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And graduates, what should you know about your personal finances before stepping out into the big wide world? (I'll bet you didn't learn this stuff in school!) Below are five key things to remember for graduates of all flavors and for the people who love them.
So, let's recap. Stay away from credit card debt. If the debt monster has already bitten you, start immediately trying to get that stuff paid off. Set-up and stick with a budget. Save money by spending less. Become acquainted with your new friend, compound interest. And finally, to top it all off, learn about investing.
As a graduate of high school, you'll probably start receiving about a gazillion offers for credit cards just as soon as you hit the halls of college (if not before). Avoid these offers! Getting into heavy credit card debt is a problem for college students who haven't yet worked out the fact that this isn't just "free money" that can be used to go out and equip your dorm room with mp3 players and CD burners. You have to pay it back, and moreover, you have to pay it back with interest. Carrying a balance while continuing to charge purchases is a dangerous game. Don't play it.
If you're a college graduate who is entering the "real world" with some credit card debt on the books, try to develop a plan now to get it repaid. Otherwise, you could be operating for years with credit card balances as a result of the things you splurged for during your four-year romp through higher education. (Parents and friends of graduates, warn them now against getting into credit card debt!)
Let me point out that not all debt is bad, however. Student loan debt isn't bad debt, and you actually get an investment in return on it (all those fun organic chemistry and literature classes have to pay off, right?). Click here for more on student loans.
Start by keeping track of your expenditures. Start by making a list of your "fixed costs" each month (things like rent, car insurance -- anything that costs a set amount). Then save receipts, write down expenses in a notebook -- whatever you have to do to keep track for a couple of months. This should give you some idea of your spending habits and patterns. From here you should be able to estimate how much you spend each month, and you should also, of course, figure out how much you have coming in from Mom and Dad or your job as a Gap clerk or your first "real" job as a recent college grad. Try to stick to your budget and even live below it.
Find places in your budget to cut back (read this article for some ideas) and start saving now -- the earlier the better. Whether you're about to graduate high school or leave college, it's never too early and, oddly enough, never too late to start stashing away money. Save, Fool, save. Get into the habit now and it will stick with you.
What exactly is compound interest? Dictionary.com defines it as "interest computed on the accumulated unpaid interest as well as on the original principal". Er, okay. Let's see if we can't make that a little clearer using an example.
Let's say you stick $1,000 dollars into an account earning 5% compound interest annually. This means that you'll get interest not only on your original $1,000, but also on the interest that is earned. At the end of the first year, you'll have $1,050. In the following year, you'll earn another 5% -- but now it's 5% of $1,050, not of $1,000. So instead of getting just $50 added to your money, you'll get $52.50, bringing the total to $1,102.50. The next year, $55.13 is added. The year after, $57.88. And all this money just keeps getting piled onto your original amount, and continues building over time. In 25 years, your original $1,000 at 5% compound interest has turned into $3,481.29. See how friendly compound interest can be?
The power of compound interest is a result of time and also of the interest rate you earn on your money. If 25 years at 5% can transform $1,000 into $3,481.29, imagine what you could do with a larger sum of money earning a higher interest rate. Historically, the stock market has returned 11% annually. But we're getting to that next, Fool, so be patient.
Start by reading Investing Basics and The 13 Steps to Investing Foolishly and your investment education will be well on its way. We explain index funds and how they might be right for you. We talk about individual stocks and the fact that what you are buying is a part of a company -- not some abstract thing just known as "stock." We also explain dividend reinvestment plans (DRIPs).
If you're graduating college and starting your first job, learn about what retirement plans your company offers -- like a 401(k), for instance. It's through learning about and participating in investments that the wonders of compound growth will really start to present themselves to you.
These five things apply to high school graduates, as well as college graduates -- and anyone for that matter! Parents, friends, and relatives of graduates, help drive these points home. Let's hear it for the class of 2000!
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