Barron’s – May 26, 2021
When Emily Bailey finished her degree in management from Indiana University Bloomington six years ago, she was among the group of graduates called the “Lost Generation” as they tried to get a career foothold in an economy still scarred by the 2008-09 financial crisis and recession. Like many, she had thousands of dollars in student loans, no job in her field, and settled on a position as a wedding planner to pay the bills.
And then, when her career was finally looking up, the pandemic came along last year and she lost the project manager job she’d gotten at GE Aviation a few months earlier. “I was pretty desperate,” she said, having turned to DoorDash for gig work while looking for full-time employment.
Despite these setbacks, Bailey, now age 28 and in a new project management job, just bought a small ranch house in suburban Indianapolis with a 10% down payment. Even after buying her house, she continues to keep at least $10,000 for emergencies in the bank and regularly saves 6% of pay for retirement in a registered account at work so she qualifies for the maximum matching contribution from her employer.
Her discipline could be an example for this year’s college graduates, who are entering the workforce in an economy still healing from the pandemic, said Paul Fenner, a Commerce Township, Mich., financial planner who taught Bailey how to budget and pull savings out of meager paychecks.
He and other financial planners stress that even in tough times people often have more power than they think to stretch limited paychecks and start building wealth. Here are some of their tips for new graduates:
Saving for Emergencies
Beginning salaries may not leave much to stash away, but financial pros say it’s crucial for young workers to make saving a requirement from every paycheck, not what is done with leftover cash. Route the savings automatically into a bank account so you aren’t tempted to touch them.
That means before committing to an apartment or a car payment, calculate first whether you can afford what you are eyeing and still save a specific portion of each paycheck.
Some rules of thumb can help. Rent or mortgages—including utilities and insurance—shouldn’t exceed 28% of gross income, car payments and insurance shouldn’t be more than 10%, and the length of a car loan shouldn’t exceed the number of years you are likely to drive the car before buying another. In addition, student loan payments should be no more than 8% of income; while it might be too late to control that proportion, graduates can apply for “income-based repayment” if their incomes are too low to handle large loan payments.
Some financial planners suggest using a 50-30-20 budget so people don’t overspend based on their income: 50% of pay after taxes would be reserved for necessities—rent, car payments and insurance, student loan payments, health insurance, phone, food and so on; 30% could go for entertainment—everything from Netflix accounts to travel, and the remaining 20% is to be saved.
The bottom line: Shocks happen and being prepared for them is a must as young adults are usually among the first cut as economic conditions tighten. So financial planners say it’s crucial to prepare by paying off credit cards entirely every month and having an emergency fund to cover basic expenses like food, housing, health insurance, phone and car payments, in case a person loses a job. Three to six months are the target.
Saving for Retirement
Besides saving for emergencies, financial planners say saving for retirement should begin with a first job, particularly if employers offer free money to employees who save in retirement accounts at their workplaces.
As a rule of thumb, if a person saves 10% of every paycheck starting with their first job, and continues the discipline until the current full retirement age (67) they should have what they need to pay for retirement even if they live into their 90s.
if 10% is too much, start smaller and work your way up. Say you are 21 and your salary is $40,000, try saving 5%, or $2,000, in your account. If your employer sweetens the deal with a match, say by giving you half of what you put into the account yourself up to a certain percentage, you would get $1,000 on top of your contribution—putting $3,000 toward your retirement, or a little over 7% of your pay.
If you keep increasing your savings each year with any raises, and your employer keeps matching contributions, soon the combination will be over 10% of your pay, and by the time you retire you should have about $1.1 million if the investments return a conservative 7% a year.
Today, more financial planners are telling young clients to fill their retirement accounts as much as necessary to get the maximum match each year from their employer but to put additional retirement savings—up to $6,000 a year—into an individual retirement account. When you save in a Roth you don’t get a tax break upfront like you do with a contribution to a typical 401(k) account or a traditional IRA. But once you put money into a Roth it is never taxed if you leave investments in the account until you are at least 59½.
Anyone who has earned money at a job or business, or a spouse, can open a Roth IRA as long as their income doesn’t exceed limits: $140,000 for singles and $208,000 for couples.
Where to Save and Invest
You can’t be daring with an emergency fund or with savings you will need within five years for a house down payment, a car, a wedding, or graduate school. For specific short-term needs, stocks are too risky because the stock market can lose 20% or more during bear markets.
Although safe money choices are paying almost no interest now, money for short-term needs should go into money-market funds or high-yield savings accounts or certificates of deposit.
Retirement money, however, doesn’t have to be protected the way short-term cash must be. In fact, being overly conservative with retirement investments can be dangerous because the savings won’t adequately grow.
Historically, the stock market—measured by the S&P 500—has gained about 10% a year on average. But there can be years like 2008, when the stock market loses 37%, or years like 2019, when it gained 31.5%.
Since guessing when these cycles will occur is folly even for investment pros, financial planners say to bet on the averages: Stick most of your money in a diverse mix of stocks through a fund like a total stock market index fund, add to it with every paycheck, and don’t touch even if a market downturn occurs. Although bear markets and losses will happen, historically the good years have far exceeded the bad.
Another diverse investment that is common in retirement accounts: target-date funds. Find them among the funds you are offered by looking for a number in the name that is close to the year you are likely to retire, maybe 2060. That target-date 2060 fund will be more tilted toward stocks while you are younger as the idea is to give your money the best chance to grow over 40 or more years, while a target date 2030 fund, for example, would have fewer stocks and more fixed-income investments as holders would likely be nearer retirement.
By Gail MarksJarvis
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