Despite an improving labor market, college grads face an uphill battle translating their skills and limited experience into high-paying jobs. As a result, investing takes a lower rung on the priority list for many new graduates just looking to make it in their field of study. But with proper knowledge and the right approach, investing can be the ticket to financial freedom down the road.
Exchange-traded funds (ETFs) have exploded over the past decade, helping investors reach ever-expanding markets and asset classes. In the process, ETFs have become one of the most popular investment vehicles for young investors looking to grow their capital while safeguarding against systemic risks.
In the following article, we present six investing tips for new college graduates just getting started in the work world. In the process, we highlight a few ETF strategies that can help you reach your financial goals.
Remember: ETF investing isn’t without its risks and costs. Read The Hidden Risks and Costs of ETFs to learn more.
1. Start Budgeting
Once you know how much you’ll be earning at your new job, set up a monthly budget and stick to it. A portion of your monthly take-home income should be allocated to savings or investment. Conservatively, this should be at least 5-10% of your gross monthly pay.
If you’ve never lived on a budget before, track all your living expenses over a three-month period and compare them to the budget you put together. At the end of the day, you’ll want to match your income against expenses and have a little left over for savings or investment.
As an entry-level worker, you might be thinking, my take-home pay is so little; what’s the point of investing bread crumbs? The truth is that even setting aside a little bit every month can pay off in the long term. More importantly, it will put you in the habit of setting aside money each month.
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2. Keep Your Costs Down
Whatever you do, try to keep your costs down as much as possible after you graduate. Depending on your field of study, an entry-level salary probably isn’t enough to live comfortably. (The whole point of being entry level is to earn the skills and experience you need to move onto higher-paying roles.)
Living with roommates, moving in with your parents and using public transit are all good, temporary measures you can take to keep costs down. If you do it right, you’ll have even more money left over to save or invest. That means more low-cost ETFs for you to enjoy.
Keeping your costs down also applies to portfolio-building. Click here to learn how smart-beta investing can help you maximize your returns regardless of the market cycle.
3. Pay Off Student Loans
Most college graduates leave school with hefty student loans. Despite what anyone might tell you, these loans must be paid back in full. (In other words, declaring bankruptcy won’t wipe out your student debt.)
Student loan payments must be factored into your budget. They should be paid off as quickly as possible to minimize interest payments and free up long-term capital. Although this isn’t always possible, it’s important to keep a good handle on your repayment schedule.
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4. Maximize Retirement Savings
As a new graduate, retirement is probably the last thing on your mind. But if you want to retire comfortably one day, you need to start planning sooner rather than later. One of the best places to start is your employer’s 401(K) retirement plan.
Workers under the age of 50 can contribute up to $18,000 annually to their retirement fund. These contributions are deducted from your paycheck automatically, which means no extra hassle setting them up. Contributions are also tax deductible and your money accumulates tax-deferred until you take it out.
Ideally, you should avoid raiding your 401(k) before retirement. This has significant tax implications and will lower your retirement income down the road.
In addition to your 401(k), you can also use ETFs to grow your retirement capital. Low-volatility ETFs, such as the Vanguard High-Dividend Yield ETF (VYM ), are a storehouse of the world’s leading companies.
For a full list of ETF Database categories, click here. For a full list of ETF types, click here.
5. Diversify Your Investments
Diversification is a risk-management technique that minimizes a portfolio’s exposure to risk. It does so by mixing a wide variety of investments, assets and methodologies within a portfolio to smooth out the ride in the event of short-term market fluctuations.
Although diversification may seem like a difficult concept to master, ETFs have rendered this process to be extremely easy. The ETF world contains many smart-beta strategies that attempt to overcome the shortcomings of traditional stock indices. Buying multiple ETFs with different index construction methodologies can be a great way to diversify your portfolio.
For example, the Guggenheim S&P 500 Equal Weight ETF (RSP ) is an equal-weighted index, whereas the PowerShares FTSE RAFI US 1000 Portfolio ETF (PRF ) is a fundamental-weighted index.
An equal-weighted index assigns the same weighting across the board and is usually rebalanced every quarter. This strategy has been shown to outperform other methods during periods that favor small- and mid-cap stocks, i.e. over longer timeframes. On the flipside to this factor is that it is more susceptible to cyclical risks, which tend to impact small-caps more severely than large-caps.
The fundamental-weighted index evaluates companies based on fundamental factors such as revenue, quality, dividend yield and earnings per share. This allows investors to integrate more complex formulas into their portfolio. However, sometimes this can undermine your overall portfolio strategy by blurring the lines between passive and active investing.
You can learn more about these methodologies by reading the following article.
6. Create an Emergency Fund
Most financial advisors recommend setting aside three to six months worth of living expenses. Setting aside extra cash is extremely important in an economy with constant churn. Steady jobs are few and far between, especially for new graduates.
A money market ETF is a smart place for your emergency fund. These funds typically invest in high-quality, short-term debt instruments, such as U.S. Treasury bonds. Although these funds don’t generate significant income, they provide safety, liquidity and preservation of capital. Funds that fit these criteria include the iShares Short Treasury Bond ETF (SHV ) and the SPDR Barclays 1-3 Month T-Bill ETF (BIL ).
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The Bottom Line
Establishing good financial habits is critical as you begin your career. Although setting aside enough money to invest will be difficult at first, the benefits over a lifetime can be enormous. As a new graduate, one of the most powerful goals you can achieve is financial independence. Keep that in mind as you set forth the principles you just learned.
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