You’ve done it! Three years of law school, a summer internship or two, several grueling months of bar exam prep, and then – hopefully – some much-needed R&R. All of this has led to you to your first BigLaw associate job, and you’ve got the starting salary – and, more than likely, the hefty student loans – to show for your efforts.
The numbers vary, but statistics suggest that less than 10% of associates will eventually go on to make partner at their respective firms (in some cases, as few as 1% will make the cut). Usually by the third or fourth year many associates have been weeded out, often as a result of self-selection due to burn out or other factors.
Even if you’re sure that you have what it takes to go the distance (or, conversely, you’re sure of your intention to transition out of BigLaw down the road), the first few years are among the most critical in terms of setting the stage professionally – and financially – for what’s to come. Simply put, it pays to prepare financially as if the first three to four years of your associate life are among the best you are likely to get in terms of your compensation, even if you ultimately go on to become a much higher earner.
A word about cash flow
When people think of budgeting, they often imagine an austere lifestyle fueled exclusively by BYO lunches and a cramped apartment shared with four other roommates. It needn’t be that way! The best budgets are highly personalized, designed with flexibility, and reflect lifestyle choices that are meaningful to you. If you love to spend your hard-earned money on travel, then by all means, use your limited vacation time to the fullest, and book the expensive direct flights! But consider getting a roommate for the apartment you won’t be spending much time in anyways. The key is to cut corners in the realms you can live with, allowing for guilt-free indulgence in the areas that you really care about. If you’re self-conscious about keeping up appearances, consider that your peers may not even notice that you are keeping to a budget if you continue to enthusiastically engage in activities that really bring you the most enjoyment (which, in your case, just might be renting a one-bedroom so you can relish the peace and quiet).
Be honest – is it really more luxurious to make that big-ticket purchase to “treat yourself,” or would time and choice be the ultimate luxury? Why wouldn’t you want to give yourself every chance to have maximum optionality by the end of your third or fourth year as an associate, because you have sufficient resources saved up for this purpose?
About those student loans…
There will come a bad day at work (hard to imagine, I know), which will be made all the worse when you log into the student loans website and are confronted with your outstanding balance. You can minimize this feeling of entrapment by setting – and adhering to – as aggressive of a loan payoff schedule as you are comfortable with.
This does not mean, however, that you should refrain from getting started as early as possible with investing. There’s no substitute for the power of compound interest, especially since you took at least three years out of the workforce for law school.
It’s possible to nearly pay down your loan balances (even a couple of hundred thousand dollars’ worth) and build up a comfortable financial cushion within the first few years of work. A couple of sample budget illustrations are available here, and here on the resource-rich website, “The Biglaw Investor.”
“Order of Operations,” or where to allocate your money first
- Your employer’s 401(k), at least up to the employer match. Generally speaking, most young associates would be well-served by choosing the Roth (after-tax) contribution option, because this will allow you to grow a pot of assets that is forever tax-free after the initial contribution. (Employer matching funds are always pre-tax.) You should be able to set this up such that the website automatically allocates new account contributions into the fund percentages you have selected, and periodically rebalances as well. An aggressive approach (primarily in equity/stock index funds – look for those with the lowest expense ratios) is typically appropriate given that this is inherently a long-term account. Because you won’t be accessing these retirement funds anytime soon, you can probably afford to withstand shorter-term volatility (ups and downs) here.
- The minimum payments on your student loans. If you haven’t already done so, it’s worth looking into your refinancing options. Click here for a comprehensive guide that includes a repayment calculator so you can see how adjusting the interest rate will help you chip away at the principal balance faster (source: The Biglaw Investor). You may have better luck refinancing after a year or two at your new job, when your debt-to-income ratio will be higher – you can refinance more than once, and it need not be an “all or nothing” decision.
- Emergency fund. You should aim to have enough cash on hand to cover three to six months’ worth of expenses. This can be in a checking/savings account or money market fund, some of which are now yielding almost 2%. The key is that these dollars should be entirely liquid and accessible to you at the drop of a hat. The unfortunate truth is that things can happen outside of your control (what if there was a sudden cybersecurity breach at your firm that put your job in jeopardy?), but you’ll still need to buy groceries the next day.
- Additional payments towards your student loans. Pay as much as you can without infringing upon your ability to save for items 1 and 3 above, which should remain the priority. Once you’ve got these covered, the question of whether to pay down loans or invest becomes a bit more complicated. Generally you want to begin with the highest interest-rate loan, working your way down to the debts with the lower carrying costs. In the short term, it’s difficult to predict whether you are likely to earn a higher rate of return in the markets than you would by repaying the loan, but you can think of repayments as a “guaranteed” return of 3% (or whatever your interest rate is). Certainty always trumps uncertainty (the concept of “risk-adjusted return”), so I am in favor of doing some of each, with a bias towards loan repayment. The momentum that you pick up by aggressively paying down your loans will motivate you to continue along the path of financial responsibility and accelerate your savings.
- Health Savings Account (HSA), if you’re enrolled in a high-deductible health plan. Industry thought leader Michael Kitces recently placed HSAs as near the top of the tax-deferred savings hierarchy, because these accounts are “triple-tax free”: contributions are tax-deductible, growth is tax-deferred, and distributions for qualified expenses are tax-free. Unlike Flexible Savings Accounts (FSAs), there is no “use it or lose it” restriction on HSAs and the balance can usually be invested (again, low-cost index funds are recommended) once the balance surpasses a certain threshold. Unused HSA balances can even be used to pay for Medicare premiums during your retirement, so there’s no reason not to contribute – particularly given the rising cost of healthcare and the likelihood that you’ll need to tap into this account sooner than that.
- Continue adding to your employer-sponsored 401(k), selecting the Roth option, up to the employee contribution limit ($18,500 as of 2018, in addition to what your employer puts in).
- Personal brokerage account. Inevitably, you have financial goals outside of someday retiring – for this purpose, you should open at least one personal (taxable) brokerage account. You might even find that you want to open more than one, each with a unique risk profile and investment mandate (i.e. if you anticipate using this money within the next few years, it should not be invested as aggressively as another account that you do not intend to dip into anytime soon).
- Backdoor Roth IRA. You will likely be phased out of making a direct Roth IRA contribution due to your income level, but you can get around this by making a traditional IRA contribution and then subsequently converting it into a Roth IRA. As my colleague Zach Gering has written previously, Roth IRAs allow savers to invest in a tax-advantaged account, and withdraw capital after age 59 ½ tax-free (with some exceptions for earlier withdrawals, including a first-time home purchase). Don’t worry – the backdoor Roth is a widely used technique that has even been “blessed” by the IRS. Note, however, that you will have to pay taxes on the conversion, so take this into account when allocating how much cash you keep on hand.
You might notice that real estate (e.g. buying an apartment) isn’t on this list. “But aren’t I throwing my money away each month on rent?” you might be asking. Whether to rent or to buy is an extremely market- and lifestyle-specific question, but after factoring in the costs of home maintenance/repairs, property taxes, purchase closing costs, and (this is the big one) the opportunity cost of tying up capital that could otherwise be invested elsewhere, many people – particularly in the New York metro area – would actually be better off renting. I’m all for buying a place if you are doing it for the “right reasons,” such as wanting the security of ownership and finding a unit that you really love – just don’t make the (often misguided) assumption that real estate is necessarily a good investment.
Also not on the list: that complicated permanent life insurance product you barely understand. In the vast majority of cases, it makes sense to stick to cheap term coverage – which you should have in place particularly if you have a co-signer on your student loans or a spouse/child who is financially dependent on you.
When does it make sense to start working with a financial advisor?
Typically prospective clients come to us on the precipice of a significant life event (such as the birth of a first child) or when they have accumulated enough capital that they’d like help managing it as efficiently as possible. This often occurs in the fifth or sixth year or when an associate is promoted to partner, but it can certainly be sooner if an individual is a disciplined saver or did not have a significant student loan balance to begin with.
As Barron’s recently highlighted, the great thing about being an investor in 2018 is the plethora of advisory options out there for investors of all profiles and budgets. Wealthspire Pathways, available to individuals with at least $100K of investable assets outside of employer-sponsored retirement accounts, is one example of an increasingly common low-cost hybrid service model that combines automated investing and human advisors. Keep in mind that a holistic advisor should do more than just manage your investments – the relationship should reflect a broader understanding of your various financial goals (including philanthropy and family planning) as well as your tax picture and employment/income outlook.
If you’re not sure if you’re ready to work with an advisor, ask! Most advisory firms (whether in-person or online) will offer a complimentary initial consultation during which you will get some feedback on your overall financial health, as well as a sense of whether it makes sense to establish a more comprehensive advisory relationship. Check with your benefits department to see if your law firm already has a relationship with one or more advisors who are familiar with the firm’s benefits packages and compensation structure, which will streamline the working relationship and is often offered at a discounted rate to firm employees.
The Bottom Line
Your life is about to become quite busy and undoubtedly your workload will leave you with limited capacity to deal with personal financial matters. Make the investment of time and energy up front to automate your savings and loan payments. You’ll be glad you did.