Financial planning is not some arcane art reserved for greybeards or life after forty. The foundation of any prudent planning effort involves saving, even when times are tough. It is a lesson taught early in fable form about the squirrel who saved nuts for winter and survived, and the other squirrel who did not and, well, let’s not go there just yet. Routine, repetitive saving is a great behavior to start when you are young, especially if you have student loans to worry about. Debt is the opposite of saving, usually has high interest costs, and must be dealt with before any real savings and investment program can begin.
With college costs exceeding $35,000 a year on average, the majority of families in our society are had pressed to fund such costs, raise a family, and plan on retirement, particularly in these austere economic times. Hope scholarships, rich uncles, and lottery winnings are in short supply, too. Eventually, the option of financial aid must be explored. Programs have been expanded by recent legislation, but market-driven interest costs will still make separate early investing questionable. Student loan programs are based on the assumption that your earnings will grow dramatically as your business career progresses. Your ability to pay will also grow right along with your progress.
As for eliminating your student loan liabilities after you graduate, that process begins by making a best effort at keeping that balance as low as possible while you are in school. If you or your parents have funds in an IRA (Individual Retirement Account) that they would withdraw for college but were fearful of incurring tax penalties, then reconsider because qualified higher education expenses can be paid from an IRA without penalty. These rules do not apply to paying down student loans, and there may be income tax to consider, but ask them to check with their tax professional for advice.
The next step is to see if you qualify for any of the special loan forgiveness provisions in the law regarding your specific loan type. There are several cases related to working for the government or serving in the military where you can pay on your loans for ten years, and then the balance is forgiven. Yes, FORGIVEN, as in done and paid for. Check with your Student Aid center for details and how to deal with any potential income tax exposures that may result.
Are we now ready to start trading currencies and stocks? Not quite yet is the right answer. The “Law of Compounding Interest” will always be around, but you must have savings deposits for the “multiplier” effects in the table below to produce magic:
For example, $1,000 invested at 10% for 30 years will result in $17,400. Ordinary savings accounts do not pay at these levels, but returns in the stock market have been around 10% for the past 80 years. That leaves two other important issues to address, inflation and taxes. Inflation has been averaging 2.5% for the past decade. Combined federal and state tax rates may take another 20% to 35% away in your early employment years. There is a way around these takeaways. Congress created Individual Retirement Accounts (IRA’s) and 401(k)’s to shelter your earnings from current tax impacts.
IRS Publication 970 will tell you all you need to know about IRA’s. If your employer has a 401(k) plan, take advantage of it. Put the balance of your savings in a Roth IRA if you think your potential earnings rate will exceed your loan interest rate. Otherwise, pay down the debt. The Roth IRA will let you accumulate earnings tax-free, and you can withdraw your contributions at anytime to pay down your loan without incurring penalties or tax on them.
Assume for the moment that you have graduated and started work at your new job. You should begin to save straight away by maintaining a personal budget that provides extra funds for that purpose. The world of investing is complex and requires preparation, knowledge and experience to be successful. The simplest way to save and invest is to choose a national discount broker like Schwab or Etrade, set up a Roth IRA, and start making regular deposits to it directly from your paycheck. Invest for now in no-load mutual funds or Exchange Traded funds (ETF’s) for diversification. Your broker will assist and guide you. Make loan payments as appropriate.
Beware of unsolicited offers and tips. These may be investment fraud in the making. Be cautious and have fun saving and investing. You will never regret starting early.
The article was provided by Chris Marchalleck, a market analyst with forex traders, an online resource for the foreign exchange market.