Financial Planning for the Fresh Graduate – How Should You Allocate Your Budget?
Congrats on your graduation! After all the sleepless nights and endless mugging, your hard work has finally paid off! That sense of achievement you felt when you received your diploma or degree might be the moment you want to remember forever. But right after this once-in-a-lifetime experience is when the reality of adulting starts to kick in. This is when we gradually transition into a more complicated but exciting stage in life, where we start to learn to be more responsible for ourselves, physically, mentally, and financially.
“Too Much To Do, Too Little Money”
Every graduate will surely have a bucket list to kickstart our adulthood. While you are busy chasing your dreams and ticking off your bucket list, don’t forget to watch out for your personal finance so that future goals will not be jeopardized. But how and where should we start our own financial management journey? Do not fret, here are the 5 KEY AREAS that you might want to consider as you begin your financial planning journey:
1. Study Loans
Should I pay back my study loan ASAP?
Though one might feel more comfortable being debt-free, rushing yourself to pay off all your education loan might be of lesser help in fixing your financial standing than you think. Why is it so? It is because we are actually losing the opportunity cost of using the repayment money to generate a higher return than the loan interest is costing us!
To help you understand better, let us look at an example below!
Mr.A and Ms.B are both fresh graduates and about to start serving their education loan of $40,000 that is being charged at 4% annual interest. While they both started on the same ground, they have decided to adopt a different approach to their debt repayment.
Mr.A who prefers to be debt-free decided to pay back all his loan amount in 2 years, with a monthly repayment amount of $1,737. Afterward, being a smart investor, he decides to continue setting aside $1,737 monthly for the next three years for an investment portfolio that is expected to generate an annual return of 7%.
Ms.B, on the other hand, appreciates the wonder of compounded interest and instead of rushing to pay off her education loan, she decides to stretch the debt repayment period to 5 years with a monthly repayment amount of $737. On top of that, she has also committed to set aside $1000 monthly over the next 5 years for the same investment portfolio as Mr.A
Now let us look at the table below showing how their cash flow will look like in the next five years.
For illustration only. Click above image to enlarge.
We can see that they both have committed to the same amount of expenditure, i.e $1,737 every month over the next 5 years. However, Ms.B’s approach allows her to generate higher investment returns over the same period, all thanks to the effect of compounding interest as she started investing 2 years earlier than Mr.A.
Bear in mind that the above illustration is made with the assumption that the investment return remains unchanged throughout the 5 years period. We should still prioritize the debt repayment if there is no suitable investment opportunity arises that makes financial sense to do so.
Also, by no means should we delay the repayment of debts for unnecessary spending just to fulfill personal desires. But having said that, one should never deplete all savings just to repay the loan as having no free cash on hand will leave us too vulnerable to the changes in life.
2. Protection/risk management
What are the risks that need to be transferred away simply because we might not be financially capable to contain them?
Health issues may occur when you least expect it. They could be a result of our lifestyles, come as we age, or encounter an accident. Should the worst happened, medical treatment costs should be the last thing we want to worry about while being hospitalized. On top of that, let’s not forget about our daily living expenses (or even those debts that we are serving) during the recovery period when we may not be able to continue working. Thus, comprehensive protection with the suitable insurances will set you free from unforeseen financial burden, take care of the bills or expenses, and allow you to focus on recuperation.
How can you allocate your asset more efficiently to better prepare yourselves for the future?
Depending on your plans for the future, time horizon (duration till the events are likely to occur), risk appetite, and comfort level of commitment, different approaches should be adopted to acquire both an assuring and progressive result.
For those who are big spenders, a personalized regular savings plan could come in handy to safeguard your wedding fund, BTO renovation fees, or even the downpayment for your first car.
With that forced discipline to save up, you buy yourself a peace of mind while fulfilling your desires, without worrying too much about your future needs.
For those who are naturally big savers, doesn’t it make more sense to put your hard-earned savings into wealth-accumulating vehicles, instead of leaving it in your bank account, slowly being eroded by inflation? Let us look at a simple illustration of how compounding interest can work in our favour.
Suppose we can set aside $200 every month for the next thirty years till age 55 to fund our retirement life with 2 options:
1. Save the money in a bank account with an average interest rate of 1.5% per annum
2. Invest the money into a portfolio that gives an annualized return of 7% over the long run
The table below shows how our money will be compounded over the years.
Click above image to enlarge
The difference might not be significant in the short run say 5~10 years. But over the long investment horizon of 30 years, a 7% annual return can actually help to grow our retirement fund to 260% of the amount that a 1.5% bank interest can give us.
“If you do not find a way to earn money while you sleep, you will work until you die” – Warren Buffet. The best way to get out of the financial rat race is to make your money work for you harder than you work for them!
4. Rainy day fund
What is this and why is it necessary?
Unpredictable events can be life-changing as well as expensive, resulting in financial emergencies. A rainy day fund provides us with the financial buffer to prevent us from going into debt for urgent needs of cash.
You may be questioning if this is necessary when you have gotten yourselves sufficient insurance protection. Bear in mind that insurance will not cover everything, otherwise, we should expect the insurance premium to be way beyond our affordable range. Therefore, we should have a pool of reserves readily available to see us through financial downtime or should unfavourable life events happen (E.g. retrenchment, temporary loss of income due to health condition, treatment for illnesses that are not covered by insurance, etc.).
Neither having too little nor too much cash on hand is advisable, as we are either leaving ourselves too vulnerable or not making our money to work hard enough for us.
Some common factors affecting the amount of emergency funds needed are:
- Income stability;
- Family background &
- Medical history (if any)
Should I even think about it this early?
While it might sound ridiculous to talk about retirement planning this early, don’t we all agree that retirement could definitely be the most enjoyable stage of life as we reap the fruits of our labour after working for almost half of our entire lives?
When we are still young, time is our greatest friend. Shouldn’t we take full advantage of the present and start preparing for an enjoyable retirement if we are financially capable to do so? Retirement planning is often a blindspot that is easily forgotten until it is too late to make any significant changes.
Bear in mind that these pointers are in no particular order of importance. Everyone hails from a different financial background and, would have different financial goals. When it comes to financial planning, one should see it as both a science and an art, as there is no one-size-fits-all solution for everybody. The first step is always the hardest, not because we do not want to, but because we do not know how to. To help you ease off your first step a little, I have prepared this “Financial planning starter pack” that contains some useful tips and tricks which can help to prepare yourselves for a greater launch. Click HERE to download.
It Is Never Too Early To Start Your Financial Management Journey
I can still remember clearly that back in 2016 when I first graduated, never did I realize how important a sound financial management plan is to a person. Back then, I simply thought that financial management was about having a monthly paycheck coming in on time and saving as much as you can. And soon, a sense of insecurity kicks in as I was planning for my future which is filled with uncertainties. How much savings will be enough? When will I be ready to take on the responsibility of having my own family? Can I afford a car with my current salary and expenditure? Is there a possibility that I could retire earlier than the age that the government has told us to?
With all these questions in mind, I came to realize the importance of financial planning, and how it is interconnected to every single decision in our life. Financial planning is never about finding out which product is the best in the market, or which investment gives you the highest return, but a set of values to help us achieve our financial goal comfortably and systematically.
One last thing before I go, I would really love to hear from you about your financial goals and what are the obstacles to overcome. Share your thoughts with me through the chat box below!
Article by Moo Hau Eng
The writer is a financial adviser representative representing GEN Financial Advisory Pte Ltd.