As graduate students, we can be overwhelmed easily by everything our stipends are ‘supposed to’ accomplish for us. If you read any personal finance material (including mine!), you will see that your income should go toward saving for retirement, paying off your debt, saving an emergency fund, saving for your short-term goals… oh, and feeding, clothing, and housing you, too! It can seem impossible to make any financial progress when faced with all these demands. Instead of trying to do everything at once, prioritize the various financial goals you might set based on both the math behind them and your personal disposition toward saving, investing, and debt.
A version of this post originally appeared on GradHacker.
In my opinion the first two goals you should accomplish with your stipend are obvious, and after that you’ll have leeway to choose among competing valid goals.
Goal 1: Pay for Your Basics
The primary purpose your stipend should serve each month is to pay for the basic expenses in your life, such as housing, utilities, food, and transportation. If that’s all your stipend can manage, it has served its purpose: providing you with enough money that you can fully devote yourself to your studies. Increasing your short- and long-term financial security will have to wait until after graduation.
However, keep in mind that it’s very possible for these basic expenses to inflate from “need” into “want” territory. “Want” aspects of these basic expenses include living alone, housing amenities (access to pool, gym, social spaces), a car/a car that’s worth a significant fraction of your yearly income, eating out, bar tabs, etc. That’s not to say that you shouldn’t spend money on those above-basic aspects of these expenses, but just be aware that you can’t justify that portion of the spending as “needs.” It’s easy for your large, fixed expenses such as housing and transportation to get away from you, so spending your stipend on the “want” aspects of your basics should be weighed against using it for your other possible financial goals (more on that later).
Goal 2: Save an Emergency Fund
Everyone should have an emergency fund, even if it’s small. An emergency fund is cash reserved only for emergencies. It’s basically money that will prevent you from going into debt when something unexpected happens. A full emergency fund is on the order of 3-6 months of expenses, but that shouldn’t necessarily be your first goal. A small emergency fund of $1,000 is a great start when you have other pressing financial goals, such as debt repayment. It’s not prudent to delay repaying high-interest-rate debt to save a larger emergency fund the purpose of which is to prevent you from going into high-interest-rate debt.
Start with a $1,000 emergency fund as your second financial goal, but after that let the math of your other choices and your gut help you decide whether to keep building the emergency fund or move on to another goal.
Accumulating Cash vs. Growing Wealth Mid/Long-Term
Cash savings has great utility. If your expenses are quite uncertain over the next year (such as when you near graduation), it makes sense to save up to be able to pay for the most costly scenario in cash. It’s also a good idea to keep cash on hand for irregular expenses, such as in a system of targeted savings accounts. As just discussed, a larger emergency fund can bring great peace of mind to certain people.
But you should limit your cash savings to the amount that you may well need in the short term (1-2 years plus any mid-term goal expenses like a house down payment or wedding). To increase your net worth in the long term and ultimately become financially independent, you need to invest for the long-term and pay off debt. As soon as you have sufficient cash on hand (by your estimation), you should start investing or paying off debt, but deciding when you have enough cash is largely about your comfort level.
It’s also fine to simultaneously invest/pay down debt and save additional cash, as long as you can accept that your progress toward each goal will be slower. For example, if you decide to save 20 percent of your income, 10 percent can go toward investing/debt repayment and 10 percent can go toward cash savings.
Investing vs. Debt Repayment
The earlier you get compound interest working in your favor, the better. You can accomplish that by investing or paying off debt. Deciding between investing and debt repayment is again a balance of math and personal disposition.
First, do the math. Put numbers on your various possible investing and debt repayment goals. Your debt repayment “rate of return” is the interest rate of the debt in question. The long-term average rate of return on your investments is estimated from your asset allocation. For example, a grad student invested 100 percent in large-capitalization US stocks could anticipate a 9-10 percent long-term average rate of return (before adjusting for inflation). Other asset allocations will have different expected long-term average rates of return. Mid-term investments should be more conservative, with a lower expected average rate of return but more muted peaks and valleys.
Compare your investing and debt repayment expected rates of return, giving a handicap to the debt repayment side of the equation because there is no risk associated with debt repayment as there is with investing. Given a certain expected rate of return for your investments, the math would argue that debt below a certain interest rate will be a lower priority. For example, if you expect an 8 percent long-term average rate of return on investing, any debt below about 5 or 6 percent might become low-priority.
Second, evaluate your personal disposition. If you feel passionate about one type of goal over another, that should have some influence on your decision. I believe that your passion for a financial goal positively correlates with the amount of effort (i.e., money) you will put toward achieving it. For example, if you hate your debt, you should pay it off, even if the math favors investing. If you are very excited to start investing, perhaps you could reduce the debt repayment handicap in your math to only 1 percent. Just don’t justify keeping high-interest-rate credit card debt because you want to start investing!
The one caveat I’ll make to allowing your personal disposition to hold sway over the math is for a very risk-averse person: you will have to start investing eventually, even conservatively, if you want to reach financial independence. You will automatically pay your installment debt off in time even if you just make the minimum payments, whereas there is no mechanism to force you to start investing. So it is acceptable to prioritize (non-mortgage) debt repayment over investing, but when you’re done paying the debt, be sure that you hold yourself accountable to take the next step to start investing.
Know that More Goals Means Slower Progress
The more financial goals or purposes for your money that you have, the slower your progress will be toward each of them. If you feel strongly about working on multiple goals at once, accept this knowing that you are making some progress in all the areas that are important to you. But if you are frustrated by slow progress to the point that you end up not devoting money to any goals, working on one or a small number of goals at a time is a better fit for you. In this case, set concrete dollar-amount goals that you can achieve within months or a small number of years and work toward them intensely. For example, set $4,000 as your goal emergency fund size, but once you achieve it, move on to something else. Paying off one debt entirely could be another concrete goal.
Living Your Life
Since our income is limited (unless we have a side income), any money that you put toward the above types of financial goals is money that won’t be used for your everyday comforts and living expenses. By no means do I suggest that you suffer through a Spartan lifestyle while you put every penny possible toward your long-term future. Everything must be in balance for you. A guideline like the Balanced Money Formula may help you work through what percentage of your income to use today and what percentage to put away for tomorrow.
My Choices During Grad School
When I was in grad school, the financial goal that most excited me was investing. Therefore, after ensuring that I could live within my means and establishing a $1,000 emergency fund, I started investing 10 percent of my gross income into my Roth IRA. Over time, I built up cash savings in my targeted savings accounts and also increased the fraction of my income that I saved for retirement. To devote more money to these goals, I reduced my living expenses by developing frugal practices. Paying off my remaining student loans was my lowest priority as they were subsidized during deferment. I’m happy with these choices given my personal disposition (not risk-averse), but if I were to do it over again I would have beefed up my emergency fund earlier, delaying increasing my investing percentage for a short time.