Financial Planning For New Grads

When students walk across the commencement stage to receive their diplomas, most enter a new world of financial responsibilities that can boggle the mind, not to mention the checkbook. Here are some general observations and suggestions concerning personal financial decisions that new graduates will face.

Establish personal financial goals and objectives

We all have goals and objectives, but unfortunately, few of us have articulated these by setting dates and dollar amounts. The goal of buying that first house needs a projected date, amount needed for the down payment and total cost estimate. Similar goals of additional education, career advancement, college education for your children and early retirement need specific dates and dollar amounts. This is a dynamic process and should be reviewed at least annually.

Create an investment plan and start early

To accumulate wealth, the adage to "pay yourself first" is a good place to start. If you view savings and investment as what is left at the end of the month, you usually will find that nothing is available for investment. People learn to live on their take-home pay, not their salary. Your paycheck will have deductions for taxes, insurance premiums, etc. Contributions into a retirement plan also will be deducted automatically and you can have a portion of your automatic payroll deposit placed in a separate account that can be designated for investment.

Avoid the debt trap

As a recent graduate, you may think you deserve a new car, stereo, furniture or wardrobe, but this probably will involve additional debt that can limit your future options. It is easy to obtain credit as a new graduate, but it can be difficult to pay off the debt. Borrowing money for the purchase of a new home is different from borrowing money for consumer goods; not only is the interest on the home mortgage tax-deductible, the home also may increase in value.

Take advantage of employer matching contributions

The minimum amount you should contribute to your qualified retirement plan should be the amount your employer will match. This is a risk-free, 100 percent return on your money. Many new graduates fail to take advantage of this matching contribution because they have allocated their income for present consumption and don't consider the long-term benefits of these contributions.

Utilize the Roth IRA

The Roth IRA is a tremendous opportunity for the recent graduate. The money contributed into the Roth IRA will grow tax-free, not tax-deferred as in a traditional retirement plan. The disadvantage of the Roth is the nondeductibility of the contribution. This disadvantage will be more than offset by the tax-free buildup in the account because young graduates will be moving into higher tax brackets as their incomes increase. One of the other advantages of the Roth IRA is the ability to withdraw money from the account without penalty or taxes for the purpose of purchasing a first home.

Framework for decision-making

Remember that any financial decision you make should utilize an opportunity-cost framework. In other words, there are many potential uses for your money; the decision to drive your car for two more years instead of replacing it now may allow you to accumulate enough money for the down payment on your first home.

Dr. Potts, BBA '70, MS '71, PhD '78 (University of Illinois), is professor of finance in Baylor's Hankamer School of Business.