By Mallon FitzPatrick
July 6, 2023 – Summer is here, and with it, a fresh flock of college graduates eager to assert their independence and embark on a new chapter of their lives. Many advisors and investors are parents or grandparents to these young achievers and are surely brimming with pride.
While congratulations and appropriately heartfelt gifts are in order, this moment also presents an opportunity for relatives to impart wisdom about the last thing their progeny are thinking about: their future beyond the next few months or years.
As any seasoned wealth planner knows, it’s never too early to start saving or investing.
Although the intricacies of portfolio diversification may lie outside a young 20-something’s scope of interests, it’s still possible to share straightforward tips for basic financial hygiene with them.
Taking the time to talk to children or grandchildren about how they can thoughtfully manage their money sets them up for success and can instill good habits that’ll remain with them for the rest of their lives. Wouldn’t you love to tell your 20-year-old self everything you’ve learned up to now about personal finances?
It’s crucial to start small in order to keep a young grad’s attention and establish building blocks they can later expand upon. By keeping it simple and focusing on budgeting, along with setting up savings and emergency funds accounts, you or your clients will give younger loved ones the foundations for a lifetime of attentive wealth planning.
The very word “budgeting” might set off a few alarm bells in a recent college grad. As a term, it invokes austerity and responsibility — neither of which are attractive to someone who just finished navigating academic responsibilities and extracurriculars. Instead, talk to them about setting up a “spending plan.” It’s an equally accurate but a far less intimidating phrase.
This plan should emphasize practicality to help them meet their goals. The 50/30/20 rule provides a solid basis for a spending plan. The breakdown: 50% of income is reserved for basic needs, such as housing costs, groceries and car payments; 30% is dedicated toward wants like entertainment, eating out, travel or hobbies; and 20% is allocated for savings goals such as a down payment on a home, a car purchase or retirement.
While the 50/30/20 rule offers a strong framework for a spending plan, the specifics should be flexible based on living arrangements and the amount of money earned. Neither you nor your grad should fret if their spending doesn’t fall exactly within that ratio: It’s a goal to aspire to and can be adjusted with time.
A reliable way to start formulating a spending plan is to review several months’ worth of bank and credit card statements to see where their money went. It will undoubtedly be an eye-opening experience for a new graduate to observe how things add up over time and seemingly small individual purchases can compound in bulk.
This exercise should also aim to identify expenses that can be reduced. When the grad reviews their statements, suggest that they single out the largest luxury or “nice to have” purchase listed and spend less on it next month. Rinse and repeat with the next highest cost item or service.
This approach helps them develop a habit of looking at their purchases with a critical eye. The resulting spending plan will more likely stick if changes are made slowly over time, so mention that it’s comprehensive but flexible.
The success of a spending plan is typically attributable to ease and simplicity. Look to see what recurring payments or processes can be automated: This might include setting up automatic transfers or deductions for rent or savings accounts. For the sake of abiding by the 50/30/20 rule or the particulars of the spending plan, also explore establishing separate accounts for each purpose. One account might be dedicated to needs purchases and another for wants spending. Explore the possibility of setting up different accounts oriented around individual savings goals, whether it’s travel or buying a car or home.
The plan should also empower your offspring to build up good credit through responsible spending. Try to direct as many expenses as possible through a credit card that’ll be paid off each month; this will also be helpful for tracking spending and seeing how it evolves over time.
Earmarking an emergency fund
While accumulating funds for ambitions such as home ownership or retirement could factor into the 20% savings allocation, the chief goal should be building up an emergency fund. This creates a margin of safety from the unexpected turns life inevitably takes. Examples include health-related emergencies or transitional periods (e.g., a major move or job loss).
When suggesting a spending plan to your recent graduate, emphasize your own experience and the choice they face between being prepared for the worst or getting caught off guard with nothing to fall back on.
In addition to the immediate benefits of having money saved for such an occasion, having a reserved emergency fund is an overall stress reducer and allows the accountholder to maintain their lifestyle during challenging times.
If your graduate already has an active investment portfolio, the emergency fund also helps them avoid withdrawing from their investment account. (And remind them not to panic and pull their investment funds during an unpredictable market downturn.)
Like a spending plan, the specifics of how to put into an emergency fund should be tailored to the individual person. Generally, it’s a good idea for a single person to have between three to six months’ worth of cash on hand to cover their expenses in the event of a crisis. Someone just entering the workforce won’t have those funds out of the gate, but it provides a standard to strive for and guidance while setting funds aside.
There are several variables to consider when padding an emergency fund, including whether there’s a dependent in the picture or a partner to pool income streams with. In these cases, the investor might want to strive toward setting aside six to 12 months’ worth of funds.
If your graduate earned a history degree, remind them that Rome wasn’t built in a day, and this emergency fund won’t be either. Still, as an essential resource, it’s necessary to establish a timeline that both achieves the desired amount and outpaces any possible emergency. For some, this may take as little as six months; for others, longer. Regardless of the circumstances, laying out a roadmap to reach the appropriate amount of funds should be a top priority.
Saving sooner rather than later
Just as it’s never too early to start saving or investing, meaningfully building wealth only gets harder the later you start. Fortunately, your grad has the benefit of time — and the accompanying potential for compound growth — on their side.
When working out the exact numbers to allocate 20% of funds toward savings, it’s productive to also think in terms of goals. For example, this includes the nature of these goals, such as milestone purchases, how long it’ll take to reach them, and the most effective means of setting aside funds ala establishing dedicated accounts.
In addition, automation can be particularly useful for savings purposes. Young folks starting their first proper job should inquire when they’ll be eligible to enroll in their company’s retirement plan. A new grad should also set up a monthly transfer from a checking account to a brokerage or savings account, as soon as possible, for non-retirement goals.
Just as it’s important to lean on learned wisdom when stressing the necessity of an emergency fund, the same applies to emphasizing the importance of a retirement account. Make sure that offspring — either yours or your clients — also understand the different kinds of tax advantages offered by 401(k)s and Roth 401(k)s, as well as the full extent of what their employer offers. If their benefits package includes an option for a health savings account, that could be an invaluable resource for offsetting a high-deductible health plan and related expenses.
The level of investment that recent college grads undertake should also align with the timeline of their goals. By and large, those with short-term aspirations can rely on primarily liquid holdings; medium and longer-term goals naturally allow for more risk.
As with their spending plan, the particulars of a younger person’s investments should reflect their present situation, their tolerance for market ‘ups and downs,’ and their desires for the future. If they haven’t yet figured out the latter — and most young people haven’t — have a healthy conversation that encourages them to think big picture about the kind of life they want to live and the steps they can take to achieve this.
Learning through lived experience
The discipline of personal financial advice has evolved tremendously over the last 30 years and looks vastly different from how it may have when you graduated college. Back then, few of us had fact-based financial insights we could rely on when we joined the working world.
Thanks to years of data on successful investor behaviors and the increasing accessibility of tools for wealth planning, budgeting and investing, it’s now easier than ever to gift a child or grandchild the tools and mindset for proactive wealth planning. Retirement is likely many years away for them — all the more reason to help them get started now on reaching their maximum financial potential.