It's a helpful exercise, especially in early career stages when there may not be much discretionary income. Though it's far from easy, the main goal of creating and sticking to a budget should be to find ways to save money instead of owing it. This will ensure that compounding works in your favor and not against you. In other words, compounding is great when it comes to investments--if you start saving in a 401(k) early, the earnings on investments will have decades to compound. It's bad news on the other side of the ledger, though: Loan balances can quickly grow out of control when compounding at high interest rates.
Saving for retirement and staying out of debt is a difficult feat for early career workers, but it's not impossible. Take a look at this example.
Sample Budget for an Early Career Worker
According to a study
by staffing firm Korn Ferry, the average starting salary for a college graduate in 2017 was around $50,000. So let's start at the beginning and create a sample budget based on that.
I used this take-home pay calculator
from ADP to compute approximately how much semimonthly paychecks would be after accounting for FICA, Social Security, and Medicare taxes. The calculator also asks for state of residence to factor in state income taxes. I used Illinois in the example, partially because that's where I live, but also because the state has a 3.75% flat rate so it's easy to compute.
In the example, the semimonthly take-home pay is $1,526 ($3,052 in months with two pay periods), assuming no contributions to a 401(k) or health savings account, and no other payroll deductions for healthcare or other employee benefits.
Contribute to a 401(k)
But, of course, you'll want to contribute to your 401(k). In these early years, it may seem like there's not enough paycheck to go around, especially with student debt, or when saving for short-term goals like a car or a down payment on a home.
But it may help to think of it in these terms: You'll get the money back years from now, when you may no longer have the ability to work. And even if there's only mediocre investments to choose from, tax-deferred compounding means taking out far more than you put in. If you don't know what to invest in, a target-retirement fund
with a date coinciding with your 65th birthday is often a great option.
When deciding how much to contribute to a plan, determine whether your company provides a 401(k) match, and aim to contribute at least that much. For example, say the company will match up to 5% of your contribution at a rate of $0.50 for every dollar you contribute. Contributing less than 5% means you're turning down money your employer is offering you.
Going back to the take-home pay calculator, I factored in 5% of gross pay as a 401(k) election. Remember that 401(k) contributions are funded with pretax dollars, and you pay taxes upon withdrawal. I think this helps with budgeting; if you direct pretax money to your 401(k) before it hits your bank account, it simplifies and automates the process of saving.
That leaves us with approximately $1,340 per paycheck, and $2,680 most months.
Food and Shelter
The traditional recommendation is not to spend more than 30% of your pretax income on housing (which includes rent and utilities). Though rent is expensive and you want to find a safe, nice place to live, I wouldn't go much higher than this, especially if you're basing this number on your pretax income.
That's $1,250 per month based on a $50,000 per year salary. Though it doesn't sound like a lot, that figure is right in line with the cost of a one-bedroom apartment from 50 cities according to this GOBankingRates study
. If you can't find a safe, reasonably priced apartment (for instance, perhaps you live in a very expensive city such as New York or San Francisco), there are ways to bring the cost down. Consider getting a roommate, or living at home if your family is amenable and you work near enough.
A squishier line item in the budget is food. Some people are perfectly satisfied spending $200 or less per month on groceries, while others will need to spend twice that amount. Cooking meals at home could help stretch pay, though: Though overall inflation has been tame, director of economic analysis Bob Johnson said
one peculiarity of the current environment is a "year-over-year decline in grocery prices (but decent-size increases at restaurants)."
Student Loan Debt
In Shakespeare's Hamlet
, Polonius advised his son Laertes "neither a borrower or a lender be." It's good advice, but I'm betting college didn't cost as much in Denmark in the Middle Ages as it does in the United States nowadays. Joking aside, though, most college grads start their careers with student loans to pay off.
The average student loan balance in the U.S. is $37,000, according to data from Student Loan Hero
. Let's assume the interest rate is 5%, and the term of the loan is 10 years. The monthly payment would be around $390 per month. Be sure to factor that into your monthly budget.
Set Aside Money for an Emergency Fund
An oft-cited rule of thumb in financial planning holds that three to six months of household living expenses should be tucked away in an emergency fund, because if you lose your job it could take you that long to find a new one. But director of personal finance Christine Benz recommends an even larger cushion--preferably nine months to one year of living expenses
, particularly if you are highly paid or work in a highly specialized field, because such jobs can be more difficult to replace.
Try to set aside 10% of take-home pay each month, or as much as you can to fund this safety net.
As you can see, this monthly budget is very tight. And certainly, there will be other important expenses such as commuting, health and wellness, clothing, entertainment, and your phone bill. Here are a few tips for staying on track.
Keep Credit Card Usage in Check
Seeing how little cash you actually have to work with every month makes it easier to understand the temptation to rack up credit card balances. Resist the urge! Credit cards offer great convenience--not only do they save you from lugging around a big wad of cash, they offer a grace period where you don't accrue interest on purchases so you can defer payment until the next billing cycle.
But aim to pay your credit card off every month--don't carry a balance if you can avoid it. The average credit card charges an annual percentage rate upward of 16%, according to Bankrate.com. Paying off only the minimum balance is not a smart strategy. Check out this calculator from Bankrate.com
; it computes how long it will take to pay off credit card balances at different interest rates and payment amounts. Let's assume you have a $5,000 balance, and you pay a minimum payment every month--say, 4% of your balance. At a 16% interest rate, it's going to take 10 years and six months to pay that off--and when all is said and done you will have paid nearly $7,400--a nearly 50% premium.
Paying for things with a debit card or using actual cash might help with overspending; find a method that works for you.
Keep a Spending Journal
Write down everything you spend money on for three months. And I mean everything--morning latte, dry cleaning bill, the album from iTunes. You might be surprised at how much money goes to things that you could probably do without.
On the other hand, this exercise might help identify some items that have relatively small price tags but are very satisfying purchases nonetheless. That, for me, is the perfect intersection.
Do You Really Need Cable?
Try to take stock of monthly recurring charges, and decide which ones are absolutely necessary and which are simply nice to have. Most people consider their cellphone and data plan an essential item, but that doesn't mean you can't shop around to find the best value for money. Cable television can be very costly, and cheaper alternatives abound. Likewise, going to the gym can be great for your health, but not so much for your wallet. If you really prefer the gym to jogging or doing push-ups at home, though, shop smart. Check for a discount through your employer, or comparison shop to see which offers the best value. (Some gyms offer discounts for paying for six months to a year upfront, and others will sell a discounted pass that limits use of the facility to nonpeak times.)
Though it may not be all that much fun, it's valuable to undertake this exercise or one like it. By putting a sharper focus on how much discretionary income you actually have to work with, you will find smart ways to spend your money and keep yourself out of debt.
For more on this topic, check out Morningstar's Guide to Budgeting.