Recent college or high school graduates entering the working world for the first time often wonder what they should be doing with the money they're hopefully learning to set aside -- paying down debts, investing in retirement funds, buying a home -- or just putting off all this boring money stuff for the future? ("No" on that last one, of course.) How do you prioritize your debts and what investments should you make? Here is some guidance on how to manage your money as you enter the working world.
List and Prioritize Your Debts
The first step is to list your debts. Then, make any required payments first (for example, the minimum monthly payment on your credit card, which you'll incur a penalty if you don't pay on time).
If you can't meet your current payment obligations, you need to figure out which debts are essential to pay first (read Nolo's article Which Debts Must You Repay? for details), and at the same time, which expenses you can reduce to get back on track.
If you can meet your current financial obligations and still have money to spare, consider whether you should prepay any of your debts, and if so, in what order. Here are some guidelines as to which debts to pay off first:
Start with the highest interest rate. First, plan to tackle the debt with the highest interest rate. This is usually a credit card. Work toward paying off your credit card debt so that you simply owe what you've charged over the course of each passing month. Your private student loan or auto loan might also carry high rates of interest. If you're not sure what the interest rate is, read through your loan agreements carefully, or call the lender directly. Some rates are variable, which means they can change. Find out when and by how much.
Keep in mind that your lowest payment might not have the lowest interest rate. For example, your minimum payment on your credit card may be small, but your payment could be mostly interest -- and a high rate of interest, to boot. And while it's satisfying to get rid of a small debt quickly, reprioritizing without taking your interest rate into account can mean paying more overall.
Pay principal first. When you make a prepayment on a loan (that is, pay more than is immediately due), make sure it goes to principal only. This will reduce the total amount you owe, and thus the amount of interest that will accrue going forward. Write "pay to principal" or something similar in the subject line on any check you send in, or if you pay online, make sure you get to choose how the payment is designated.
Pay off student loans last. Federal student loans offer much more flexibility than other forms of debt, which is handy if you hit hard times. (For more information, see Nolo's article Student Loans: Cancellation, Deferment, and Forbearance.) These loans don't usually carry the highest interest rates, either, especially if you consolidate them. Also, you can usually deduct the interest you pay on student loans, as long as your adjusted gross income is less than the current IRS limits. To find out more, read Nolo's article Student Loan Repayment Options.
Prioritize Your Investments
Once you've got your debts organized, it's time to look at your investment and savings options. Here are some common ones:
Keep an emergency fund. It's a good idea to keep at least a couple months' worth of expenses in your bank account, or better yet in a separate bank account, in case you lose your job or have an unexpected large expense, like a major car repair.
Save for a house. If home values where you live are on the increase, you may be motivated to buy soon, before they exceed your reach. On the other hand, if prices are stable or falling, you may snag yourself a bargain -- though you may also have time to buy at a better price or be able to afford more by waiting and paying down other debt first. What you should do depends in part on your plans for the next five years. (For more information, see Nolo's article Buying a House In Your Twenties: Are You Ready?)
Save for retirement. Saving early means bigger payoffs in the long run. If your employer matches your contributions to a 401(k) plan, contribute enough to take advantage of the full matching amount. (Free money!) If you don't have a 401(k) or aren't sure how retirement plans work, see Nolo's article Saving for Retirement: The Basics for Those Getting Started.
Invest elsewhere. You may be an entrepreneurial sort who wants to invest in the stock market, or perhaps start a business. Recognize that these options don't usually provide the tax advantages of buying a home or saving for retirement, but now is the time you're probably most able to accept risk, before your cash is committed elsewhere.
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