Graduates: Don't Save for Retirement. Pay Yourself First. Use this Three-Tiered Approach to Securing Your Financial Future.
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If you are like me, you have graduated from college or grad school staring at your credit card and student loan bills, wondering how you'll pay them off and if you will ever be able to pay for the things you want and need in life, much less save for your future.
Our parents have been telling us for years about the importance of contributing to a retirement savings plan, but for the recent college graduate population, preaching to save for retirement is baloney. As a millennial swimming in student loans and credit card debt, it is impossible to plan for retirement.
I do, however, encourage you to take advantage of your employer's 401(k) plans, but only to max out any employer match programs offered. If your employer is willing to match your contribution, placing money into your 401(k) up to your employer match is the single best investment you can make for yourself, with a 100% guaranteed return upfront. But with fewer employers offering 401(k) plans and matching programs these days, there are more immediate and important things to save for before retirement.
A tiered approach to saving -- first for emergencies, then for immediate other high-cost expenses and then (and only then) for retirement, works best for the recent college grad. Here are three surprisingly simple ways to build out your personalized tiered approach to saving and (ultimate) wealth:
1. Prepare yourself for catastrophe with an emergency fund.
As of 2016, approximately seven out of ten Americans had less than $1,000 in savings for catastrophic events. Contrast this stark statistic with the general rule of thumb that you should set aside savings equal to three to six months' worth of expenses for your emergency fund, and you begin to see a problem.
How do you save all of this money at once when starting from scratch? You don't.
The key is to pay yourself first by designating a certain percentage of your paycheck, perhaps the 10-20% you would have put into a retirement fund, toward your emergency fund, just as you set aside money for rent or your cell phone bill. By treating your emergency fund as a priority, you are more likely to maintain consistent contributions. And by investing just patience and small increments, you may be surprised at how quickly your emergency fund will grow into a resource that can provide peace of mind. With the right discipline, it can take as little as six months to save six months' worth of expenses.
But what if a catastrophic event arises before your emergency fund has been filled, or if the amount exceeds what you have prepared for? In the instance where your transmission dies or you need emergency oral surgery, ask your retailer or doctor if they provide specific financing for that problem.
"Most providers now offer "Point of Sale' financing at costs much lower than credit cards or with "Same as Cash' periods, allowing you to recover at little to no cost and get back to saving more quickly." Derek Barclay, cofounder and President of LoanHero, a Point of Sale lender, told me in an interview. "Credit cards are not the right way to pay for large ticket items, but specific financing for catastrophic or high-ticket events can be surprisingly cost-effective."
2. Keep building that resume with an educational fund.
You may have just graduated, but the job market is competitive, so you may want to pursue additional education to set yourself apart. Or if you have children, providing them with the best education is one of the best ways to help them achieve financial well being.
There are several options for educational funds, including 529s, Coverdell accounts or tuition prepayment plans, but extremely low-cost financing is also typically available for these educational costs.
Taking financing for education is one of the safer financial bets to make in life. But remember, no matter which option you choose, the key to funding a future educational account is to pay yourself first by designating a certain amount of each paycheck toward your specified educational fund.
3. Live large when it matters most by starting a special occasion fund.
A smart strategy for covering expenses related to special occasions like weddings or vacations is to pay yourself first by establishing a special occasion fund. But sometimes it is impossible to plan far enough ahead to save all the money you need, like when an old friend suddenly announces that she's getting married in Italy in six months (which I did to my poor, unsuspecting friends). However, you don't want to spend the next eighteen months paying off the credit card expenses associated with toasting her nuptials.
These decisions are ultimately discretionary and deciding whether or not to participate may, oddly, require the most discipline on your part, both in planning and knowing what you can afford. Rather than take financing, it may be best to refrain from the expense altogether.
Saving money, taken by itself, is not something to be afraid of, but being responsible means knowing your options and approaching the saving v. financing decision the right way. Entering the real world doesn't have to result in falling into debt. Treat yourself best by paying yourself first.