After four or five years of living in the cocoon of college life, college graduates are often thrust into the real world with minimal financial preparation. Grads who leave college with a mountain of student debt are expected to manage it along with the rest of their finances which suddenly become more complex. The inability to gain a solid financial footing early on can compound their financial problems later on as life takes hold. Too many college grads go through the first 10 or 15 years of their lives with only hindsight as a way to understand what they should have done differently. Here, we offer three essential truths for recent grads to know as they enter the real world.
Embrace the Virtue of Living Beneath Your Means
As a college student you had to find ways to get by on limited funds and you spent four years delaying gratification in pursuit of a goal that will finally allow you to enjoy a normal lifestyle. The problem is, when you have no real purpose for your money other than chasing a lifestyle, you end up using every extra dollar you earn in the pursuit of more. So, you find yourself at the end of the month having to start from zero again. Any emergency or an opportunity for a fun splurge that arises, forces you into a mad scramble to come up with funds or you succumb to using a credit card, making minimum payments for several years. It’s a vicious circle that can only be broken when you start spending less than you earn.
Rather than entrapping yourself when you can least afford it, why not discover the freedom that living beneath your means can bring. Create a budget that targets a level of spending at least 10% below your take home income. Allow some of the frugality you learned in college to spill over in real life until you achieve stability in the relationship between your income and spending. It’s a habit that will serve you well for the rest of your life.
Discover the Power of Compound Interest
The biggest mistake young adults make is to think they have plenty of time to start saving for their financial goals. While it’s true you have decades to save for retirement and other goals, what you aren’t considering is the high cost of waiting to save. Through the magic of compound interest, when interest is earned on interest, the growth of your money is exponential. But, you need time to maximize the benefits. Consider the following scenario:
Recent grad Jonathan starts contributing $20,000 a year to his retirement plan at age 25, but he stops saving at age 45. After graduating, Katy enjoys the good life and waits until she turns 45 to start saving. She starts contributing $20,000 to her retirement plan and continues until age 65.
Assuming they both earned 6% annually on their savings, after contributing the same amount to their plans, Jonathan ends up with more than $2.5 million in his retirement account. Kathy has just $800,000. That is the true cost of waiting to take advantage of the power of compound interest.
Do Not Underestimate the Power of Debt After College
When you go into debt, you experience the power of compounding interest in reverse. It’s what leads to the debt spiral that keeps millions of people from achieving their financial goals. Especially if you are carrying student loan debt out of college, you need to quickly learn how interest works and the effect it has on your finances. If you are carrying student loan debt, you need to have a plan to pay it down as quickly as you can. That goes back to Tip #1 Living Beneath Your Means and using the excess cash flow you generate each month to pay off debt.
Considering that more than half of recent grads will have to postpone major live events and purchases… such as buying a house or car, getting married and starting a family and even delaying retirement, because they are beholden to the loan providers, debt can be a dream killer. An important rule of thumb to follow right out of the gate is, if you don’t have the cash to pay for it, you can’t afford it and you certainly can’t afford the debt.
Don’t be afraid if you’re feeling over-whelmed with facing the real world and unsure about your money… the first step is acknowledging to yourself that money is a powerful thing and it deserves to be looked after. Ask for help if you feel lost or seek a financial planner to help you get you on your path toward financial freedom and gaining a hold of your finances! You are capable.
About the Author: Lauren Davidson is a recent graduate from the University of Pennsylvania. As she transitions into the ‘real world’ she is looking to use freelance writing as a way to make extra money to pay down her student loan debt.