Top Ten Financial Planning Steps For Engineers
Financial Planning is more crucial to our personal wealth then ever before. I mean, it was always important, but past generations had a few more built-in mechanisms to get them to the promise land. Take pensions, for example. I think it is safe to assume that you won’t have a company sponsored pension that will pay you an annuity once you reach a certain age and/or tenure with the company. This was called “Retirement” because you were guaranteed to to be paid a certain percentage of your regular pay until you passed away (i.e. you could not run out of money as long as you did not over-spend). These pensions also come with access to Health Insurance until you were eligible for Medicare (in the U.S.). Of course, those days are long gone. Oh, and let’s not forget that Social Security, which is underfunded and unlikely to pay out the same size distributions that it has in the past. Therefore, we will have to plan for our own “Retirement”.
Before screaming blinding at the gods for lack of a fully funded pension and SS, let’s take a moment to appreciate one of the major draw-backs of the pension system. I am surrounded by people right now at my company that have ~5 years to go until they retire but are mentally and financially ready to go right now. However, they won’t go because there is a promise of even more money if they stick around another five years. The sunk cost fallacy and FOMO is driving people to do things they would not do otherwise. The scenario is often called the “Golden Handcuffs“. Oh, and that pension money can’t be transferred to your kids or grand-kids when you pass. You get the same amount of money if you live 1 day post retirement or another 30 years. All that money you earned is gone, no more. We can do better that this!
Okay, so what, exactly is “Retirement” when there aren’t pensions to define it? In the grand scheme of things, it is that point where you reach financial independence; that point where you go from working to have enough money to live to simply living (within some financial constraints). It doesn’t mean you are too old too work. It doesn’t even mean that you have stopped working. It just means that you get to choose how much and when to work because your basic lifestyle needs are already met with what you have in savings/investments.
Now, depending on your lifestyle choices (and how much you spend to support those choices) coupled with how fast you can accumulate savings, your retirement might happen in your 60’s, 50’s, 40’s, 30’s, or even your 20’s. You can’t know the future, and goals are for losers, so we will implement a strategy to give us flexibility for that future. Our friends over at Mr. Money Mustache have taken this thought and run it to the extreme by defining the minimal lifestyle that you will be happy with and then figuring out how much you need to make that happen until the end of your life. Good reading if you have the time.
To be fair, this advice could apply to anyone working in the post-pension world, but engineers fit a certain demographic. Hard workers, high earners, somewhat risk adverse, confident in their own abilities, maybe a bit too optimistic that things will just work out. Read below for a strategy that will get you where you want to go, wherever that might be. This list is probably most helpful for someone just starting out in their career, but it is never too late to make adjustments.
Have I convinced you why you should care retirement? Like, right now? Let’s get on it!
1.) MAXIMIZE YOUR INCOME
I know this seems obvious, but too many people will make the mistake of assuming that low wages now will mean high wages later. In reality, your salary is a negotiation with your employer (or your client if you freelance). They will pay what what they have to pay in order to have the right talent on board. This is not to mean that you should take any high-paying, dead-end job as opposed to a lower-salary but-with-great-upside job. It is to say that your future salary negotiations will be based on your current salary. So don’t be afraid to ask for the most you can get. Curious what is reasonable? Spend some time at Glassdoor or even talking to a recruiter in your field. You can even talk to your colleagues. I know, weird right? But why don’t we confide in each other a bit more? Why should HR have all the data? You might be surprised what you learn.
Along these same lines, don’t be afraid to develop a side hustle, including getting an advanced degree. Even though you might be fully employed, it doesn’t hurt to have other options open to you should something happen with your main gig. In the perfect world, your side hustle augments your main career path.
2.) MINIMIZE YOUR LIFESTYLE.
As your income grow you will need to fight hard to avoid lifestyle inflation. Lifestyle inflation is the human tendency to increase spending based on the size of your paycheck. The more you spend, then the more your friends spend, so the more you spend, and the next thing you know you are in a viscous cycle to the bottom. Why do we do this? Ego? The desire to look like we “made it”? Just wanting to have fun? I don’t know; probably a mix of all. But it is a trap that is easy to fall in to. This is not to say that you should not have fun or enjoy your free time. Quite the opposite, really. It’s just that you might need money to have fun TO A POINT (i.e. you need a car or uber to get the free beach) but there is very little reason to go beyond that point. Learn to enjoy life without all the material trappings and it will pay off dividends beyond simply saving money.
3.) SAVE. SAVE. SAVE.
If your (large as possible) paycheck exceeds your minimalist lifestyle the, Boom, you are saving. If you aren’t there yet then keep tweaking both until you are. Recall that interest on your saving grows exponentially, so do your best to think of future you enjoying a blissful financially independent life. Cutting back a little now can pay off huge in the future. If you still aren’t getting where you want to be then check out the various tools out there that can help with putting money away.
4.) INVEST METHODICALLY.
So you have money coming in and are saving it. Great! Now, what do we do with the savings? Here is where is all too easy to overthink things. There is no need to get fancy or take unnecessary risk. That will only make you more reluctant to do it. What you really need is a system that takes away some of the guesswork and allows you to stop stressing and start doing.
Here is the system I recommend:
a.) Put enough into your 401k to get the company match. Free money here! Do this from your very first paycheck. No exceptions! Okay, you are except if you don’t have a 401k because you are self employed. In which case, get an IRA!
b.) Get an emergency fund going. You would, ideally, like to have 6 months of living expenses banked. Since you are being smart and avoiding the temptation to inflate your lifestyle, this should be a very achievable objective. An FDIC insured checking or savings account is fine for this fund. You want it to be easy to access when you need it.
c.) Don’t accrue more debt. Pay off the debt that you currently have. For many, that debt will be a student loan. You were smart and got an engineering degree, so your ROI will be high. But you still need to get that monkey off your back.
d.) Get to the point where you are maximizing your 401k/IRA contribution. This may take a little time depending on your paycheck and current debt, but you will get there. The 401k contribution comes off your pre-tax salary, so this has the wonderful benefit of lowering your taxable income. Those taxes instead go right into your savings. Beautiful! Now, you will be taxed when you pull the money out in retirement, but you will have earned interest on those dollars for decades. Don’t get jealous, but you probably have neighbors that are multi-millionaires based on their 401ks alone. And, unlike a pension, this money can be given to someone else when you pass away. It is an awesome deal. Investment wise, do a bit of reading on the subject based on what offerings are available to you in your account. You will likely have a very low cost, diversified fund (like a lifestyle fund pegged to a retirement date) that you can pick up and make things really simple. There is probably even a built in tool that will help you with your choices.
e.) Still got money to stash away? Awesome! Open up a Roth IRA and maximize it every year. Unlike the 401k, the principle in this account is paid AFTER taxes. However, you won’t be taxed on your capital gains when you pull it out. And, because you have paid taxes already, the PRINCIPLE can be pulled out whenever you need to (but can only be put back in up to the maximum allowed per year, so think before you pull everything out!). After a few years of savings this account might be close to what you have in your emergency fund. Once that happens, this can become your high interest earning emergency fund. Again, you could pull out what you need (say, $10k for an emergency) but you can only put it back in at the limits for the year ($5,500k as of this writing, meaning that $4,500 dollars won’t get to enjoy the benefits of the Roth for that year. Not a huge deal but something to think about). So, only use it in an emergency. Which, you know, is kind of the point.
f.) Okay, now open up a fully taxable investment account through any number of online brokers. Initially fund it with money from your old emergency fund. This is not a day trading, gambling, stock-picking, chart reading, whatever kind of account. You just want to get exposure to diversified stocks. All you REALLY need are some free, no load ETF’s. You can also deploy a robo-investment company like Betterment or Wealthfront to do the trading for you. Do a bit of research here since the world is always changing. Avoid the temptation of thinking that you can day trades stocks and make a quick buck here.
e.) Planning on having kids, going back to school, or putting a spouse through school? Then open a 529 through your state. This is very similar to the way the 401k is structured, except that the funds will now need to go to educational expenses.
After that, start getting fancier. This is a great problem to have!
5.) STAY HEALTHY
There isn’t much you can do about a chronic illness or severe injury that ends up impacting your ability to live life to your fullest. But you can lay they ground work to make sure that you maximize the number of years you are healthy or to overcome an illness or injury that might impact you. Exercise, eat well, avoid being too stupid with your body. Talk to your doctor if you are having any issues; don’t be embarrassed because they have seen it all.
6.) HEALTH INSURANCE
A little bit of a rant there: It is absurd that we (in the U.S) have allowed health INSURANCE to be tied to our employer and then allowed access to health CARE to tied exclusively to that health INSURANCE. I get why it happened, but we can do so much better. And I am not even talking about single payer healthcare and/or universal health care. I am just talking about the fact that somewhere along the way the cost of health care got tied up into this insurance thing which was then buried underneath an employee benefits package. The result is that the cost of the commodity (health care) is hidden from the consumer and is now pretty much a fabrication that is disconnected from the market. Because it is disconnected from the market, there has been very little pressure to drive down the real cost of the commodity. And that high, fabricated, cost has prevented us from having a real discussion how to provide health care to everyone. We are just stuck in a circular, political argument. I am crossing my fingers that this is the the next field to be disrupted since the fact that your employer controls your health care, but not your pension, is just absurd. End Rant.
Until that happens, though, you will need to buy insurance through your employer or on your own. If you are young and generally healthy, I would recommended going for the high deductible plan with an HSA. Don’t be scared off by that high deductible either. What it is really doing is allowing you to put the money that you would have spent on premiums right into your own (disconnected from your employer) Health Savings Account. With a bunch of healthy years under your belt, that account can really grow in size to help offset the cost of a bad year down the road.
If you want to branch out own your own, then you will need to look at purchasing insurance on the open market or through the Affordable Care Act Exchanges. It can be expensive, so shop around and plan accordingly.
7.) GET LIFE INSURANCE
If you have a family, and you provide a significant amount of the income for the family, then make sure you have enough insurance to replace your income until your youngest child turns 22, including the cost of college. Get this when YOU are young and healthy and is a CHEAP way to have piece of mind. Get an insurance plan on your OWN, not JUST through your employers group plan. It is okay to pick up cheap supplemental insurance from your company, especially since the first couple of tiers are practically free, just don’t rely on it for the bulk of your insurance needs. Just think of it as a bonus. Why? Well, if you buy through your employer it is likely NOT transferable when you leave. Should you develop a chronic illness, your individual rate will jump through the roof. What you pay through your group plan shouldn’t go up…as long as you work for that employer. As soon as you leave that company then you won’t be able to afford life insurance. Ouch.
Anyway, talk to an insurance agent to get the most accurate details, but a cheap whole life plan when you are young that is supplemented with cheap term insurance as you get married and have children, will give you a nice mix of insurance without paying through the nose. I, personally, avoid looking at insurance as some form of investment. You most likely have better options than that (ugh, go read Step 4 again).
8.) LEARN TO DO IT YOURSELF
You can tell from this site that I am kind of big on DIY. In fact, it is my main hobby at this point (outside of running/biking). I have always been in to building things and am a big supporter of the Maker Movement. In fact, this willingness to be hands on is why I became an engineer in the first place and has really set me apart in my career. It truly is shocking how few people know how to use basic tools (sigh). Anyway, learning how to do things your self has all kinds of tangible benefits:
Save Money – I guessitimate that I save, on average around $5-10k a year by DIY’ing. A self funding, even profitable hobby? You better believe it! Some things, like doing your own large-scale drywall plastering, are rarely worth it to do on your own (too much of a learning curve) while other things are easy money.
Build Confidence – At this point I figure that there isn’t much I can’t learn and execute from studying YouTube. Even the website is an example of “following the bouncing ball” until I have a site that actually functions and looks semi-professional.
Protect Your Main Investment – If you own a house or condo then you have more than enough projects to keep you busy. If you get really in to it, then you could always buy up fixer-upper homes and flip for some side income.
Be Smarter When Hiring Pros – We don’t have time to do everything ourselves, so sometime it makes sense to outsource. If you have an idea of how something should be done and an idea of how long it would take you to do, then it makes it much easier to evaluate if a quote from a pro is reasonable.
Be Okay Even If There Is No Pro To Hire – Sometimes hiring competent help can be more difficult than just doing it yourself. A while back I wanted to plumb in a utility sink in my basement so that I could keep the really dirty stuff out of my laundry sink. I tried to hire to someone to do it but hardly anyone would come out to quote! I finally got one plumber to show up and I could tell he just really didn’t care to do the work. I think the opportunity cost for my smallish job just was not worth it for these highly paid professionals. With literally no other option, I just went for it.
Skill Stacking – You just never know how something you learn from doing some random task can augment other skills you already have. I also believe that developing skills outside of your core discipline really helps to strengthen that discipline, even if some of the benefit it just walking away for a bit and thinking about something else for a while.
Developing Outside Interests – If I wasn’t trying to save money on my first place by creating my own art to go over the mantel then I never would have found out how much I enjoyed creating art. So being brave and trying to do-it-yourself could very well lead to finding other interests that get your life going in unexpected directions.
9.) REVISIT YOUR PLAN YEARLY
Let’s go full circle now. Dump all of your assets and debts into a financial aggregating tool like Mint. It is a great way to see how you are doing year over year and can act as a great reminder to check in on your investments. It also makes tax time much easy.
Things to ask yourself: Are you spending less than you are earning? How much are you spending per year? Do you feel like you are missing out and need to earn more? Or are you pretty comfortable with where you are at? What about the future? Do you have any big changes on the horizon, like getting married, having kids, or changing careers? Could you be doing better?
Still saving? Cool. Keep going. Need to adjust or call in some outside help? Reach out to an independent financial adviser and get their take on it. Just intervene early while time is on your side.
10.) RETIRE ALREADY
So, when can you call it quits and sit on the beach all day? This is a deeply personal decision that has more to do with how much you love your career, what you would do with your time if you stepped back from your career, and how much risk you are willing to live with. Financially speaking, a safe rule of thumb is that you will never run out of money if you can live off of 4% of your total savings per year. I won’t repeat the math here, but this should be your financial goal. True financial independence.
So, like I said in the intro, retirement does not have to mean sitting on the beach all day. It really just means financial security and independence. What would you do all day if you didn’t have to go to work?
Good Luck! – Brandon
Disclaimer: I am NOT a financial planner! Your individual needs may differ significantly from what I have written above. Ailing parents, inheritance, health issue, tax issues etc. can easily put you into a more complicated category. If in doubt, sit down with a certified financial planner who is working on YOUR behalf, not that of a bank trying to sell you an investment.
