7 Steps from College to Financial Independence
Congratulations to the Class of 2021!
Graduating from college is a major milestone on the road to financial independence. It sets you up for a potential lifetime of success by raising your expected salary by about $25,000 per year, and that’s only the beginning.
The steps you take today can also set you on a long-term path toward wealth and financial independence — real independence, with the money you need to do what you want to do and the time to do it, free from the daily grind.
Step 1. Forge a path to financial independence.
When you enter the workforce after college, your financial situation changes dramatically. With a full-time job and a college education, you’ll be flooded with offers for credit cards and personal loans, giving you far more purchasing power than you’ve ever had before.
It’s important to use that power wisely.
What’s the first step? Decide on the future you want and build that future into your financial plan, starting with a simple, manageable budget.
If the word “budget” makes you cringe, you’re not alone. But budgeting doesn’t mean you have to scrimp and save every dime or deprive yourself of the things you love. Far from it.
Real budgeting — the kind of budgeting that can get you where you want to go — is about planning your future while making sure you have what you need to enjoy life today.
That means building a comprehensive financial plan — one that includes managing your debt, growing your savings, paying your bills, and still having plenty of fun along the way.
Step 2. Separate what you want from what you need.
As you build your plan for financial freedom, the first step is to separate the things you want from the things you need. Start by making a list of all your monthly bills, and be sure to include things like insurance that you might pay for quarterly or even annually instead of monthly.
Then, add your other expenses, like groceries or dry cleaning. They aren’t technically bills, but you still need them, so they need to be in your budget. Finally, include any loan or debt payments, such as for a car loan, student loans, or credit card payments.
On the “wants” side of that balance, make a list of things like Netflix and takeout that you really enjoy and want to be sure to keep.
When you see everything together, it can start to feel like a lot, but that’s exactly why a budget is so important. It can help you figure out how to make it all happen while you’re working toward the future you want.
A personal finance app like Simplifi can do this for you. It sets aside enough for your bills every month so you can see what’s left in your spending plan.
Add things like groceries as planned spending, and include loan payments or saving plans as goals you want to contribute to each month.
Once you’ve added your goals, whatever you have left is yours to spend however you want, knowing your financial future is solidly on track.
Step 3. Free yourself from expensive loans fast.
A basic budget needs to start by covering your expenses, which includes making the minimum payments on any loans or debt you might be carrying.
Once those are covered, the next step is to get out from under your most expensive debt.
What’s expensive debt? It’s any debt with a high interest rate.
Credit cards are a classic example. Even cards that start out with an introductory rate of 0% have a much higher rate that kicks in down the road. If you don’t pay the card off before that initial time period ends, you’ll suddenly be responsible for a lot of extra interest.
If you’re carrying credit card debt, pay that down as quickly as possible. On top of making the minimum payments, contribute as much extra as you reasonably can every month.
The key word here is “reasonably.” If you try to put so much toward your credit card debt every month that there’s nothing left for a celebratory cup of coffee, chances are good you won’t stick to it very long.
Instead, make a plan! Decide how much you want to contribute toward your credit card debt every month, and then make those payments with confidence, knowing you still have some money left to spend on whatever you want.
If you’re using Simplifi to manage your finances, set up a savings goal for those credit card contributions. Track your progress and celebrate your wins each month as you take another chunk out of that debt!
Step 4. Plan to retire on your own terms.
Once you’ve paid down your high-interest debt, it’s time to start saving for retirement. Why? Because the best way to retire on your own terms is to start working on it early. It all comes down to the power of compounding interest.
Here’s an example:
Let’s say you start contributing $100 each month to your retirement account when you’re 35 years old. At an average annual return of 6.5%, you’ll have over $110,000 by the time you’re 65. That’s not bad, but it gets even better.
Now, let’s say you start putting that same $100 toward your retirement every month when you’re only 20. By the time you’re 65, you’ll have almost $323,000.
Many employers also offer to match your retirement contributions up to a certain amount. That can turn your $100 contributions into $200, giving you over $645,000 if you start when you’re 20.
Plus, as you move up in your job, you’ll be able to contribute even more, putting the dream of being a millionaire easily within reach. The sooner you start, the sooner you’ll get there.
If you have to choose between contributing $100 each month to your retirement or paying off a low-interest loan early, it’s often better to make your retirement contributions a priority and pay off that inexpensive debt over time.
Do you have enough in your budget to max out your employer’s retirement contributions and still pay off that credit card soon? Great! Do both!
Simplifi lets you set up as many goals as you need to track all your monthly contributions and make sure your plans stay on target.
Step 5. Build yourself a safety net.
Once you’re paying down any expensive debt aggressively (like those credit cards), and you’re contributing to your retirement every month, it’s time to work on building a short-term safety net.
Ideally, it’s a good idea to save up enough money over time to pay your expenses for 3 to 6 months. It’s often called an emergency fund, but it’s great for more than emergencies.
For example, if you need to buy a new car, you can use some of those savings for a significant down payment to help you get a better interest rate. You can also use it to meet any unexpected expenses without having to take out a high-interest loan.
It might sound intimidating to try to save that much money, but small amounts add up over time. Create an emergency fund as part of your financial plan and contribute to it each month.
If you’re using Simplifi, add that fund as another savings goal to track your progress on everything at once: your debt payments, your retirement, and your emergency fund.
Step 6. Beat these benchmarks.
Another benefit of paying down your high-interest debt is that it can help raise your credit score by reducing your total debt and building a positive credit history.
Your credit score is one of three key benchmarks that can help you track your progress as you work toward the future:
- Your credit score
- Your debt-to-income ratio
- Your emergency fund
Your credit score:
A score of 670 (out of a possible 800) is considered good. A score of 740 or higher is excellent. If you don’t know your score, you can order a free report directly through Experian.
Your credit score is important because a good score can lower the rate of any money you need to borrow, from a car loan to a new home, so you’ll pay less in interest.
Building up your credit history can take time, but there are several things you can do to boost your score.
Your debt-to-income ratio:
Your debt-to-income ratio is the total amount you’re spending on loan payments every month, divided by your gross monthly income.
For example, if you spend $1000 per month on loan payments and your gross monthly income is $5,000, your debt-to-income ratio is $1,000/$5,000 or 20%.
A low debt-to-income ratio can lower your interest rate when you borrow money. In other words, you want your credit score to be high, but you want your debt-to-income ratio to be low.
A debt-to-income ratio of 43% is the highest ratio you can usually have and still get a qualified mortgage. A rate below 10% is considered excellent.
Your emergency fund:
For your emergency fund, work on building up enough savings to pay your expenses for 3 to 6 months. That only includes your short-term savings, not your retirement fund.
Short-term savings include funds you have in a checking or savings account, for example, so you can access that money when you need to.
You’ll also want to build your retirement savings, but it can cost you a lot to pull from those savings early. That’s why they aren’t considered part of your short-term savings.
Step 7. Don’t leave free money on the table.
On top of those retirement matching funds from your employer, your job might also entitle you to a wide array of employee benefits. Make sure you know what those are so you aren’t missing out on opportunities.
In most organizations, representatives from the human resources department are happy to meet with employees to discuss and explain the benefits you might have available.
They won’t always be free, but insurance and other benefits offered through your employer are often less expensive than buying them separately. Every dollar you save is another dollar you can put toward your long-term financial plan.
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