Financial advice for people starting out, with examples

Financial Advice Start a retirement account as soon as you can. When I hired on at NASA in 1994, my annual pay was $27,000. This was barely enough for me to get by on. I shared a house with three other people, I was driving an old car, I ate the cheapest possible foods and shopped carefully with coupons. I was still strapped. I would have liked to take advantage of the 401k retirement account that my employer offered, but I couldn’t. It’s fully understandable. It wasn’t until a few years later when pay raises increased my income to get me above subsistence level, that I was able to invest. So I started to save for retirement as soon as I could - several years after I got the job. Why should you start as soon as you can? Two reasons. 1) Employer matching. Most employers will “match”, i.e., contribute the same amount as you do, up to a certain amount. It depends on the employer, but in my experience they’ll match between two and four percent of your income. You can contribute more than that (although there are limits, defined in the tax code) but they match that small amount. It’s not a lot, but it’s free money and you should take advantage of it. 2) Compound interest. What that means is you earn money on the money you contribute, and you also earn money on the interest paid to you by your investment. So the earlier you start investing, the more interest you will have to earn money on. This can add up to an astonishing amount over time. Make a budget and list everything. Include some savings at a bank or credit union, so you’ll have resources if something goes wrong - car repair, surprise fees, etc. If there’s a part of your budget that surprises you (like the amount spent on entertainment or clothes or insurance) you may have to make some hard choices. Shopping for new insurance is painful but worthwhile. You may need to go to thrift stores for clothes for a while. You might need to find less expensive entertainment. How you spend your money is up to you, but you need to be aware of how you’re spending it, and making a budget is a good way to do that. Example from my life: I moved into a cheap rental house. I didn’t know, at that point, how much various forms of heating cost. The house had baseboard electric radiators. They warmed the place just fine, but the first electric bill was several hundred dollars. It was about the same as my rental payment. The house had a wood stove, so I checked into how much it would cost me to get a cord of wood. That was $75, plus renting a vehicle to go get it. For $100, I heated the house with the wood stove for the rest of the winter. I had been surprised by the cost of the electrical utility, and I made the choice to pay with my manual labor to run the wood stove rather than dollars for electricity. I also had to educate myself on how the wood stove operated, and learned to get up in the middle of the night to check on it, to see if it needed wood. To me, that was a small price to pay to save a couple thousand dollars over the course of the winter. Once you know your budget, and you can survive on it, then you can plan for investing. Anything over your necessary budget plus some savings, you can invest. Most employers will pull your 401k contribution directly from your paycheck. That makes it easy and forgettable to invest, which for most people is the best way to do it. Set it and forget it. If you start your contribution when you get a pay raise, your wallet won’t see any difference. There are two ways to approach this. Put your entire pay raise into your investment, with the reasoning that it won’t make any difference in your daily life. Or put part of it into investment and part of it into your pocket, so that your current standard of living can increase. The earlier you are in your career, the more attractive the second option is. However the earlier you are in your career, the more you’ll benefit from compound interest, which you’ll get more of from the first option. When you change jobs, DO NOT CASH OUT YOUR 401k. You can leave it where it is for a while, and then “roll over” your old one to an IRA or a 401k elsewhere if necessary. Cashing it out means that A) you’ll have to pay a large portion of it to the government because there are rules about how old you can be to take it out without penalty, and B) you will lose the advantage of the compound interest. If you have to move the contents of an old 401k, read up on it so you understand how to roll it over. Once you’re putting at least the minimum into retirement investing, and you have a healthy emergency fund at your local savings institution, then you can also invest in non-401k things. I shopped around and found a company that let you invest without big fees - in my case, at that time, it was Vanguard. There are more options now. I saved up the minimum amount to get started, which at the time was $2000. My birthday present to myself that year was buying into the fund I chose. Because I’m not a financial expert, I chose a fund that generally matched the market - the Vanguard 500. This was another “set it and forget it” plan. I let Vanguard figure out which were the best things to invest in for that fund, rather than spending a lot of time and effort trying to figure out what individual companies to invest in. I think this is a good plan for most people who aren’t naturally inclined to spend a lot of time researching companies and the stock market. Once I’d made the initial investment, I set up my Vanguard account to automatically pull $200 a month from my bank account, which was an amount that I felt I could afford. And that was it. I left it alone. Vanguard did a good job of managing the fund, I didn’t have to remember to add money regularly, and I earned interest on the initial $2000, the $200 they pulled every month, and the interest from every previous quarter that I’d held the investment. It all worked in the background without me having to do anything after I set it up. I signed up for a DRIP, a dividend reinvestment plan. So Vanguard never paid me anything directly - any time the stock paid dividends, it was added to the investment so I could earn even more. This also meant that I did not pay taxes as they didn’t pay me anything. I would, however, have to pay taxes when I eventually took the money out. The taxes would be far less than earnings when I eventually did take my money out, so that was all right. That investment was the best birthday gift I ever got myself. It took me a while to save up the initial $2000, but after that it took no thought or effort on my part. For comparison, I started my 401k around 1997, at age 27. I started the Vanguard account in 2008, at age 38. So it took me quite a while to get to that point. In the meantime I bought a house (which was a good investment for me), and many things in my life changed that took money. I hope it would take you less than 11 years after starting retirement investing to get to the point of personal investing, but that’s how long it took me. I’ve taken money out once to help with a house purchase. It was about $5000. Between my initial contribution, monthly contributions, that one withdrawal, and market changes, the account has over $70k in it. If I’d put my $2k and a monthly $200 under my mattress, and not taken that withdrawal? I’d have $30800. Investing it more than doubled the money. I’d have had to remember to add to it every month, and my mattress would be lumpy.