The Investing Basics for all Stages
There are only two ways to invest assets: as a lender or as an owner. Every investment boils down to one or the other. You own stocks and real estate. Or you lend people money by buying a bond, i.e. lend the government or a corporation money; they pay you back along with interest for a set period of time. You might ask, what about cash? Cash when stored in a bank is actually being lent to said bank and then lent out to their customers. Think bond.
Ownership is riskier and should pay better than being a lender. Lending should be slow and steady. You need a blend of both. Also, don’t confuse insurance with an investment. Insurance is for the risk you cannot afford.
When investing, many people talk about the power of compounding interest, or earning interest on interest. The Rule of 72 is a shortcut to estimate the number of years required to double your money at a given annual rate of return due to compounding
interest. So if you get a 10 percent interest rate it will take 7.2 years for your money to double. Compounding interest is what makes your money work for you.
Many lawyers leave law school with what seems like an insurmountable amount of debt. This fact should not stop you from saving for your future. Young lawyers benefit immensely from saving in their firm’s 401(k) Plan. Although an $18,000 maximum contribution seems undoable, you should set aside some amount of your earnings. If your firm makes a matching contribution, it should be at least that amount. There is no good reason to leave “free” money on the table. As I often say, something is better than nothing. At the early stage of your career, you are used to living on first year wages and often you are working so many hours you do not have time to spend it. Regardless of your debt burden, pick a number and stash the cash in your 401 (k). It can even be $100 per month or pay period. Even this meager amount will start to
add up over time.
Now that you have decided to save for your future be sure you invest those dollars in something that has growth potential. Remember this money is for after you turn 59 1⁄2 years old as the minimum timeframe and ideally, if you plan appropriately, you will not draw on these funds until after you reach age 70 and the government makes you take a required distribution. When you start saving early, it enables you to get the most benefit from compounding interest and your money has the opportunity to get the most amount of doubling. Another prudent financial planning practice is to start an emergency reserve or saving account, with the goal of having three to six months of living expenses saved in cash. Additionally, now is the time to get your will and advance medical directives in place.
You want to be steadily increasing your 401 (k) contribution to maximize your contributions. For 2017 that number is $18,000. 401 (k) contributions provide two really powerful benefits. They lower your taxable income, and they provide tax-free growth of your money. As you start to increase your contributions to your retirement plan you will really see the power of compounding interest and you will see the numbers become bigger and bigger for the doubling. Your emergency reserve should now be six months of your living expenses sitting in cash to ensure you can financially handle an emergency. Now it is time to revisit and update your will and medical directive, and if you have started a family, you need to look to add guardianships and potentially a living trust. Additionally, consider term life insurance to protect your spouse and children. A guideline to determine how much life insurance is prudent is either ten times your salary or enough to cover your debts and any other big-ticket item for your children like college and school expenses. You want to ensure your spouse has choices. By this point most of you have already purchased a home or have started a home purchase nest egg. If you haven’t made the biggest financial purchase of your life yet, be sure to meet with a qualified lender to better understand what you qualify for and how much of a down payment you will need to amass.
At this point in your career, you are being sought out for your services. You want to keep up your 401 (k) savings but you also want to start an after tax investment account. The goal of this account is to save between seven and ten years’ worth of living expenses. Why, you might be asking? It is to take advantage of the Rule of 72. Now no one can predict the stock market, but if you give your 401 (k) nest egg seven to ten years of time before you start taking distributions, your retirement savings should double that last time. Often this last doubling is the most crucial as we are talking about the largest number of dollars at work. The math works the same to get you from $200 to $400 as it does to get you from $2,000,000 to $4,000,000. Everyone always likes the latter example better but it is still just compounding interest either way!
At this stage of your career you should again review your estate plan to see if you want to make any changes as your children start to have children and family dynamics often change. Perhaps you want to include your favorite charities.Also be sure to evaluate your medical directives and medical power of attorney.
Finally, at all career stages, it is paramount to sit down with a Certified Financial Planner to review your specific situation. If you’re just getting started it’s best to start down the right path. Mid-career, it is important to make sure you are still headed down the right path and determine if you need to make small shifts to better accomplish your goals. Pre-retirement you need to understand the financial implications of retiring before you unplug from your career and paycheck. Often, it is not that you cannot retire, but rather it’s a matter of ensuring that you are giving yourself options so you can live the very best life possible in retirement.