Adulting as a Professor: Finances
Updated: Feb 9, 2020
Inspired by a conversation with a friend and by the Patriot Act episode on Why We Can’t Retire, I am starting a post about adulting this month. This topic deserves multiple posts and I will start with finances.
As an academic, you spend a significant portion of your life—typically ten years—as a poor student or trainee (as seen in the chart below). As I mentioned before, academics are often underpaid for the amount of effort they put in, but once you get a faculty position, you do typically see a spike in your annual income. With increasing income, the quality of life increases as well and often times people fail to use their money judiciously. Instead of seeing a corresponding growth in wealth, we are often just burying ourselves in credit card debt instead.
If you just started working and earning some real money, it might feel like a bad time to think about retirement because it seems far away. In fact, right now is the best time to give it a though. A couple of years ago, I started reading about the F.I.R.E. movement. If you haven’t heard of it, it stands for “Financial Independence, Retire Early” and the key idea is that if you start saving up to 70% of your income in your 20s and invest it, you have the opportunity to retire in your 40s. In summary, it means continuing to live like a poor student (even though you are earning more) for 10-20 years and then let the build-up of wealth serve as a source of income. It is a sound strategy for people who do not enjoy their job and are able to be financially disciplined.
For me though, I love my job and I do want to live a little in my 20s and 30s. So, instead of going all-in with saving 70% of my income, I aim for around 30-50% in savings. The most important thing to remember is that saving early has a compounding effect. For example, if you invest $10,000 in an S&P 500 index fund today (at the start of your career), in 30 years, it will grow to $174,495 with a rate of return of 10% (the historical annual growth rate of this fund). After reading and listening (via NPR’s Planet Money and The Indicator podcasts) about economics, I have come to the conclusion that the best strategy for investing is simply to use index funds (e.g. Vanguard Target Retirement 2055 Fund) and forget about it. Index funds are essentially a mixture of the stocks of the top companies in the stock market and it is close to impossible to beat the market. Many employers will make it easy and use index funds as the default options for the retirement plans (e.g. 401(k) in the US). When you have the funds, it is a good idea to max out your 401(k) after you have exhausted other options (which I will discuss below).
Housing makes up the biggest fraction of most American’s expenses. You should aim to spend less than 30% of your income on housing. In fact, if you are looking to purchase a house, most mortgage approvals will look at whether you can afford your mortgage payments based on this ratio (30% of your income). You will often hear that you should buy a house as soon as possible because renting is like flushing money down the toilet. After renting for years and purchasing two houses, I disagree with this advice. I would rather say that you should buy a house when you have saved enough cash to pay 20% as the down payment and the monthly mortgage is less than 30% of your monthly income. You want to pay 20% down because there are often additional mortgage insurance costs (can be thousands of dollars) if you pay less than that. Renting is not a bad idea because when you do buy a house and pay a monthly mortgage, more than half of that money is ‘wasted’ because it is simply going towards interest and not towards the principal of the loan. In addition, owning a home comes with additional maintenance costs which are approximately 1-2% of the price of the property annually, property taxes (~1% of the price of the property annually), and insurance (~1% of the price of the property annually). As an example, if I am renting a place for $700/month, I should only move towards purchasing a property if the mortgage, taxes, and insurance are significantly less than $1400/month.
Once you do feel like you have saved enough cash and are earning a steady income to pay monthly expenses, purchasing a home can be a good move if you intend to keep it for at least five years (if it is a shorter duration than five years, you will often lose too much money in the purchase and sale for it to be a worthy transaction). Purchasing a house is a good way to build your net worth if you live in a location with a steadily growing housing market. Zillow (US) or Zolo (Canada) are useful resources not only for looking up houses of interest but to look at market trends. Although the housing market will only grow by a few percentage points (~2-3%) per year on average, it has a huge impact on your net worth because this growth is on the total price of the property (which will be in the range of a few hundred thousand dollars). In addition, paying off a mortgage is a good way to make use of your savings because you can make direct contributions to the principal amount of the loan (and thus save on paying interest, currently ~3%). With the help of a healthy housing market, your net worth can grow by tens (or even hundreds) of thousands of dollars in 5-10 years.
I have mentioned net worth a few times without explaining what it means. It is simply the difference between your assets (e.g. cash, house, investment) and your liabilities (e.g. credit card bill, mortgage loan). It is a useful indicator of your financial condition and also a useful way to set goals. For example, if you want to retire at 65 and you will live for another 20 years with expenses of $100,000/year, you would want your net worth to be over $2,000,000 by the time you are 65. To reach such a goal, you might set milestones such as I want to have my net worth as 1x my annual income by the time I am 30, 5x my annual income by the time I am 40 and so on. You will only know whether you have reached a goal if you measure it. An incredibly useful tool for keeping track of all your finances and getting a complete picture is Personal Capital. It is quite simple to link your different accounts (assuming you do your banking online) and see them all in one place. As seen in the screenshot below, Personal Capital will automatically calculate your net worth and highlight the trends observed.
In order to reach your goals of building net worth and saving a certain fraction of your income, you need to take two steps: i) making saving automatic and convenient (e.g. by a fixed monthly deduction from your paycheck—which is often the case for 401(k) mandatory contributions), ii) track your spending. Personal Capital is a useful tool for budgeting as well. The beauty is that you can look at different categories of expenses and see where you spend the most money and which cutbacks will have a significant impact. For example, transportation is the second biggest monthly expense for most people and you want to ensure that it does not exceed 20% of your monthly expenses. Food will be another major expense and eating out often will add to the spending. I think the key is that when you see the different categories of monthly (or even annual) expenses, you realize that cutting back on certain frequent expenses (e.g. eating out) will have a much greater impact than infrequent ones (e.g. Netflix).
Owning a car
Since transportation can be a big fraction of expenses, I did not buy a car until I absolutely needed it (i.e. when I moved to Indiana). Before then, I lived within walking (or biking) distance of my university and I simply used public transportation to get around. When I did finally get around to owning a car, an important decision was whether to buy or lease. First, I decided on what type of car I wanted. Although a Tesla Model S would have been my dream car at the time, it was way too expensive (~$100,000 for something with a decent range). So, I settled for a Hybrid Camry instead. Although I was hassled by the car dealerships initially, I did eventually learn that Carmax was a good place to find the actual prices of the cars you wanted. Second, I realized that cars lose value rapidly with a huge drop in the first year and almost a 50% drop in the first three years. So, when you lease, you are essentially paying the price of this drop when you lease over a period of three years. Over the long run though (9-10 years), continuing to lease is only slightly more expensive than purchasing because the maintenance costs of an older car increase significantly with time whereas a leased car by default is no more than three years old. For me, leasing made sense (at least initially).
I have been doing my own taxes since my first internship which was during the first year of university. So, it didn’t usually feel like a burden. When I moved to the US though, things got complicated because now I needed to file taxes both in Canada and in the US. I had to learn about differences between being a resident, non-resident, deemed resident, deemed non-resident, a non-resident alien, and a resident alien. Luckily, Canada and the US have tax treaties and thus, tax credits can be exchanged. I have been using myTaxExpress for the Canadian filing and Tax Slayer for the US and they have both served the purpose well. Last year, I had to learn how to file the Canadian tax using a paper form and it was interesting to go through the if statements and jumping around forms (reminded me of Sheldon from The Big Bang Theory and his obsession with filing taxes). I do have a hang of it now. For those of you willing to spend hours figuring out which forms to file, all the information is indeed available on the Canada Revenue Agency and Internal Revenue Service websites. Otherwise, spending $50-100 on a tax specialist is probably worth it for dual-country cases.
Some loans are healthy (mortgages) and others are not (student loan, credit card debt) because as I mentioned above some can help you grow your net worth while others are simply a drain on your financial state. I was fortunate to pay off my student loans right after I finished my Ph.D. Since the loan was interest-free as long as I was in school, I waited to pay it off until after graduation. The most important thing here is to consolidate your loans to the lowest interest rate item and then pay it off as soon as possible. Paying off a loan is as good for your net worth as investing in a stock with the same interest rate.
If you have found other hacks and tricks to managing your finances or building your wealth, please share them as a comment below.
Disclaimer: If it was not already obvious, all the advice listed above is simply from personal experience and I have no professional authority over the matter.