It’s an exciting time of the year for recent high school graduates who are heading off to college. It’s also an anxious time, as many young people branch out on their own for the first time and face decisions and responsibilities that are new and challenging. College, while exciting, often comes with its fair share of financial pitfalls. Here we discuss five of the most common financial mistakes to avoid when starting college.
Five Common Financial Mistakes
1) Budget neglect: Many people think budgets are just a plan to restrict spending. That is a misconception. Rather, a budget is a plan to ensure that what you spend is intentional. Instead of making a series of in-the-moment, unplanned decisions, a budget prioritizes your spending. It can even help you save for bigger-ticket items, like a spring break vacation, a new car, or paying off student loans.
Creating a budget starts by listing your income, expenses, and other sources of funds, like investments. These inputs come together to create a plan on how much is needed to cover expenses, how much is left over and what to do with the additional funds.
Many parents provide financial support during college, either by sending money on a regular basis or paying certain expenses, like cell phone bills. While parental financial support is quite common, it may be empowering to allow students to pay all expenses directly. Rather than having parents be responsible for setting aside funds and paying bills in a timely manner, students can learn these life skills and take full ownership over the entire budget.
2) Bank fees. College is a perfect time to establish your own bank account. This allows students to access money for spending and to pay bills using a checking account, online bill pay, or a mobile payment app. This is a necessary step to becoming financially aware of spending habits. One pitfall, however, of accessing a bank account for incremental spending is ATM fees.
Any time you get cash from your account at an ATM that is not associated with your bank, you are charged a fee. ATM fees have been rising every year for the last 13 years, hitting new highs for the past 11 years*. Bars and gas stations, places students tend to frequent often, often have some of the highest fees.
Fees are generally just a few dollars which can seem inconsequential at the time. But think of it this way: Every time you get $20 from an ATM that charges you $3, you are spending 15% on fees. If you spend $3 just once a week to get an extra $20, you throw away $156 in one year on fees alone. To avoid these high, unnecessary fees, find a bank that is close by (within a few blocks), or use an online bank with free ATM fees. The idea is to avoid fees whenever possible, so plan your money needs ahead of time.
Another banking pitfall when using a checking account for spending needs is to avoid overdraft protection. Overdraft protection, which covers spending if you use more than you have, sounds like a great feature. What it does, however, is create undisciplined spending. Overdraft protection in essence encourages overspending, and charges fees for “loaning” you money. A better mantra: If you are out of money, stop spending; don’t spend more than you have.
3) Are you creditworthy? Avoiding overspending does not mean that all borrowing is bad—sometimes you need to borrow to buy larger items like a car or a house, or finance your education. However, before lenders give you a loan, they typically assess your credit history, to ensure you pay your bills.
Establishing credit is the first step. The easiest way is through opening a credit card in your name. Then you need to cultivate and grow your credit in a prudent way.
Building credit takes time—you should intend to keep the account open for as long as possible. But beware of free upgrades and interest-free offers from companies which may lull you into purchasing more than you can afford. Be mindful of how debt fits into your budget—if your budget says you can’t afford to pay the card off in full each month, that’s a sign you’re overcharging. An effective way to start is having a small, recurring monthly charge, like your monthly video streaming subscription, and paying the bill in full each month.
Keep an eye on your growing credit score. You’re entitled to one free credit report each year from all three credit reporting agencies, and can track your credit for free with services like Credit Karma.
4) Failing to save. While for many students, money can be tight in college, it’s never too early to start saving or investing. Having a budget in place is a good start. But consider ways to reduce your spending and put that unused money into savings. Or you can increase your income by getting a part-time job. If you can work, contributing to a Roth IRA, an independent retirement account which is funded with after-tax income, is a terrific way to save and invest.
Normally earnings on investments are taxable; but with a Roth IRA, earnings grow tax-free, which we calculate is an additional 2% return each year. Moreover, when you pull money from a Roth IRA later in life**, the withdrawals are completely tax-free since the contributions were made with after-tax dollars. Roth IRAs have earnings limits—$135,000 in 2018 for a single filer—so college is an opportune time to save in this retirement vehicle since college students typically earn less than this amount.
A recent study showed that 1 in 3 Americans has $0 saved for retirement—that’s an unfortunately high number. While retirement seems a lifetime away, savings habits developed early on will set you on a path for financial success for the rest of your life.
5) Frivolous spending vs. building wealth. All purchases are not the same. Sometimes, what you buy is just stuff, with no lasting value. An example is clothing. Other purchases have lasting liabilities or ongoing costs, such as pets or subscription services. Then there are assets; something that has a value after you purchase it, and can even grow more valuable.
Assets can go up and down in value, but they can’t call you for money! In fact, you may not realize it, but your greatest asset is you; your ability to work and generate future earnings. You are human capital, and college is a pivotal time when it can be nurtured and grow in value through your acquired knowledge. That knowledge is then converted into financial capital throughout your career, bringing you closer to your life goals.
College is a time to learn—to gain academic knowledge, as well as know-how on how to navigate life and its challenges. Part of that learning is understanding how to set yourself up for financial success after you graduate. Most graduates will exit college with an abundance of academic knowledge, but some also leave with plenty of debt and financial missteps. By avoiding these five common mistakes, you can depart college a wealthy graduate—someone who has little stuff and a couple of liabilities, but takes every opportunity to add an asset. This graduate converts his/her human capital into financial capital, while saving a portion of the budget and investing for the long term.
*Source: bankrate.com; as of November, 2017
**After age 59 ½
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.