As your graduating son or daughter prepares to enter the working world, they might start asking you questions such as, “How much they should spend on rent?” “Is it okay to splurge and buy concert tickets this summer?” While entering the real world includes the fun of finally earning a regular paycheck, it also includes the burden of learning how to spend it. Some simple rules of thumb can be very helpful in answering these questions.
To budget efficiently after graduation, Wall Street Journal contributor and money guru Manisha Thakor recommends dividing your grad’s income into four chunks. The first cut of the pie goes to Uncle Sam, which, for this example, we will round to 25 percent of pre-tax income. The next chunk is for needs – think rent, student loans, transportation, healthcare and food. Aim for this total to be no more than 45 percent of total income. Although this percentage might not be achievable initially – depending on student loan amounts and cost of living – think of it as a number to work toward over time. Next are expenses for fun, which may include a friend’s wedding, summer concerts and shopping for that new work wardrobe. This category is easily the most tempting category in which to overspend, so your grad should restrict his or her spending to no more than 15 percent of their income. Last, but certainly not least, is what they should be saving. When possible, your grad should strive to bank 15 percent of their paycheck. Their future self will say thanks for years to come.
Regular small expenses like coffee runs with friends can add up to large amounts over time. While often overlooked compared to big-ticket items like rent, these expenses can significantly erode planned savings. There are a number of methods out there today to help track spending. Many commercial banks have online software that will break down spending into rough categories. Personal finance apps like Level and Mint can also be downloaded for free and offer various visual ways to keep an eye on spending habits.
Before thinking about building a retirement nest egg, there are a few other items to consider. Student loans will mature soon after graduation. It should definitely be a priority to pay these off sooner rather than later, and the same goes for any outstanding credit card debt. There will likely be minimums your grad is required to pay each month, but they always have the option of paying more. If they can afford to, do so, even if it’s as small as contributing an extra $30 a month. This will reduce the length of time on their debt and therefore the total amount of interest paid, saving money in the long run.
Once your grad has made progress on paying off loans, or if they were fortunate enough not to have them, they should start working to build an emergency fund. You never know when a significant medical expense might arise, a layoff might occur, or perhaps a tempting new adventure will present itself. This fund should ideally equal six months of base salary. This is a big number, but don’t feel pressured to save it overnight. Rather, direct a portion of allotted savings to this fund each month, and in time, they will reach their goal. Once achieved, they can start saving for other items such as a car or future down payment.
While saving might feel like a self-imposed tax at the moment, it will pay off tenfold in the future. The reality is that the best and easiest time to start saving for retirement is actually today – and yes, I really mean as a 22-year-old. Each dollar saved this year will accumulate interest for over 40 years, if your grad works until the current retirement age, and perhaps even longer. To have money in the future for big ticket items like a car, a down payment, or even retirement, focus on the willpower to save instead of the size of the current paycheck. Don’t worry about keeping up with the Joneses, but rather know that the new cool is fiscal discipline.
Ann Martel, a Vancouver native, is a rising senior at Wellesley College (MA) and a visiting student at MIT’s Sloan School of Management. She is the daughter of Mark Martel, president of Martel Wealth Advisors.