What should I know about student loans if I want to be considered a responsible borrower?

You should only borrow what you need.

A loan, unlike a grant, is borrowed money that must be repaid.

You must keep your loan servicer informed of any changes in your name, address, telephone number, Social Security number, or school enrollment status.

You must repay your loan even if you didn’t get the education or job you expected, and they can’t be canceled because you didn’t complete your education.

You can prepay the whole loan or any part of it at any time without penalty.  This means you are paying some of the loan before it’s due.

If you apply for deferment, forbearance, or consolidation, you must continue to make payments on your loan until you have been notified that your request has been processed and approved.

Your student loan account balance and status will be reported to national credit bureaus on a regular basis.  Repaying your loan responsibly can help you establish a good credit rating and failing to repay your loan can damage your credit rating.

The consequences of defaulting (failing to pay according to your loan contract) on a federal student loan are severe and long lasting. For example, you might not be able to buy a car and your federal income tax refund could be applied to your student loan balance instead of being sent to you.

There are repayment options available to assist you if you’re having trouble making payments.

How and where do I start saving money?

The best time to start saving money is now. When you look at the bills you have to pay each month, it may not seem like there is much extra to put away for down the road. But saving for your future is an extremely wise financial choice, and even starting small with saving can take you far—farther than you might think. If you approach savings with a plan and with an understanding of your options and decisions, you’ll likely find the process less intimidating than expected, and you’ll be glad you started sooner rather than later.

A savings goal—or a specific amount of money to have saved by a certain period of time—can help you determine and be disciplined in setting aside money on a daily, weekly, or monthly basis in order to achieve your target. When thinking about savings goals, it can help to think about where you need your money to go and where you want your money to go. Are you hoping to purchase a car soon? Do you have an emergency fund set up? When thinking about your goals, be sure to ask yourself if they are long-term or short-term—will you need that car in the next month, or can you wait a few years?

Savings can be set aside in a variety of ways. For example, if you’re saving for retirement, your employer will likely automatically deduct a certain amount of money from your paycheck to be put into your retirement fund. See the Investing questions on the Cultivating Currency site for more information on that topic. But what if you’re saving money for a computer or down payment on a house? Where should you put your money? Or what if you’re creating an emergency fund?

An emergency fund is an important part of saving. When a crisis (like a natural disaster or job loss) or unexpected event (you need new glasses or a car repair) comes up, you will want to be prepared. It’s wise to designate savings for an emergency fund as part of your spending plan, and good general goal is to have three or more months of living expenses available in an emergency fund.

After you have an idea of why you are saving money and what you are saving money for, you need to actually save that money—where do you keep it? If you want your money to be somewhat easily accessible, a savings account is a safe and viable option. Savings accounts are money deposited in a bank or credit union. When looking for a bank, look for an institution that is insured by the Federal Deposit Insurance Corporation (FDIC). Credit unions are member-owned cooperative organizations; look for credit unions that are insured by the National Credit Union Administration (NCUA). Like banks, credit unions have somewhat low interest rates, meaning your money doesn’t earn as much as time passes. Because these types of accounts are convenient to access and earn lower rates of interest than other less accessible options, think about using savings accounts for your short-term savings goals. At your bank or credit union, ask about different accounts—the interest rates, fees, pros, and cons associated with each type of account.

When making your savings goals, it is helpful to have at least a general idea of how much a particular item or event costs. You may have an idea of how much tuition will be or how much money you need to save before you can buy a computer. If you’re saving for a vacation, you may not know the exact costs, but you should certainly have an estimate. Many calculators exist to help you determine how much you need to save in order to meet your goal. Knowing where you plan on saving your money will give you a more specific estimate of how much you need to save over a certain period of time, as interest rates differ depending on the financial institution. Using a calculator or spreadsheet to calculate savings may also demonstrate how even a little savings each day can add up quickly.

What is the difference between saving and investing?

Both saving and investing have pros and cons, and the best choice depends on your reasons for saving money. Some questions to ask yourself before determining if you should save or invest are: Do I need to be able to easily access my money? Do I intend to save this money for a relatively short or long period of time? Am I willing to earn more money if it also means the possibility of losing more money?

Saving money in a bank is safe, easily accessible, but earns little interest. When compared to investing, there is less risk of losing money if it is kept in a savings account. Depending on which type of savings option you choose—CD, savings account, or money market, for example—you typically do not need a large sum of money to open an account. If you hope to take your money out of savings in a few months, or if you want it to be accessible in the case of an emergency, a savings account would give you that convenience and ease of access. However, if you plan on letting your money sit for an extended period of time, it won’t earn a lot in a savings account, as interest rates are low. Savings accounts also do not protect against inflation, or “purchasing power risk,” which becomes a greater threat the longer your money sits.

Investing can be riskier, but it can also lead to greater reward, and it is usually better option for long-term savings goals (for example, three years or longer). There are several options for investing, including stocks, bonds, and mutual funds. Investments can increase or decrease in value quite rapidly, so the risk involved depends on your type of investment, where you invested your money, when you sell your investment, and other factors, including the fact that your money is not federally insured. However, your potential to earn more money is greater, especially over an extended period of time. One way to help avoid risk is to diversify, or invest in a variety of places (in other words, don’t put all your eggs in one basket). Because of the risk involved as well as the long-term, less accessible nature of investments, investing is a good decision for those who are financially stable and have money secured elsewhere, such as in an emergency fund and/or savings account.

Long-term savings and investing

401 (K)

What is a 401(K)?

A 401K is an employer sponsored savings plan. As an employee, you decide how much you want to contribute to your retirement plan each month and your employer automatically deducts this amount from your paycheck. The employer then puts this money in the 401(K) where it can generate returns. The money can be invested in a variety of ways including mutual funds of stocks and bonds. Although the employer is the one that puts the money in the account, you as the holder of the plan determine how you want the money to be allocated among different assets.

What are the benefits of a 401(K)?

One benefit of a 401K is that you are not taxed on the money you contribute to the plan when you make the contribution. Even though it is technically income coming out of your paycheck, this money is contributed to the 401K tax free. Another advantage of a 401K is that many employers have a matching contribution plan. This means that the employer specifies some set amount that they will contribute to your retirement plan. For example, they might add 50 cents for every dollar you contribute, up to a limit.

How much can you contribute to a 401(K)?

If you are under the age of 50, you can contribute up to $17,500 (2013) a year. If you are 50 and older, you are allowed $up to 23,000(2013) a year to catch up. The more you contribute each year the better. Try to contribute the maximum amount if you can. You at least want to make sure you contribute enough to meet the requirements for your employer’s matching contribution.

Withdrawals

With a 401(K), you cannot make any withdrawals until the age of 59 1/2 years. If you choose to take money out of the account before then, there is a 10% early withdrawal fee. Once you turn 70 1/2 years old, you are required to start making withdrawals and there is usually a minimum amount you have to withdraw each year. When you make withdrawals is when you are taxed on the money. This money is included in your taxable income and it is taxed as ordinary income.

Roth IRA

What is a Roth IRA?

IRA stands for individual retirement account and it is another means to save money for retirement. You make contributions to your account but in contrast to a 401(K), these contributions are taxed at the time of the contribution. However, the money is not taxed when you make withdrawals.

A Roth IRA is different from a traditional IRA and provides many benefits for young people.

What are the benefits?

A Roth IRA can be beneficial to younger people. Although you are taxed on the contributions you make up front, chances are that you are in a lower tax bracket while making these contributions that what you will be in when you start making withdrawals in retirement. So in the long run, it is likely to save you money.

How much can you contribute to a Roth IRA?

If you are under the age of 50, you can contribute $5,500 (2013) a year. If you are over the age of 50, you are allowed to contribute $6,500 (2013) a year to catch up. There is no minimum amount required to contribute by federal law although the financial institution is likely to have a minimum amount to open the account. However, the more you can give the better.

Withdrawals

The rules for withdrawals from a Roth IRA are more flexible than those of a 401(K). First of all, withdrawals are not taxed since you were already taxed on the money when you first contributed it. The only stipulations are that you must be at least age 59 1/2 (or dead or disabled) to make withdrawals and the account has to have been open for at least five years. Another advantage of Roth IRA’s is that you are not required to withdraw money like you are with a 401(K). No matter how old you are, you can keep your money in the account and let it grow. For a young person who is concerned about locking up their money for decades, the Roth IRA offers more flexibility than other retirement accounts.

Distributions are deemed to come first from contributions. So if you needed to, you could withdraw all your contributions without any taxes or penalties, at any time. If you withdraw more than your contributions and tap into the earnings in the account, then you will owe taxes and perhaps an early withdrawal penalty if you don’t meet the age and 5-year requirement.

Here is a summary of the differences between a 401(K) and a Roth IRA in 2013:

401 (K)

  • Contributions Taxed? No
  • Withdrawals Taxed? Yes
  • Maximum Annual Contribution: 17,500 (or 23,000 if over age 50)
  • Withdrawal age without penalty: 59.5
  • Mandatory Withdrawals: 70.5

Roth IRA

  • Contributions Taxed? Yes
  •  Withdrawals Taxed? No
  •  Maximum Annual Contribution: $5,500 (or 6,500 if over age 50)
  •  Withdrawal age without penalty: 59.5
  •  Mandatory Withdrawals: Never

Written by Katie Leginsky, Peer Educator, Financial Wellness Program, University of Illinois Extension, 2012

I want to invest my money in either stocks or mutual funds. What’s the difference?

The first thing that someone like yourself should know before you invest your money is what you want your money to do.  What is mean by this is are you looking to make a quick buck or are you thinking about the long haul?  This choice will determine the types of investments you will find attractive.

There  is a plethora of different investment instruments that are available for someone who’s looking to invest.  This can be advantageous but daunting to the investing newcomer.  What’s an ETF?  What are financial derivatives?  What are blue chip stocks?  These might be some questions that a novice investor may have when looking at different avenues of investment.  Often, financial jargon tends to get in the way of understanding the various forms of investment.

Stocks are a type of security that designates ownership in a publicly traded company.  By owning a share of a company’s stock, you have a claim to their assets and earnings.  In essence, you become an owner of a company.  By purchasing common stock, you have a right to vote at shareholders’ meeting and are entitled to receive a dividend, which is a portion of a company’s profits paid out to its owners.  By purchasing preferred stock, you do not have the right to vote at shareholders’ meetings but can still receive a dividend.  The reason why this type of stock is classified as ‘preferred’ is that in the event of liquidation (when a company goes out of business). Preferred stockholders have priority over common stockholders in the company’s assets and earnings.  That is to say, the residual assets and earnings are divvied amongst preferred stockholders first and then to common stockholders.  In the event of liquidation, common stockholders may not get their investment back!  This, however, does not mean that common stock is a poor choice of investment.  Thanks to the United States’ accounting system, the financial information of publicly traded companies must be publicly reported so that anyone can see it.

In the same vein, mutual funds are a collection of various financial instruments managed by a mutual fund company such as Vanguard and T. Rowe Price.  A mutual fund pools money from its investors and invests that lump sum of money in various securities.  This basket of securities can include stocks but is not limited to them.  A mutual fund can be comprised of bonds, money market securities, other mutual funds and commodities, to name a few.  A mutual fund manager will then invest that money in accordance to what type of mutual fund it is.  One that focuses on long term financial stability will buy and sell securities that are not very risky.  Relatively small risk investments offer relatively low returns but will continue in the foreseeable future.  Higher risk investments offer higher returns, but there is a chance that the company offering that security will not perform well.  This is called the risk-return tradeoff.  Higher risk investments must offer a higher return because there is a high level of uncertainty of success and life of a company in the future—which translates to a higher risk of you not getting your money back.  With mutual funds, you’ll also have to be aware of the various fees and commissions that you’ll have to pay.

The type of investing that you want to do depends on how risk averse you are.  If you like taking risks, you’ll probably want to invest in stocks or mutual funds that offer the potential for higher than the market average returns. If you do not like taking risks but want to see constant returns on your investment, you’ll probably want to invest in blue chip stocks or large cap mutual funds.  Blue chip stocks are the stocks of companies like General Electric—companies that are well established and very stable.  Large cap mutual funds are like blue chip stocks in that they are comprised of large corporations that are well established and financially stable.

Apart from the basic mechanics of these types of investments, one  thing you must know is what you want to do with your money and what you want your money to do for you. Make sure you ask yourself the following questions before you do any investments:

Do you want to invest your money?  If so, which to do you prefer—high returns and high risk or low returns and low risk?

Written by Eric Pinter, Peer Educator, Financial Wellness Program, University of Illinois Extension