The Financial Basics Every New Grad Should Know

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If you're a recent college grad, congratulations. As you settle into your first job, you'll probably have more money flowing through your life than ever before.

Take a minute to think of your financial potential. Let's say your starting salary is $45,000. If you're 21 years old, earn a 3 percent raise each year, and work until you're 70, you will have made nearly $5 million by the time you retire! (To use your actual salary and change other assumptions, use this lifetime earnings calculator.)

Here are seven ideas for making the most of your financial potential.

Plan to succeed

To be intentional about your use of money, you need a plan. That's right, you need a budget — or as I prefer to call it, a cash flow plan. Today, free tools such as Mint.com make the process relatively painless.

There are three key activities involved in using a budget: planning, tracking, and adjusting. First, figure out how much of your income you need to allocate to housing, food, clothing, and all the rest of your expenses. Your income will determine how much you have for discretionary spending on, say, entertainment.

Then, keep track of your expenses. You can jot them in a notebook or spreadsheet, or link a tool like Mint to your checking account and credit cards, so it can do much of the tracking for you.

Don't be discouraged if you don't hit your numbers each and every month. Your assumptions may have been unrealistic. Plus, your goals and circumstances will change, so the amounts you allocate for various categories will need to be adjusted over time as well.

Put some away

The key to building wealth is to set aside a portion of every dollar you earn for saving and investing. There are two separate types of savings that are important.

First, there's an emergency fund. In life, stuff happens. An important way to avoid going into debt for that stuff is to have some money set aside in savings. Financial advisers often recommend your emergency fund have enough to cover three to six months' worth of essential living expenses.

But when you're just starting out, you probably have relatively few breakable moving parts in your life. For example, renting an apartment is less financially risky than owning a home. If that's you, having three months' worth of expenses in savings is probably enough.

The second type of savings is for periodic expenses. These are expenses that occur every year, but not every month — things like a semiannual car insurance premium, end-of-year holiday gifts, or a vacation. Take the annual total of each of these items, divide by 12, and then put that much in savings each month. That way, when the expense comes due, you'll have the money already set aside.

Invest for your future

A little bit of money invested each month for a long time and at a decent rate of return will eventually turn into a lot of money you can use for retirement. Using our earlier assumptions (age 21, starting salary of $45,000, and a 3 percent annual raise), if you invest 10 percent of your salary (a good target) and generate an average annual return of 7 percent, by the time you're 70, you will have built a retirement nest egg of $2.7 million!

Bottom line? If your employer offers a workplace retirement plan, such as a 401(k), sign up as soon as possible. And don't miss out on any matching money.

Keep your biggest expense under control

Aim to spend no more than 25 percent of your monthly gross income on housing — even better if you can keep it to no more than 20 percent. If you own, that's the combination of your mortgage, insurance, and property taxes. If you rent, that's the combination of your rent, insurance, and utilities.

Keeping your housing costs within that range will give you the margin you need to save, invest, and enjoy financial peace of mind.

Avoid a car payment

Vehicles depreciate in value quickly, so avoid financing them. If you can't pay cash right away, see if you can go without a car, at least while you save up for one. That may be viable if you live in a city with good public transportation. If not, get the least expensive used car that's highly rated by Consumer Reports.

You're not looking for something flashy. You're looking for a car you can pay off quickly and keep for a long time. By the time you need to replace it, the combination of your savings and the value you'll still be able to get when trading in your current car should enable you to afford a nicer car.

Choose your bank or credit union carefully

Too often, people choose where to open a checking account based on which bank has the best promotion. Once you go to the trouble of setting up online bill-pay with your utilities, insurance providers, and others, the hassle factor involved in changing banks goes up a lot. So, choose carefully.

If you use an ATM frequently, you'll want a bank with lots of ATM locations. And you'll probably want a bank that doesn't charge a fee for a low balance.

Get a credit card

Having a credit card in your own name will help you start building a credit score, which is beneficial for everything from getting a job to paying the least for insurance. (See also: How to Use Credit Cards to Improve Your Credit Score)

If you don't have a credit card already, see if you could get one through your bank. If not, a retailer may be more willing to approve you — but retail cards are notorious for having high interest rates, so make sure you pay off your bills quickly. If you still have trouble, look into getting a secured card. With a secured card, you'll have to put down a deposit, which will usually be equal to your credit limit.

Just be sure to be responsible. That means using your credit card only for preplanned, budgeted expenses, recording any charges in your budget right away, and paying the balance on time and in full each month.

If you take the steps and build the habits described above, you'll give yourself the best possible chance of making the most of your financial potential.

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