As sure as the redbuds are blooming here in the Midwest, new graduates are popping out everywhere I turn. Practically every other family on my block has a student graduating from college this year. Their parents are thrilled to be done with the tuition bills, and they are understandably proud of their children's achievements and their next chapters. Some of these young people have landed first jobs, some are pursuing further education, and others are mulling their next steps. Their parents want to make sure they head down the right paths, financially and in every other important way, too.
If you have a new grad in your life, one of the best gifts you can give is to impart a little bit of financial wisdom. (Of course, cold hard cash can help cement your message.) Rather than a whole lecture, financial advice doled out in bite-size pieces is more likely to sink in. Here are some key bits of financial advice to consider. (Readers, if you have your own tips to share with new graduates, leave them in the comments section.)
Step Away from That Comparison
My recollection of the years after college is that a certain competitive spirit prevailed among my peers; more than at any other time before that or since, I remember feeling especially attuned to who had landed the most lucrative job, who purchased a home first, and so on. In hindsight, those comparisons weren't predictive: My peers who got off to a fast start didn't universally end up ahead. And in any case, comparing ourselves to our peers--or worse yet, people we think are doing better than us--isn't helpful to our own financial well-being, according to research prepared by Morningstar behavioral economist Sarah Newcomb. Following a survey of several hundred people, she and her team concluded that "Frequent, upward comparisons … were associated with higher financial stress, lower satisfaction, lower savings and overall more negative feelings about one's own financial life." Instead, the research concluded that the survey respondents with a financial role model (rather than those who engaged in peer benchmarking) were more likely to feel confident about their ability to meet their financial goals. Thus, one of the best gifts you can give a new grad is to offer to be a financial mentor or discuss how you got past the comparative rat race. For many of us, the "aha" moment is that money in the bank (or in investments) buys more flexibility and peace of mind than stuff ever could.
Let ROI Light the Way
Many new college grads who have started their first real jobs quickly hit a financial fork in the road: Should they steer their precious capital toward paying down student loans or invest in an IRA or company retirement plan? While it might be tempting to focus on vanquishing the debt and then move on to retirement savings, in most instances it’s wise to do some of both. You have to service your debt, of course, and being debt-free provides valuable peace of mind. Also, the return on debt paydown is guaranteed, whereas investing in the market doesn't guarantee you anything. With a new grad's long time horizon, however, assets invested in stocks within a tax-sheltered vehicle like an IRA or 401(k) plan have one of the highest potential long-term returns of any possible capital allocation. Even though interest rates on student loans have been creeping up (rates on new Stafford loans are headed over 5%), stocks' very long-run returns have been higher than that. Return on investment can be a valuable compass for multitaskers throughout their financial lives, helping them identify the best uses of their capital at any given point in time.
Get Started on Long-Term Investing (Even if You're Starting Small)
In a related vein, new grads might be surprised at just how little it takes to get started in investing--and how much those early investments can add up. A $1,000 initial investment (graduation gifts!) with additional $100 investments each month for 40 years, earning a not-unreasonable 7% rate of return, would add up to $280,000. The beginning investor's best friend today is Schwab, which offers its lineup of very low-cost index funds with a $0 minimum initial purchase. A check in whatever size you choose, an application for a Roth IRA, and some information on the power of compounding make for a graduation gift that keeps on giving. (Just bear in mind that your grad will need to have earned income in 2018 in order to contribute to an IRA for this year; if he or she is a full-time student, a brokerage account will be the better bet.)
Be Prepared for Periodic Disappointments
Even as you want to underscore the merits of getting started in investing for long-term goals, it's also wise to set expectations. Stocks have been running up for the better part of a decade, so it's realistic to assume that the volatility they’ve been experiencing so far in 2018 could persist in the years ahead. If you're evangelizing about the merits of stocks, be sure to discuss the fact that they don't always go straight up. And if you've come up with your own strategy for coping with market volatility, whether it's not checking your balance or taking a walk, share it with your new grad who's just getting started.
Always Have a Safety Net
At the risk of being a downer, it's hard to go too far wrong by telling new grads to mind the downside: Even if they feel invincible, they still need to insure against bad outcomes by purchasing health, renter's, and disability insurance. And at every life stage it's crucial to build at least a small financial cushion to cover unanticipated expenses. The common rule of thumb is that you should have three to six months' worth of living expenses set aside in ultrasafe investments like an online savings accounts, but that figure can seem hopelessly daunting to young people who are just starting out. Emphasize to your new grad that the emergency fund is meant to cover very basic expenses: housing costs, insurance expenses, utilities, and food. From that standpoint, amassing a cash cushion looks a lot more manageable.
Invest in Human Capital Before Life Gets Complicated
Some new college grads have their sights set on further education, while others are itching to start their careers. Many MBA programs and law schools even require enrollees to get some work experience under their belts before enrolling in their programs. But as much as new grads might enjoy the respite from homework and tests that comes along with having their first jobs, remind them that one of the best investments they'll ever make is in their own human capital--their lifetime earnings power. And just like investing in the market, the earlier they make additional investments in human capital and additional education, the more it's likely pay off.
It's also worth noting that from a practical standpoint, many new grads are relatively unburdened with family and other obligations in their early and mid-20s, making it an ideal time to tackle further education. Additional education needn't entail advance degrees and/or hundreds of thousands dollars, either: Pursuing certifications and earning designations can lead to salary increases, too, and many employers offer tuition assistance for further education and training.
Mind Your Big-Picture Allocations
The preceding points have hit heavily on the importance of allocations: harnessing the long-term potential of human capital by investing in additional education and taking advantage of stocks' long-run return potential by steering money into stocks. Those all fall squarely in the realm of finances and investing. But if you have a close relationship with a new graduate, share what you've learned about the biggest allocation of all: your time-on-earth allocation. Do you regret that you spent so much time at work while your kids were growing? Were you so glad that you took time away from your other obligations to be with a sick friend or elderly parent? All of us are trying to balance time spent earning money alongside doing stuff that brings us joy or does good. In the end, the right time-on-earth allocation is incredibly personal and may change over time. The best advice for a new grad on this front is simply to say that in contrast to investing financial assets, the time-on-earth allocation is one that deserves frequent monitoring.