I recently had an interesting discussion in the comment section of one of my posts about how much money you need to earn each year to start investing. This Rebel Reader is about to graduate from college, and he wanted to know if a salary of $50,000/yr was enough money to start investing.
My initial response was “Hell yea! and here’s how I’d do it”, but I got to thinking about this question and I’d like to lay out a more comprehensive straight out of college game plan for anyone looking to live frugally, grow wealthy, and stick with it.
Any road to financial independence will be bumpy, but this should serve as a general guideline to getting there safely. So I’m going to throw down some assumptions and see where this plan might take the average college graduate with a $50,000/yr job.
- Student Debt: Average debt coming out of college is $26,600. There are lots of ways to reduce this number during school, but I’ll keep this assumption for now.
- No other assets: I’m assuming that our intrepid college graduate is hitting the job market with only a few dollars to her name.
- 4% Raises: She’s a go-getter, putting in the extra time at work to average 4% raises.
- Annual spending of $22,000 ($1833/mo): If you want more info on how to do this, check out the rest of my blog
- All investments are in broadly diversified Vanguard stock index funds which return a long-term average of about 6%/yr
Year Number 1
Bright eyed and bushy tailed, our hero (let’s call her Saving Sally) strikes out into the working world to earn her first paycheck. She spends her evenings reading about personal finance and investing, and her weekends hanging out with friends and hiking. Life is good and she is amused by her in-debt friends who go further into debt to buy fancy cars and whatnot.
- Income: $50,000
- Taxes: I’ll assume an overall 20% tax rate so she’s earning a monthly salary of $3,333 after tax- leaving $1,500 left over after living expenses
- For the first 3 months, almost all of this savings goes into an emergency fund – so there’s $4,500 in there by the end of month 3
- Savings: Starting in month 4, $250/mo goes into a savings account until there’s about $10,000 in there
- Student Loans: Sally throws the rest ($1,250) at repaying student loans each week
End of year 1 Results
- Student Loans: ($15,350)
- Savings Account: $5,650
- Net Worth: ($9,700)
Year Number 2
Sally’s been working hard for a year now, putting in a few extra hours, getting to know her new city, and generally enjoying life. She doesn’t have a high net worth (in fact it’s rather negative), but she’s become quite confident financially from all the books and blogs she’s read.
- Income: $52,000 ($3,467/mo AT)
- Savings: She continues her $250/mo savings rate without noticing it because it’s automatic
- Student Loans: Because of the 4% raise, Sally is now able to clobber the her loans by $1,384/mo
- Debt Free:: Since Sally’s student loan balance will hit $0.00 in December, she’ll have $1,258 to add to the savings account for year 2
End of Year 2 Balance
- Student Loans: $0.00
- Savings Account: $9,908 (or 5.4 months living expenses)
- Net Worth: $9,908
Year Number 3
Now Sally’s gonna get a little funky. She’s excelled at work, paid off her massive student loans in 2 years, and built up almost 6 months savings in an emergency fund. Now, since she’s already used to living on $22,000/year, she’ll be able to start investing aggressively to eventually achieve financial independence.
- Income: $54,080 ($3,605/mo AT)
- Savings: I’d cool it on savings for now since 6 months worth of living expenses should be plenty for now
- Student Loans: They are but an unpleasant memory…
- 401K: Hopefully Sally’s employer matches 5% of her contribution, but either way, she wants to max out the $17,500/yr limit with $1,458/ mo contributions.
- Roth IRA (or Traditional IRA, either way is fine): She’s almost able to max out her first IRA with the $314/mo that’s left over ($3,768 out of $5,500) – The snowball IRA Method from Evolving Personal Finance might be useful in this situation…
- Tax implications: I’m over simplifying the tax situation. You get a great benefit from the 401K being tax deductible. For the purposes of keeping it simple I’m going to err on the conservative side and not count those tax savings
End of Year 3 Balance
- Savings Account: $9,908
- 401K: $17,500
- IRA: $3,768
- Net Worth: $31,176
and then a few years passed…
Year Number 10
After years of living frugally, working diligently, and investing the rest in her 401K, IRA, and taxable accounts, Saving Sally is well on her way to financial independence. She climbed out of debt in under 2 years, and now owns significant assets. By my calculations, she won’t be financially independent until about year 15, but she’s definitely got some more options now.
End of Year 10 Balance
- Savings Account: $9,908
- $401K: $173,206
- IRA: $51,825
- Taxable Accounts: $45,555
- Net Worth: $279,493
So what do you think? I know I made some interesting assumptions, like not buying property. Is this similar to your 10 year plan?