss how we can help you, schedule a call with a member of our team.