How Recent Graduates Can Prepare For Financial Independence
You're done with school. You've landed a job. You have your own apartment. For the first time in your life, you are truly on your own. That's definitely exciting, but it can also feel a bit confusing and scary, especially once you realize how expensive it is to be an adult.
Though it seems overwhelming now, don't worry. You can make a plan for your money and live the life you want. Here's how.
Understanding your salary and paycheck
So you've landed your first “real" job. That deserves a big congratulations!
Now to burst your bubble: That grown-up, full-time salary isn't quite as much money as you might think. Here are some common line items you'll find on your paycheck and what they mean, so you can get a better idea of how much money you really have.
- Gross and net pay: Gross pay is the total amount of money you earned, before any taxes or other deductions are taken out (more on that below). Net pay is the actual dollar amount you take home after these deductions.
- Taxes: There are a number of taxes that get taken out of your pay, and those are outlined on your paycheck. Expect to see deductions for federal and state taxes, as well as Social Security and Medicare taxes (also known as FICA taxes).1
- Insurance: If you enrolled in medical, dental, and/or vision insurance through your employer, they may cover a portion of the premium. The amount you're responsible for paying is deducted from your paycheck before taxes are taken out.
- Retirement contributions: If you signed up for your company's 401(k), IRA, or other retirement savings account, those contributions are also deducted pre-tax (unless you signed up for Roth contributions).
Once you get a good idea of how much money you have coming in every month, you can start to devise a budget.
How to create your first budget
The first step in creating a budget should be figuring out how much money you need to live on. These are your essential expenses, which include things like housing, food, transportation, minimum debt payments, health care, and other needs. Generally, it's a good idea to try to keep your essential expenses to 50% of your after-tax income, according to the 50/20/30 budgeting rule.2 This will allow you to save 20% of your income (for retirement and emergencies) and still have 30% of your post-tax income left for enjoyment, like traveling, eating out, entertainment, and new clothes. And if your income should suddenly go down dramatically (due to, say, a cut in hours or a layoff), you can always temporarily cut back on your discretionary spending and savings to cover the basics.
Your housing is most likely going to be your biggest expense within the essentials umbrella. It's recommended to keep housing costs to a maximum of 30% of your budget.3 Of course, that's just a guideline. In some locations, this might not be possible. Conversely, if you can find an apartment that costs less, that's great. The difference between your rent budget and the maximum 50% budget for essentials is what you have left over for utilities, groceries, health insurance, your minimum student loan payment, etc.
Here's a breakdown of what that might look like if you took home $3,000 each month:
Essentials (50%), such as
Total = $1,500
Next, another roughly 30% of your take-home pay should go toward expenses that are considered "wants." These are items that you don't necessarily need to live, but make life a little more enjoyable. Also known as discretionary spending, the expenses that fall into this category include restaurants, fitness, Netflix, concert tickets, hair cuts, manicures, movies, etc. Here's how this would fit into your $3,000 monthly budget:
Discretionary Budget (30%), such as
- Dining out
- Personal care
- Other miscellaneous expenses
Total = $900
Finally, the last 20% of your monthly budget should go toward savings and extra debt payments. Your retirement contributions to a workplace 401(k) are taken out of your earnings before you get your paycheck, so be sure to factor that in. In addition to saving for your future, you should also focus on building an emergency fund and making extra payments toward any loans. After all, ridding yourself of high-interest debt will save you money in the long term.
Here's how that might look as part of your budget:
Savings Budget (20%), such as
- Retirement savings
- Emergency savings
- Extra debt payments
- Vacation savings fund
Total = $600
Keep in mind that when you get started budgeting, you might run into a problem that many young adults face: More money going out than coming in. If you find that your spending doesn't align with your ideal budget, there are two things you can do.
The first is to cut back on some expenses. It's tough to cut back a ton on essentials like rent or bills. But there are probably items in your discretionary budget that can be reduced. It may not seem very fun, especially as a fresh grad with newfound freedom, but you might want to keep living like a college student until your income catches up with your ideal lifestyle. Consider cutting back on things like takeout and streaming services to make more room in your budget.
Of course, you can only reduce your spending so much. Your other option is to increase your income. Consider generating side income by picking up gig work such as driving for a rideshare or delivering food, walking dogs, freelance writing, or tutoring. You don't have to take on a second full-time job -- even a few hours a month of side work can help you make your budget work.
Tips for sticking with your financial plan
Once you've put all the work into planning your budget, you don't want to blow it. So how can you stick to your plan and avoid overspending?
Build an emergency fund: One of your top goals should be building up an emergency fund over time. This gives you a financial safety net to fall back on if an unexpected expense pops up, such as car trouble or a medical bill. Aim to save three to six months' worth of expenses.
Keep debt to a minimum: Remember that every dollar in debt you accumulate will cost you far more than over time, since you'll have to pay interest on your outstanding balance until you pay it off. This is especially true for credit card debt, which typically has a much higher interest rate that a mortgage or car loan — and doesn't offer you the benefit of building equity in a home, or have transportation to that new job. For example, if you carry a $5,000 balance on a credit card at the average rate of 16% APR,4 you'll end up racking up an extra $800 in interest over the course of one year.
Automate as much as possible: Take the pain out of paying bills and setting aside savings by setting it up to happen automatically. You can set up auto-pay for your bills and have savings automatically withdrawn from your checking account. Just be sure to keep an eye on your balance to avoid overdrafting.
Reward yourself: Budgeting isn't about living a life of restriction — it's making a plan for your money. So if you've been doing a good job of sticking to your plan, be sure to reward yourself with something fun like a fancy coffee or new outfit every now and then.
Important disclosure information
This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.
- “What Is FICA?" SSA.gov, https://www.ssa.gov/thirdparty/materials/pdfs/educators/What-is-FICAInfographic-EN-05-10297.pdf, accessed January 27, 2021. Back
- Eric Whiteside, “What Is The 50/20/30 Budget Rule?" Investopedia, https://www.investopedia.com/ask/answers/022916/what-502030- budget-rule.asp, published October 29, 2020, accessed January 27, 2021. Back
- “How Much Should You Spend on Rent?" Mint, https://mint.intuit.com/blog/housing/how-much-should-you-spend-onrent/, published October 2, 2020, accessed January 27, 2021. Back
- Kelly Dilworth, "Average credit card interest rates: Week of March 10, 2021," CreditCards.com, https://www.creditcards.com/credit-cardnews/rate-report/, published March 10, 2021, accessed March 16, 2021. Back
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