Here’s the scenario: You have graduated college and landed your first “real” job (delivering pizzas does not count). You have bills to pay, and for the first time, maybe even investment decisions to make. Where do you start? What do you do first?
This scenario may apply to you, your child, or even your grandchild. It’s likely that either you or someone close to you is nearly ready to take those first few steps to eventual financial freedom. It’s important to develop good financial habits at an early age, as these are the habits most people retain their entire life. Here’s a list of helpful hints to get someone on their way!
The first place to start is to make sure your income allows you to maintain your spending level. Start by listing your monthly after-tax income at the top of a sheet of paper. Then, list all the expenses you incur monthly, starting with those that cannot be avoided, such as car payments, rent or mortgage payments, utility bills, etc. Subtract your expenses from your income to see what’s available for savings. If your income is less than your expenses, you should either find ways to earn more income, or find ways to decrease your expenses. A budget is avoided by many, but really should not be.
2. Save for a Rainy Day
The next step is to take set aside some funds as a “rainy day fund”, or “emergency reserves.” In most cases, you should have the equivalent of three to six months of basic living expenses available from emergency reserves. Depending on your risk tolerance, this may mean either cash in a money market fund, or cash available from a line of credit. We strongly recommend that you have at least one or two months worth of living expenses available in a cash equivalent, such as a money market fund.
3. Manage Your Debt
Once you have established an emergency fund, take control of any debt you have. Some debt, like mortgages or school loans, comes with tax benefits, and is not necessarily bad debt. Income tax breaks are available to those who carry mortgages or school loans. Car loans are usually necessary, but not really “good” debt. You should make sure your car payments fit into your monthly budget. If they don’t, consider downsizing your car or leasing. Finally, there is credit card debt. In general, credit card debt is the worst type of debt you could have, as interest rates on most cards are generally higher, and no tax benefits exist. In most cases, any extra money left over after expenses should be used to pay down credit card debt.
4. Start Investing!
Now the fun begins! You’ve taken care of the basics, and can begin saving money for your long-term life goals, such as retirement. There are some valuable savings vehicles available for those who can save, specifically Roth IRA accounts, and employer sponsored retirement plans (such as 401(k) plans, 403(b) plans, SEP & SIMPLE plans). If your employer offers a “match” on contributions to a company retirement plan, this should be the first place to save. You are basically giving yourself a raise by saving your own funds in these plans as well. You should invest enough in the company plan to take full advantage of any “match” offered.
If you are eligible for Roth IRA contributions, you should use the Roth IRA as your next place to save. Tax credits are also available for low-income earners who make Roth IRA contributions, making them even more appealing. Roth IRA contributions grow tax-free, meaning that income taxes will not be due on distributions from the Roth IRA. $5,000 may be contributed to a Roth IRA in 2011. One suggestion is to make monthly contributions to a Roth IRA, spreading out the contributions over the entire year. If you still have money remaining, consider contributing the maximum allowed to your 401(k) plan. After that, all additional savings should be added to a regular brokerage account. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or [email protected].