Where the smartest get stumped - Financial Planning for the new techie
This post is a one that strays from the normal path at The Elbow Patch. However, I do believe it is a very important topic for the intended audience - The science or tech professional of today.
I work with young data scientists and engineers on a day to day basis and many a time, our conversations turn from discussing models and business problems to discussing personal finance and life goals. I have to say, I am very impressed with this generation of professionals joining the workforce. Many of them are focused on life goals quite early in their career and are keen to seek advice and acquire learning that will help them lead responsible lives.
On the other hand, these eager young minds are the minority. Today's starting salaries especially in fields like data science is very high compared to any other profession (and for a fair reason). Think about this: The current average salary in the US is $50,000. However a software engineer or data scientist can walk right out of school and command salaries of $100K, sometimes going up to $150-200K in the tech hubs like silicon valley. It's easy when you are earning that much to give in to temptations like fancy apartments and expensive cars. Let's also not forget the fat student loans from the over-priced education of today.
Technology today is also changing rapidly. We have to constantly keep up and the work pressure to deliver products at speed today is unbelievable. A young professional today is probably spending 8-10 hours of active work, 1-2 hours of keeping up with technology, and another 1-2 hours of studying or pursuing side projects to boost their portfolios. In essence, I see a higher chance of this generation of professionals burning out. A vast number of young professionals are targeting early retirement as they are aware of this fact. In the simplest sense, it is time to view your life as a professional sportsman who has a short shelf life rather than a white-collar professional who spends 40 years in the workforce.
I think I have established fairly well why this article is necessary. So it is equally important for a professional to be financially literate and well aware of how to put this money to good use. As data-savvy as data scientists like to call themselves, they do suffer from the lack of awareness of how to invest money. It's easy when you are working numbers but have no personal relationship with them. It's a whole different ball game when you are writing models for your own money.
So, I wanted to write this post with some considerations and resources that I hope will help new professionals joining the workforce (not just data scientists or engineers) plan their financial life.
So let's jump right in and discuss some financial goals that every person should have
Ideally, you should save at least 3-6 months of salary in an emergency fund. This might be a daunting ask for someone who is setting out. So I would suggest starting with a goal of 1 month and then slowly finding your way to 2, 3 and finally 6 months. Traditionally it was suggested that one holds this money in a high yield savings account or deposits (CD's). However, in today's low-interest environment, that is not practical at all. My suggestion is to keep one month's expenses in a high yield savings account (like Ally) and the rest in a stock investment with a 60/40 split between stocks and bonds. Don't get scared by the 60/40 stock-bond allocation advice. No one is asking you to be a trader here. You can quickly set this up with a service like betterment that makes this process easy for you. Check this article out for more info on why investing your emergency fund is a good idea.
Now that we have saved our emergency fund, let us start working on our retirement fund.
I'm sure there are a few of you thinking "hey I am just 22. Shouldn't I worry about retirement at 50 or something?"
Remember what I said earlier about thinking like a professional athlete? You may burn out much sooner or choose to retire early and spend your life traveling. Secondly, let's leverage the advantage of compound interest. To make a million dollars at age 60, you only need to save $360 per month if you are 25 vs $1000 if you start at 35 or a whopping $3500 if you start at 50. You can see why you should worry about retirement now rather than at 50.
OK, so now you get the point. How then do you invest? Welcome to the wonderful world of tax-advantaged accounts. If you are a tech professional working at a company, chances are you are already enrolled in a 401K. There are multiple advantages to your 401K.
You get to save taxes now. Currently, you can save up to $19,500 of pre-tax income a year. In simple English, you do not have to pay taxes on that $19,500 of your income.
Most companies (especially tech companies) have attractive 401K matches. This is free money. at $0.25 for every $1, a $19,500 investment into your 401k generates an additional $4800 of investment by your company into your 401K. Do not miss out on that investment
The investments in your 401K account grow tax-free.
I see this as an advantage though my financial advisor friends would frown at this. As you grow your 401K, it is a source of loans for life events like buying a house or higher education. Your credit is not hurt and you pay the interest on the loan to yourself. Very cool!
It is pretty simple. Go ahead today and max out your 401K. If you don't know what to invest in, just pick a target-date retirement fund with the year you will be 60. If you want to be savvier, just invest it all in a total market fund like VTSAX or add about 20% of bonds (VBTLX) to smooth the ride. Just put your money in and forget about this investment, irrespective of what the market is doing.
Now that we have the Retirement fund out of the way, let's talk about other goals in life like early retirement or taking a year off to travel the world or even funding your own entrepreneurial venture.
This is where your ROTH IRA and taxable accounts come in. Especially in the early stages of your career, you qualify to invest in a ROTH IRA if your pay is under the IRS limits for a ROTH. If you don't, congrats on the good paycheck and do not fear. You still have the Traditional IRA that you can use. However, if you can contribute to a ROTH, I highly suggest it as you can pull out money from your ROTH without any penalties after 5 years. This liquidity is very valuable especially if you have a goal like early retirement.
Currently, you can contribute up to $6500 (as of 2020) annually to either a ROTH, Traditional, or some combination of the two. You should max this out every year. Invest it using the same formula as the 401K. You can start this at a traditional brokerage like TD Ameritrade where you might have some more room with your investment choices, or go with an option like betterment where someone else takes care of the headache for you. Either option is good.
Once you have exhausted the option of the IRA, start parking the rest of your savings in a taxable trading account. Again, you can choose a traditional brokerage like TD Ameritrade where you might have some more room with your investment choices, or go with an option like betterment where someone else takes care of the headache for you.
A Quick Case Study
I am going to take some liberties here to drive the point home. Your tax calculations may be different. So please bear with the intent here.
Let's consider Sarah, who is a new data scientist making $100K a year. Combining federal taxes and state taxes, she would be paying a tax rate of 30%. Sprinkle medicare and social security taxes and we are looking at about 32%. So in effect, if Sarah does not save anything, she is going to end up paying $32,000 in taxes.
Let that sink in. $32,000 in taxes!
let us take the case of maxing out the 401K. Sarah's income is now 80K and her taxes are $25.5K, a full $6K lower than the base case.
With a traditional IRA contribution of $6500, Sarah's taxes are now lower for two reasons - lower taxable income and lower tax bracket.
By maxing out her 401K, Sarah has potentially earned another $5K in company matches
So in effect, Sarah could save close to $10,000 by just saving money in the right investments. By saving another $360K of post-tax income in a taxable account, Sarah can add another $1 Million to her net worth by the time she is 60. Pretty cool right?
Keeping it simple is the best idea here. Target saving 50% of your gross salary. Max out your 401K, max out your IRA, and save the rest in a taxable account. Do not get swayed by the stories of people making a quick buck by timing the market. It is unsustainable. Invest in ETFs or market funds like VTSAX. Even the great investors like Warren Buffet recommend this strategy. Check this article for more.
I hope this blog post at least gets you to start thinking about your financial future. Remember that we are all gifted with the opportunity of working in such a good profession. Let us be responsible for the opportunity we all have.
I have mentioned some products and have made some fund recommendations throughout this article. I personally use these services and invest in these funds and so am providing them as examples you can consider. This article is only meant to get you to start thinking about your financial future and should no way be construed as qualified financial advice. Please do your own research and consult with a financial advisor before you invest.