In the last few days, a bevy of recent college graduates about to enter the workforce have written to me and asked what they should be doing with their finances at this point in their life. These are the smart ones - they realize that taking a few steps in the right direction now are going to put them ahead of the game for the rest of their lives.

That being said, here are seven things that any recent college graduate should strongly consider doing as they enter the workforce.

Set up an automatic payment plan on your student loans. Call up the people that hold your student loans and see if there are any benefits for making the first twelve or twenty four or thirty six payments on time and also if there’s a benefit for making automatic payments on the debt. Quite often, you can get a half-percentage point or more knocked off by doing these things, but even if you don’t, set up an automatic payment plan. Don’t pay extra, though, unless the loan is very high interest (above 9% or so).

Sign up for the 401(k)/403(b) immediately at work. Ask the person who helps you set it up how much of a match the company provides, and contribute enough of your own to get all of the match. Ideally, you want to contribute enough so that the total of your contribution and the match is 15%. Since you’re just starting out, go with aggressive investment choices.

Start an emergency fund. I recommend setting up an account at an online bank, like ING Direct or HSBC Direct. Their accounts are convenient (especially ING) and they pay a very nice return (well over 4%). Then set up an automatic contribution to this emergency fund each week - $25 is good. Why an emergency fund? This is the money you tap if your car breaks down so you don’t have to go in debt - the interest works in your favor if you put in the money ahead of time.

Get to know as many of your professional colleagues as you can. This not only includes people in your own workplace, but people working similar jobs in other workplaces. Read the book Never Eat Alone and really absorb the advice - it’s incredibly valuable. You’ll eventually find that this group of people is the most valuable thing you can cultivate in your profession, even more valuable than your job over the long term.

Practice frugality. This is perhaps the most dangerous point in your life for letting your spending get completely out of control. Don’t let it. Be vigilant and keep your spending under control. Of course you’re going to want to spend some money right now, but put a very firm cap on it and keep it in place.

Start an investment plan. My advice is to put everything in the Vanguard Target Retirement 2050 fund - Vanguard’s funds are very well managed and they treat you very well. Open one up directly through Vanguard and set up regular contributions to it. Why? This will put you on pace to do whatever you want down the road - it might be a house down payment, it might be the first step towards retirement, it might even pay for some incredibly fun things in a few years like international travel or a BMW - whatever you wish. Just get one started, start some automatic contributions, and let it grow.

Have fun. Do things. Go out with friends. Travel a bit. If you’re going to spend money at this point in your life, don’t spend it on stuff, spend it on experiences. You’ll have plenty of time to get stuff when you’re older and have a house and a family and you’re wishing you had more experiences when you were first starting out.

For many people going to college, they’re scared to get involved with a major that won’t pay a lot. I know I was - after strongly considering stints as both an English major and a math major, I instead got into a major with significantly higher earning potential because I didn’t want to face huge student loans with an $18K job right after finishing my studies.

Interestingly, Congress addressed this very issue with the College Cost Reduction Act of 2007; here’s Anya Kamenetz’s review of that very bill (you may remember Anya as the author of Generation Debt, which I reviewed in detail a while back):

To my mind, the most significant student benefit in the bill is income-based repayment. Under these proposed new rules, graduates whose earnings don’t exceed 150 percent of the poverty line (about $15,000 for a single person) would be exempt from repaying student loans. All borrowers could opt to repay no more than 15 percent of their income above that amount, known as “discretionary income.”

So if you earn $25,000 a year, you’d be guaranteed to pay no more than $121 a month regardless of your total loan burden. After 20 years, all remaining balances would be forgiven (10 years for eligible public servants).

This bill helps out students who are considering careers in social work and other humanities fields, but it falls just short of really helping people in another career that really need the help: teachers. There are some teachers at the lower end of the pay scale that will benefit from this, but many teachers make just enough to be out of the higher end of this bill, unfortunately.

Let’s use an example of a teacher making $33,000 a year, a reasonable number in this area. If that person lives alone, their poverty line of income is $9,800 and thus 150% of that is $14,700. That means that the teacher will have $18,300 of their salary that is eligible for student loan debt repayment, of which 15% is required for student loans (a total of $2,745). That means that under this bill, a teacher making $33,000 a year and living alone has his or her monthly student debt repayment capped at $228.75.

This bill will likely help out some people in the first years of their career, and others will be helped over the entire length of their loan. Given the balance needed between helping out low-paying professionals and also making student loans worthwhile for lending institutions and for the government, I think the bill hit a very nice spot.

The real take-home message here is that students majoring in fields that won’t provide a large income post-college are saved from the double whammy of large student loan payments and low salary, which for many students was enough to keep them out of a major that they may have been passionate about. It certainly was for me, and I may have made a different choice had this law been in effect when I was a student.

My daughter will not be born until September, but a few days ago, I opened a 529 college savings plan in her name. Just as with my son, I’m contributing $75 a month to it, plus any cash gifts they receive until their sixth birthday, plus a small birthday gift for each one until their sixth birthday (after that age, the decisions move more into their hands with my guiding influence). I plan on paying in until her eighteenth birthday, the same as my son.

How long is that? According to my calculations, she will likely be a part of the high school class of 2025 (looking at that number almost makes me shudder).

How did you set it up? For now, the 529 is literally in my name. Upon her birth, I will set up a custodial account in her name and transfer all savings to her. Since the amount will be small (less than $12,000, obviously), it will not have any tax consequences.

Why did you set it up? The earlier I get started on my daughter’s savings, the longer she will have to have compound interest work in her favor. For example, using an estimated 10% annual return, let’s say I put in $50 a month starting at her birth and stopped contributing at age six; in comparison, let’s also say I started putting in $50 a month starting on her sixth birthday until she was eighteen. I end up with significantly more money in the account following the first route - the power of compound interest is very powerful.

How will it turn out? Contributing $75 a month starting three months before her birth, and assuming a 10% annual rate of return, she will have $46,866.29 in the account on her eighteenth birthday. That’s assuming no additional contributions, no gifts from other family members (especially early on), and no birthday gifts from me. My son is actually substantially ahead of this pace and is looking at about $60,000 when he turns eighteen.

Isn’t prenatal a bit excessive? By contributing that $75 for just three prenatal months, she’ll have $1,373.70 more in her 529 college fund on her eighteenth birthday than if I just started when she was born. That’s cash that she will definitely be able to use when that time rolls around, even if college isn’t her choice.

My advice to all expectant parents is to buy your child their first gift as soon as possible - start a college savings fund for them and set up automatic contributions, especially if the child isn’t born yet (by setting one up in your own name to transfer later). This money will help them finance their education down the road without sinking you into debt with a monster loan when the day comes. Plan ahead and everyone will have a happy future.

I received an email from a college student today, who I will call Erica. She told me the following:

I’m a 19 year-old university student. I have no debts and all my university fees are covered by scholarships. I live at home, so I have no rent or household related expenses. Since I have had a job since I was 13, I currently have $25,000 invested. This summer I landed an internship where I make $750.00 per week. I have very few expenses and a decent income. I have been looking for budget advice, but very little seems to apply to me. Do you have any suggestions? Also I am planning on getting my Ph.D. in Economics, so I will be in school for quite a while.

Erica is off to an incredibly solid financial start in life and has all of the opportunity in the world in front of her. She has basic financial sense and some good career sense as well; she’s obviously setting herself up for a great life. So what should Erica do with her good fortunes? Here are a few things I recommend for Erica - and for anyone else in a similarly good situation early in life.

Give yourself a very simple budget and stick to it With no debts and only minimal expenses, most of Erica’s money this summer could potentially be invested. I would budget a small spending stipend from each check (it really depends on your lifestyle), cover all expenses, and then automatically invest the rest somewhere else. You’ll have some very large expenses to cover later on down the road - if you can sock some money away now, all the better.

Start a Roth IRA Erica is likely to be far below the income threshold for a Roth IRA now, but late in life she will likely be in a rather high tax bracket. Take advantage of the tax shelter now and use some of that investment money from the internship to fully fund a Roth IRA this year. Funding $4,000 into a Roth IRA at age 19 means that it will have a worth of $181,037 when you can take it out at age 60 - and you won’t have to pay a dime in taxes on any of it.

Put the money in something simple There’s no reason to worry about portfolio management. Just invest in a low-fee broad based index fund. I’m a big fan of Vanguard and I strongly agree with their low-cost investment philosophy. If you want to really dig around and learn more, try reading The Bogleheads’ Guide to Investing.

Here’s some additional advice that might apply to Erica, not directly financial but quite valuable nonetheless:

Build relationships with people at the internship and at college Build a strong connection with people while you’re there and make every effort to keep in contact when you leave. These will be great professional contacts to have down the line. If you’re like me and this sounds like an “easier said than done” task, I really recommend reading the book Never Eat Alone - it’s a great look at how to do this well.

Follow your interests It’s your life - follow the things that excite you, not the things that excite other people that you merely go along with. College affords you the opportunity to really figure out what your interests are - don’t miss out on it because you’re worried about fulfilling expectations.

Be involved Find an organization or two that really speaks to your interests and get involved with gusto. The others you find there who are also deeply involved will likely be people who will match up well with you throughout the rest of your life.

Good luck, Erica. You’re already off to a great start.

This is a really interesting story that I thought I would share with all of you. I do have a few comments below, but I thought I would let Kelly tell her story (I edited this email a bit to eliminate some privacy concerns and polish a few tiny grammar issues):

I wanted to write to you and tell you that your site convinced me to quit my job and make some other big changes in my life. I have been trying to get ahead for a while now but I didn’t know what to do. Your site helped me a lot and thank you.

I am twenty years old. I did not go to college after high school mostly because none of my friends did. I stayed in my home town and got a job about thirty miles away making $12 an hour as a factory worker. It didn’t have any health insurance or anything so there were no real benefits other than $12 an hour for someone out of high school. I thought about taking some classes at a college but every night I came home really tired and so I never did anything.

It took me about forty five minutes to drive there every day and I used a gallon of gas each way plus I paid about a dollar in toll each way. That means $8 each day plus my car insurance and all the extra miles on my car.

When I read your site about figuring what your time is worth (note: I’m guessing this article) I spent some time thinking about it and with the cost of my car and the insurance and the gas and the time to go to work I realized I was wasting a lot of time and money. In fact I figured out that my real hourly wage at work was about $7 an hour for a job I hated.

So I started looking around town and I found a job as a waitress at a restaurant that paid $4 an hour plus all tips. I trained there on Saturdays and Sundays and found I could make $10 an hour easy working there and way more on busy shifts. Plus I could walk there since it was only four blocks away and get there in ten minutes.

I quit my job at the factory and now I’m working four weeknights and a weekend night at the restaurant. Even though it pays less on paper than my old job I have more money in my pocket because I don’t spend money on the car and I don’t buy my lunch in the cafeteria because it’s free at work. I sold my car too and I signed up to take some classes at the college during the week days using the car money. I can take the city bus to classes and back home, then walk to work.

Before I read your site I thought I was doing the right thing working at the factory but I felt like I could not do anything to help myself. You got me to think about what else I could be doing and that the best paying job isn’t always the one that will give you the most money. I am taking English classes now and I can already write better than before. I want to try to become a technical writer.

This email was one of the best things I’ve read since starting this site - I feel like something I’ve written went out there into the darkness, touched someone, and profoundly changed them. Some thoughts:

She traded her car for an education To me, this spoke highly of the maturity of this twenty year old. When I was twenty, I can’t say that I would have made such a choice - it takes some serious bravery to go without a car in those heady youthful times. The truth is, though, that it was the right choice - with her job and her classes available by foot and by public transport, she doesn’t have a major day-to-day need for a car right now, and the ongoing cost of the car (insurance and any payments she might be making) would just drag her down. Plus, that car money opened the door to education.

She likely also came up with health coverage Depending on the college (I got the impression that it was a smaller liberal arts college, not a community college, but I may be wrong), she might have access to health coverage via her student fees at the school - at the very least, access to a student health center. If that’s the case, then she is in substantially better shape than before having no health coverage at all.

She’s investing her energy in herself instead of giving it away to a factory During the daytime hours during the week when her energy and focus are peaking, she’s attending classes to better herself. Her job, in terms of when her concentration is peaking, is secondary, as it should be when you have a job to afford to live, not trying to build a career.

She quit her job to take a lower paying one - and it was probably the best personal finance move of her life.

Today, I stumbled across a very interesting tool at the New York Times website that attempts to place you in one of five socioeconomic groups (upper fifth, upper middle class, middle class, lower middle class, bottom fifth) based on a number of factors (occupation, education, income, and wealth). I’m quite happy to share my results with you:

Occupation My primary occupation and side businesses all place me in the upper middle class range.

Education I received a bachelor’s degree, which puts me in the “top fifth.”

Income I used our whole household income estimate for 2007, which includes my primary employment, my wife’s primary employment, and income from my side businesses and investments. This puts us just in the “top fifth.”

Wealth Because we’re just now digging out of some stupid financial decisions, we are decidedly in the middle class range for wealth.

Average Overall, this tool identifies my family as being “upper middle class,” even though our wealth is decidedly “middle class” at this point. I would conclude that our other socioeconomic factors (our job, our education, and our income) all indicate that our wealth should move into the upper middle class range as our life goes on and perhaps even into the “top fifth” range and thus the tool has a bit of an age bias (it’s hard for young people to have accumulated the wealth that is identified as “top fifth” unless your last name is Rockefeller or something).

What else can we learn from this tool?

Education is a major key to upward mobility Assuming that education plays a significant role in class mobility as indicated in this article, the best way you can position yourself to move up in class is by working hard and getting an education. Completing a bachelor’s degree puts you in the top fifth in education simply because only 9% of Americans actually manage to acquire one. So, get an education.

Jobs that require you to use your mind generally have more prestige than manual labor jobs This isn’t surprising, but intellectually challenging jobs populate the upper third of the job prestige list, while physical labor jobs populate the bottom (craftspeople are somewhere in the middle). If you feel you only have the skills for physical labor, one potential way to move up is to look at a trade that mixes physical labor with basic problem solving, like carpentry, plumbing, electrical work, and so on. If you’ve got such a job and are looking to move up, it will likely require getting more education. In short, always work to improve yourself by learning new skills.

There is some age bias here As I mentioned above, younger people are inherently hamstrung by the wealth column, as most of us twenty and thirtysomethings are dealing with a very large debt load and not that many years in the workplace building up our wealth. In other words, the longer you’ve been earning money and not spending more than you earn, the more likely you are to be moving up in class due to the net worth bias.

This tool lays out exactly how to get ahead in America: get an education, constantly look for ways to improve yourself and aim upwards, and spend less than you make. If you do those three, you will move up through the classes. The people that fail to do these things are downwardly mobile.

I recently received this email from a reader:

I need some Buyer Beware advice on how to choose a lender for a student loan with a parent as co-signer. My 19 year old will be attending university and he has to take out 100% loans. The annual amount is a hefty 50K. When I review the lenders listed on the university’s recommended lender list, I do not have enough knowledge to know how to choose a lender. The interest rate is always variable on any student loan when it is in the student’s name and the parent a co-signer. But there is a lot of fine print attending each loan that I simply do not understand. Given what has happened with the sub-prime mortgages I feel that I might be stepping into a black hole with the student loans. The two categories of sub-prime mortgages and student loans appear to be very similar.

Obviously, it’s going to be impossible to describe every type of student loan in a single post, so instead I will offer some basic tips for evaluating student loan options. I went through this process myself not all that long ago and the scars are still fresh in my mind.

General Categories

In the United States, student loans generally fall into these general categories:

Federal student loans to students
This group of loans include Perkins loans, Stafford loans, Federal Family Education Loans (FFELs), and Ford Direct loans. These loans are guaranteed by the federal government and are generally a very good deal. There are subsidized and unsubsidized versions (subsidized is better, as they’re basically interest-free while the student is in school) - the subsidized one has some pretty strict income requirements. The drawback is that they have a very low cap: $3,500 for incoming freshmen in 2007. In the past, rates on these loans have been very nice, but they are set to start approximating the rates on private loans starting later this year.

Federal student loans to parents
PLUS loans are federal government loans directly to parents for the purpose of paying for college. These are not loans that the student will repay - the parent is solely on the hook for them. Again, the rate used to be quite nice, but the rates are going up later this year.

Private loans
This is the meat and potatoes of it, the type of loan that most people will wind up having to take because other sources didn’t cover the cost of education. These are basically consumer loans from private lenders with no collateral, which often means that the rates are not particularly comfortable.

Six Tips For Comparing Student Loans

It is very difficult to offer concrete advice on which loan offers to take without looking at the options, but here are six tips that can help you separate the good from the bad.

Use the APR to compare the loans, not the “rate” The “rate” that many loans give out is not really very useful for comparison, because many loans with low rates have a ton of additional fees tacked on. The real tool for comparing the loans is the stated APR, which includes the various fees that they tack on. Remember, though, that APR isn’t perfect - it’s only an exact comparison tool for loans that have the same term. This, of course, means that you should…

Shop around thoroughly, regardless of the stated “rate” Many companies thus use a very low “rate” in order to attract your attention, then effectively do a bait and switch, giving you a loan with a very high APR and a low “rate” because of all the other stuff tacked on in the middle there. Thus, don’t toss out loan offers because they have a high rate - they may have low fees in other respects.

If you have difficulty with the APR and term math, ask what the monthly payment will be and multiply it out by the term For example, if you’re trying to compare a ten year and a twenty year loan, find out what the monthly payment will be for each and then multiply that payment by twelve, then by the number of years you’ll have the loan to see how much you’ll be paying total. Obviously, you want the smaller amount here.

Look at fixed-rate loans unless you think the Fed is going to significantly start dropping rates I’m not the right person to be giving long-term advice on where interest rates are headed. My suggestion is to talk to people in the finance industry (especially those you trust) and ask them whether they think the prime lending rate will be on average lower or higher over the next ten years. If they think higher or about the same, get a fixed-rate loan, otherwise get a variable-rate loan. I was luckily able to lock in some fixed rates in 2003 when loan rates were very, very cheap - I actually do better with my money in an HSBC Direct savings account than paying off my loans early.

High origination fees are usually a red flag If an origination fee for one loan is excessively high compared to the others, this may be a red flag, especially on a variable-rate loan, because the rate could skyrocket and the origination fee (tacked onto the overall balance) will really hurt you in the long run. Small differences aren’t usually that big of a deal, but if you’re looking at double or triple difference in origination fees, something’s afoot.

Check your credit report If the borrower or the cosigner have poor credit, the terms for the loan will likely be worse. Thus, one part of the process is to check the credit report of everyone who might be signing for the loan and then ensure that the people with the best credit do the signing.

I’m very happy to be living in Iowa, where things are quiet, we have very strong public education, and we’re also home to one of the best investment opportunities in the country for parents of future college students. That doesn’t apply to me, you might be thinking. Wrong! Iowa’s stellar 529 plan is open to all U.S. citizens:

Any U.S. citizen or resident alien with a valid Social Security or taxpayer identification number and valid U.S. mailing address can open one or more accounts for any future student. There are no income restrictions.

Let’s back up for a second. What’s a 529 plan? From Wikipedia:

A 529 plan is a tax-advantaged investment vehicle in the United States designed to encourage saving for the future higher education expenses of a designated beneficiary. It is named after section 529 of the Internal Revenue Code.

At first, you might think that this is merely a savings account for college, but think again. Here are ten reasons why Iowa’s 529 program is a great investment in your child’s future:

1. Tax free growth As long as you keep the money in the account, the growth of that money incurs no federal or state taxes. If you take that money out and directly hand it to an institute of higher learning, those earnings still incur no federal or state taxes.

2. The account holder retains control of the account, regardless of the age of the beneficiary. Let’s say you invest in this account for years and suddenly your child is 18 and decides to forego college. They can’t access the account; you still control it and the options are up to you: take out money with the tax penalty, wait until they’re ready, or…

3. The beneficiary can be changed at any time to another family member. You could also give that money to another of your children, or even to yourself if you want to go back to school.

4. Money can be used in over 8,000 domestic and 800 foreign institutions. Almost every institution of higher education allows you to use the money in a 529 to attend there.

5. It need not be used just for tuition. You can use it for tuition, room, board, fees, books, supplies, and required equipment. All you need to do is provide proof that the expenses are related to education and within the reasonable limits of the program (a Ferrari is not “required equipment,” for example).

6. Very high maximum contribution limits The maximum contribution is well over $200,000 in almost every state. If you max out your contributions at every step, a 529 can potentially cover an Ivy League education.

7. Very low minimum monthly contribution limits. You don’t need to donate very much at all to keep an account open, making this a viable option for people at all sorts of different income levels.

8. Large lump-sum donations can avoid the gift tax. Let’s say your infant son receives a large gift in an estate. You can put a lump sum of $60,000 into the 529 (or $120,000 if married and filing jointly) and avoid the gift tax on that money, but then you can’t donate any more for 5 years.

9. Assets in 529s are protected from bankruptcy. Let’s say everything goes south and you have to file for bankruptcy. The money you put into the 529 is protected from bankruptcy, so your financial mistakes won’t damage your child’s college education.

10. Iowa residents get an extra bonus. Iowa residents can deduct up to $2,925 in contributions annually per beneficiary from their state income tax. Yes, by putting money in, you get a state tax break.

Surely there’s a drawback… The only major disadvantage of 529 plans is that many of them often have poor investment options, but Iowa’s plan does not: the investments are managed by Vanguard and, from their site, “your only expense is a management fee of 0.62%.”

What about my own state? Almost every state offers a 529 plan of its own; you can compare them all here. Iowa’s plan, however, is open to all U.S. citizens, so if you don’t like your own plan, you can choose Iowa’s plan.

How do I get started? Take a look at the College Savings Iowa site and get more information. It’s a great plan - I use it myself.

How do you use it? Each month, I automatically put a specific amount into my son’s 529 - and I’ve already started one for my unborn child. I’m not putting in enough to pay for his entire college education, but enough to supplement potential scholarships that he may get.

If you’re waiting on starting a 529 for your child until you have time to do the research, you have all of the tools at hand now. It’s a great way to save for your child’s education without tax penalties, and now you have all the information you need and at least one good plan available to you.