The Biglaw Investor http://www.biglawinvestor.com Sun, 19 Feb 2017 13:25:32 +0000 en-US hourly 1 https://wordpress.org/?v=4.7.2 http://www.biglawinvestor.com/wp-content/uploads/2017/01/favicon.png The Biglaw Investor http://www.biglawinvestor.com 32 32 111859200 Budgeting is For Professionals http://www.biglawinvestor.com/budgeting-is-for-professionals/ http://www.biglawinvestor.com/budgeting-is-for-professionals/#comments Fri, 17 Feb 2017 11:00:00 +0000 https://www.biglawinvestor.com/?p=2265 Check out The Biglaw Investor or read Budgeting is For Professionals

In the previous post of this two-part series, I argued that budgets are for beginners. Why box yourself into projected spending when you can review an automatically generated spending report and adjust accordingly? Today we’ll argue the other side. To understand why budgeting is for pros, let’s first think about professional athletes. I can think […]

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Check out The Biglaw Investor or read Budgeting is For Professionals

In the previous post of this two-part series, I argued that budgets are for beginners. Why box yourself into projected spending when you can review an automatically generated spending report and adjust accordingly? Today we’ll argue the other side.

To understand why budgeting is for pros, let’s first think about professional athletes. I can think of no better example than fan favorite Roger Federer, who recently secured his 18th Grand Slam title at the Australian Open in January. Federer is the all time leader in Grand Slam titles (his nearest competitors are Pete Sampras and Rafael Nadal, both tied at 14) and is making the case for being considered the greatest male tennis player of all time.

Federer’s win at the Australian Open is even more impressive because he’s 35 – long past the “prime” of his career – and the fact that he hadn’t played in a grand slam event since Wimbledon in the summer of 2016 due to a knee energy.

So, how did he get back on top?

As I recently had reaffirmed in Grit (thanks for the recommendation Anita), remarkable accomplishments like winning the Australian Open are a combination of thousands of unremarkable steps that happen behind the scenes. Humans, however, are quick to invoke “talent” when describing these remarkable feats. Why? Because it’s a defense mechanism employed by our egos that lets us know that we don’t need to compete with Roger Federer. Had we seen how Federer practices each and every day – and how ordinary that all seems – we might start to put pressure on ourselves to do the same. And, if we don’t live up to that expectation, then maybe we’re not as good as Roger Federer.

So we fall back on describing Roger Federer as having innate “talent” that we could never possess. It’s easier.

Professional athletes aren’t immune from this thinking as well. If you’ve ever taken an interest in elite athletes, you know that they’re all doing everything humanly possible to compete at the highest level possible. The perfect diet? Check. Insane workout schedule? Done. For an elite athlete, they’d be willing to do almost anything to achieve an extra 1% edge. That 1% edge could blow the competition out of the water.

We see this with the rampant use of performance enhancing drugs. When you’re that competitive, any edge is the difference between winning and losing. There’s a great documentary on this called Bigger, Stronger, Faster but the premise is pretty simple. When you’re elite, you’re not looking at making 10% or 20% gains. You need the slightest edge to overcome your competitors because the slightest edge is all that’s left.

So, if you’re a personal finance ninja, what can you do to get a 1% edge? Why, you could budget of course.

Budgeting lets you dial in your expenses exactly. You Need a Budget (YNAB) has a pretty easy explanation of how budgeting works.

  1. Give Every Dollar a Job. All incoming money needs to have a specific purpose. You’re in charge, so you chose and prioritize appropriately.
  2. Embrace Your True Expenses. It’s those large, less-frequent expenses that are messing up your budget. Instead of dealing with them as they come up, take the lumpy expense and divide by 12. Now you know the true cost of your expenses each month.
  3. Roll With The Punches. Boxers move in the same direction as the punch to lessen the blow. When (not if) you overspend in budgeting, just keep going. Be flexible.
  4. Age Your Money. The money you spend today should be the money you earned last month. There’s no stress if you’re spending the previous month’s earnings because you’re not worried if you have enough money in the bank to cover a credit card bill.

It’s easy to see why this approach could lead to less stress (if you stay on top of it) and zero margin for mistakes.

For one, you’re being intentional about each incoming dollar which means you won’t be allocating it to that Hulu subscription you never use. Second, you’re paying attention to your true expenses. Fixed monthly expenses are the easiest when it comes to budgeting. In fact, it’s so easy that you could do all the budgeting in your head.

But your budget isn’t entirely made up of fixed expenses.

First, there’s the variable expenses (e.g. electricity). But those aren’t that hard either, because they don’t move up or down by very much.

But what about Christmas gifts? Do you know your annual travel expenses? These are much harder things to include in a budget. Most people just deal with the expenses as they come up, but with YNAB you’re forced to think about them and account for them on a monthly basis.

After that, it’s all about being flexible. When you overspend in one category, you need to shift money from another category or you have to carry the negative balance into the next month. That’s pretty much how money works. You can’t spend money you don’t have without going into debt. It’s a simple concept, but something that is easy to miss. If you’re making a lot of money, you won’t even realize that you’re borrowing from yourself until one month when you overcorrect and cut all spending to get back on track. We’ve all had those situations.

Before I started budgeting with YNAB, things like a tax refund or a month with three paychecks were my opportunities to reset.

Does that sound like something you’ve done?

If so, you might be doing a great job saving a lot money, but could you be doing 1% better. What would happen if you banked the entire third paycheck or tax refund rather than using it to pay off a credit card bill that got a little higher than you expected? For some, this might be a big deal. For others, it won’t matter. Each person needs to find the right balance.

Whatever you decide is best for you, I’d hate for anyone to think budgeting is hard.

My YNAB system is pretty simple. It works like this. Each month I get paid. Each month I record an entry showing that my paycheck arrived and I categorize it as money that’s available next month.

On the first of each month, I “budget” for the month by clicking one button that auto-populates that month with the budget amounts from the last month. I tweak as necessary. Included in those monthly expenses are things that I pay for yearly (like Christmas gifts or my Dropbox subscription). I suppose you could say that I’m “saving” money for these yearly expenses but I just look at it like I’m spending $100 a month rather than saying I spend $1200 each year on Christmas gifts.

Then, I record expenses in the system as they occur. This is much like balancing a checkbook or using Quicken. It takes me about 15 minutes a week and it’s only slightly harder than reviewing my actual credit card statement to make sure there aren’t any incorrect charge. As I enter each transaction, YNAB takes the category information for the entry and applies the expense to the budget. At a glance, I can quickly see how much I have left in each category (much like a digital version of the envelope system).

Inevitably, I screw things up during the month. I spend more than I anticipated. I have an annual bill that I forgot to put into the system. To handle it, I simply re-allocate money from another category (or bring in new money from savings) and keep going. If it’s an annual expense, I create a new budget category and start allocating $10 a month (or whatever it is) each month towards the expense.

Using YNAB has been a game changer when it comes to (1) thinking about money and (2) dialing back expenses. First, I never feel guilty about spending money. If it’s in the system, I’ve already accounted for it and if it’s not, I just move some money over. That means when a quarterly expense comes up, I don’t think “Oh shit, it’s time for that expense … guess I should spend less on restaurants this month.” Instead, I just pay the expense and move on. Second, no money goes out of the door unnoticed. This is a pretty powerful motivator to make changes when I’m spending money on something that isn’t maximizing happiness. Third – and I can’t emphasize this enough – with YNAB, managing my finances really is a “mind like water” experience.

I was always saving a lot of money before. But now, I’m saving even more and I hardly think about it.

Yet, I know that many readers don’t want to budget. In the previous article, Budgeting is For Beginners, I went over all the reasons why you don’t need a budget, so I won’t rehash them here. If you’re not budgeting, you’ll probably be just fine. Pay yourself first and it’ll all work out okay. But if you want mind like water or to be a pro that wants the 1% edge, give budgeting a chance.

Let’s talk about it. Do you budget? Is budgeting worth all the hassle just for an extra 1% gain? Comment below!

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Budgeting is For Beginners http://www.biglawinvestor.com/budgeting-is-for-beginners/ http://www.biglawinvestor.com/budgeting-is-for-beginners/#comments Wed, 15 Feb 2017 11:00:00 +0000 https://www.biglawinvestor.com/?p=2262 Check out The Biglaw Investor or read Budgeting is For Beginners

Budgets are often a hot topic. Some see them as essential, while others have no interest. This is the first of two articles I’ve written that look at budgeting through a pro/con lens. Today I argue that Budgeting is for Beginners. (See the follow up post: Budgeting is for Professionals). First, it’s probably worth taking […]

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Check out The Biglaw Investor or read Budgeting is For Beginners

Budgets are often a hot topic. Some see them as essential, while others have no interest. This is the first of two articles I’ve written that look at budgeting through a pro/con lens. Today I argue that Budgeting is for Beginners. (See the follow up post: Budgeting is for Professionals).

First, it’s probably worth taking a second to make sure we’re all on the same page when it comes to defining a budget. A budget is a spending plan. It’s a forward guess as to where you’ll be allocating your dollars for the current month and beyond. It gives you a bird’s eye view of expenses so you can make sure that your expenses line up with your values and expectations. A spending report is not a budget. Budgets are done in advance of the actual spending. To budget, you’ve got to come up with numbers that reflect your expected spending for each category. Once your money runs out from a category, you have to do two things: either (1) stop spending or (2) allocate funds from a different source to the category.

For many people, budgeting has two major problems. It implies guilty feelings when you overspend in a category and it’s generally a pain in the ass to keep track of everything. If you’re like most people, you’ll often find that budgets are also pretty boring since they look the same each month.

In fact, most lawyers could probably get away with as little as six months of budgeting (here’s a budget for a first-year associate). Once you establish how much money is coming in and how much you want to save, does it really matter how you divide up the “spending” portion? If you’re budgeting with a significant other, most of the budget fights are going to happen in the first few months of living on a budget. After everything is ironed out, spending will be on autopilot and it’s hard to imagine fighting over something on month 18 (unless you never really resolved the original conflict).

The other big reason to avoid budgeting after six months is that the big decisions have all been made. You’ve already decided what job to take (income), the type of housing to buy or rent, what type of care to drive, etc. You’ll be left with only projecting whether household expenses should be $100 or $150 next month, which isn’t likely to have a major impact on your long term success.

The other reason why lawyers might not need to budget is because it’s a lot of work when you can have an online service creating a spending record for you automatically. For example, if you hook up your accounts to Mint, you only need to check in after each month, review the data and then decide if you’re going to alter spending habits going forward. Spending reports take a lot less work and trigger less guilty feelings (i.e. I spent $X last month on restaurants, which was a bit more than I wanted, but that’s okay because I’ll spend less this month).

IF you’re a little more hardcore, rather than using Mint to develop a spending report, you might have a spreadsheet that keeps track of your fixed and variable expenses. Since the fixed monthly costs (housing, cell phone, insurance premiums) don’t change, they’re the ones staring you in the face and daring you to lower them. If you work on reducing your fixed monthly expenses, you’ll free up more cash flow which will allow you to save more money (shocking, I know). While it might seem straightforward, spending records are usually very helpful in reducing fixed expenses. If you decide you want to save more, a spending record makes it pretty easy to see that you can get some big wins by going after your biggest monthly costs.

There really seems to be only a few different types of people when it comes to spending money: (1) you have the people that don’t budget or track anything, but simply look at their bank account balance to determine how much money they have to spend; (2) next, you have the “pay yourself first” crowd that sets a savings target, moves that money out of their spending account each month and then spends the rest as they please; and (3) people that allocate each incoming dollar to a specific purpose and then follow up throughout the month to see whether the dollars are being spent as expected.

If you’re in the first category, a budget could be really helpful in getting a grasp on spending. If you predict that you’ll spend a certain amount of money in different categories and then find you’re spending 3X your expectation, perhaps you’ll change your behavior accordingly. Financial spending is like eating, something we do every day and something we’re drastically likely to underreport in our own mind.

If you’re in the third category, a budget might be an over obsession with your spreadsheet. It’s not at all uncommon for a new grad with $200K in loans to become hyper-focused on a spreadsheet during the early years. While watching every penny can lead to financial success, it can also promote burnout and there’s something to be said for whether you might have a better use for your time such as making a little side money or developing other skills.

Another reason to skip a budget, is that your income should be increasing over time. Is there any point to budget if you focus on paying yourself first and saving your raises? What does it really get you to save an additional 1%? Have you shaved off 3 months from your retirement date? And, again, wouldn’t that time be better spent finding something to do now that you enjoy? Sure, you may waste a few dollars here and there but you’ll probably be happier for it.

For all of these reasons, I come across many people that are “Post-Budget”. Interestingly, many are still eager to talk about budgeting and whether they should be doing it or not. Most seem like they’re looking for justification and reinforcement that budgeting isn’t necessary. I’m happy to oblige. As long as you’re making conscious decisions and reviewing a spending record, these people will be just fine by focusing on their savings rate, making good investment decisions and increasing income.

Let’s talk about it. Have you budgeted? Would you describe yourself as “Post-Budget?” or do you budget now? Comment below!

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Finding Your Personal Efficiency http://www.biglawinvestor.com/finding-your-own-personal-efficiency/ http://www.biglawinvestor.com/finding-your-own-personal-efficiency/#comments Mon, 13 Feb 2017 11:00:00 +0000 https://www.biglawinvestor.com/?p=2240 Check out The Biglaw Investor or read Finding Your Personal Efficiency

There’s a lot of advice on the internet about how to save money. You could cut the cord or stop drinking lattes. You might sign up for one of those fancy new apps that rounds up each transaction and shuffles the extra change over to your savings account. The problem is that I have no […]

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There’s a lot of advice on the internet about how to save money. You could cut the cord or stop drinking lattes. You might sign up for one of those fancy new apps that rounds up each transaction and shuffles the extra change over to your savings account.

The problem is that I have no idea if these are good ideas for you. There’s a saying that we shouldn’t forget that personal finance is personal. What might seem like an unnecessary expense to me could be something that’s very important to you.

The information that’s out there is only helpful in finding your own personal efficiency. But that hard work is creating it. Like a custom suit or dress, your own personal efficiency is personal to you.

When you figure out what’s unimportant and not contributing to your happiness, be ruthless in cutting it out. For me that’s cable TV, cars and owning a fancy home. They just aren’t priorities right now. But good luck convincing me to drop a house cleaner, U.S. Open tickets or trips to the Caribbean. Those are expensive and (in my mind) worth every penny.

The important part is making conscious decisions with your money and creating an efficiency that works for you.

You can’t do this unless you know what you’re spending.

You can’t know what you’re spending unless you track it.

Therefore, the first step is to figure out how to track your spending. You can sign up for an account with Mint and let it do it automatically. Or, you can use a service like YNAB which will require a little more work on your part.

If you’re not ready to commit to either of those, you can simply look back at your expenses over the last month. The reality is that you probably have a lot less transactions than you think. In less than an hour you can tally up everything into rough categories to see where the money is going.

How many monthly subscriptions do you have for services that you aren’t using?

How many bills are $20-$30 higher each month than they probably should be?

Are you comfortable with the amount of money you spent on food? Alcohol?

Once you take the time to add everything up, it’s actually pretty easy to start making a few cuts. Certain transactions will jump out at you as wasteful based on your own personal criteria.

This is an important point. You won’t see these transactions and think “oh wow, I really don’t want to stop spending money on that”.

Instead, you’ll see these transactions and say, “What the heck was I thinking?! I don’t even watch Hulu. How long has that been going on?”

Efficiency is a beautiful thing. They say that when our thoughts and actions don’t line up, it creates cognitive dissonance. There’s a nagging feeling that you carry around with you that you should be doing something different.

When you’ve created your own personal efficiency, you never have these thoughts. You spend money consciously and without concern because it’s exactly what you intended. When you’ve decided that those incoming dollars have a specific purpose, you won’t think twice when they go out the door to fulfill that purpose.

Let’s talk about it. What are you doing to create your own personal efficiency?

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NY’s Telecommuting Tax Penalty http://www.biglawinvestor.com/new-york-telecommuting-tax-penalty/ http://www.biglawinvestor.com/new-york-telecommuting-tax-penalty/#comments Fri, 10 Feb 2017 11:00:00 +0000 https://www.biglawinvestor.com/?p=2194 Check out The Biglaw Investor or read NY’s Telecommuting Tax Penalty

Did you know that some states have regulations requiring both residents and non-residents to pay state income taxes on all income earned from a company that’s located in that state even if the employee lives and works in a different state? Neither did I. Did you know that New York is one of those states […]

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Did you know that some states have regulations requiring both residents and non-residents to pay state income taxes on all income earned from a company that’s located in that state even if the employee lives and works in a different state? Neither did I. Did you know that New York is one of those states along with Delaware, Pennsylvania, Nebraska and New Jersey?

I realize this will only apply to select group of readers, but I think it’s worth pointing out all the same: If you work remotely for a company based in New York, Delaware, Pennsylvania, Nebraska or New Jersey, even if you physically never step foot in those states, you may be subject to state income tax in those states.

The reason why I think this is such an interesting topic is the general trend to decentralize work. At my firm we have multiple associates that work remotely. One that I work with frequently is based in Florida. Her husband is a cardiologist, so she told the firm she planned on following him to Florida when he found a job there. The firm didn’t object and she’s been working remotely ever since.

As a Florida resident who never travels to New York, I always assumed that she didn’t pay New York state income taxes. And, since Florida doesn’t have a state income tax, I further assumed this to be a great deal for her as she effectively saves around 10% on state and city taxes while still being paid at the New York market rate.

This is every New Yorker’s dream. Get established in New York. Make New York money. Move to sunny Florida and successfully fend off New York’s inevitable challenge to your claimed change of domicile. Pay no state income taxes on your income. Is it too much to ask?

When I first heard about this, I assumed it couldn’t possibly be true. How does a state even have jurisdiction over a nonresident? The New York State Department of Taxation and Finance has a memo that is clear on the law.

Section 601(e) of the New York State Tax Law imposes a personal income tax on a nonresident individual’s taxable income that is derived from New York sources. The tax is equal to the tax computed as if the individual were a New York State resident for the entire year, reduced by certain credits, multiplied by the income percentage.

Naturally, this law has been challenged. In Huckaby v. New York State Division of Tax Appeals (04-1734), a New York state court found Thomas L. Huckaby liable for taxes on 100% of the wages he earned from a New York employer while working from his home in Tennessee, which has no state income tax. Although Huckaby, a computer programmer, worked approximately 25% in his employer’s New York office, he admitted he worked from home most of the time for personal reasons. The New York Court of Appeals, the state’s highest court, upheld the decision. To be exempt from New York taxation, such wages must entail “duties … which by their very nature, cannot be performed at the employer’s place of business,” the court said.

While most states apply a “physical presence” test, New York applies a “convenience of the employer test.” In other words, in New York the income must be earned by work performed out of New York State for the necessity of the employer, rather than out of convenience.

As you can imagine, there aren’t a lot of reasons why it’s necessary to work for a New York company outside of the state of New York. However, imagine working for a New York company that requires you to spend all of your time in Alaska working on an oil pipeline. In that scenario – or any scenario where your employer requires you to live outside of New York – you shouldn’t be subject to New York State income taxes. But if you’re living in Florida because it’s sunny? That’s just convenient for you (and it turns out, convenient for New York too).

One of the many problems with the Huckaby case is that it’s quite old. The Court of Appeals upheld the ruling in March 2005. Huckaby himself worked remotely from 1983 until 1991. This case has nothing to do with modern “telecommuting” trends and is clearly outdated. But it’s good for New York, so I don’t expect the state to change it anytime soon.

There’s also the possibility of double-taxation, since the state where you are a resident will still want its fair share too (if there is a state income tax). While there should be tax credits to mitigate the double-taxation, it obviously bears further research if this situation applies to you (or if you are planning on doing something like this in the future).

New York provides some guidance on how you can be exempted from paying nonresident taxes if you meet certain factors. Those possibilities are set forth in TSB-M-06(5)(I). They’re unlikely to apply to a lawyer that is working remotely for a New York firm.

Meanwhile, Congress has been trying to do something about the problem. The Multi-State Worker Tax Fairness Act aims to abolish the “convenience of the employer” test and force all states to rely on the “physical presence” of the employee. It most recently died in 2014 but apparently was reintroduced in 2016. According to the AmericanPayroll.org article, New York state opposed the legislation. That’s hardly surprising since they’ll see a loss in taxes.

It’d be good to see federal legislation enacted to straighten out this mess. Even if you live in a state where the double taxation problem is eliminated by credits, it doesn’t make any sense to force a taxpayer to file two separate returns.

How did this work out for my colleague? Well, if you’ve been following the thread, the key part is New York sourced income. I wouldn’t be surprised if she’s employed by a different office of the firm (maybe the one that rhymes with Boshington TP), thus avoiding the problem. I didn’t want to ask.

Nonresidents Do Not Pay NYC City Taxes

This is routinely misunderstood, so I thought I’d take a second at the end of the article to make sure it’s clear. If you are not a resident of NYC, you do not pay NYC taxes.

This wasn’t always the case. It was only in the early 2000s that New York City stopped taxing non-NYC residents for income earned in NYC, hence the reason why it’s still largely misunderstood (especially among NYC natives).

This means that if you live in New Jersey, Connecticut, Long Island or even Florida, the long arm of NYC won’t reach you there (above we’re just talking about state taxes).

Further Reading:

Hat tip to MissBonnieMD who alerted me to this blatant money grab by the state of New York.

Let’s talk about it. Would you be interested in working remotely for a company in New York?

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What’s the Average Market Return? http://www.biglawinvestor.com/whats-the-average-historical-market-return/ http://www.biglawinvestor.com/whats-the-average-historical-market-return/#comments Wed, 08 Feb 2017 11:00:00 +0000 http://www.biglawinvestor.com/?p=2110 Check out The Biglaw Investor or read What’s the Average Market Return?

Knowing what the “market” returns seems like a basic fact. You probably just type it into Google and two seconds later you get your answer. Surprisingly, that’s not the case. Everyone seems to have their own opinion on how the market has previously performed. And don’t even get started on how the market will perform […]

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Knowing what the “market” returns seems like a basic fact. You probably just type it into Google and two seconds later you get your answer.

Surprisingly, that’s not the case.

Everyone seems to have their own opinion on how the market has previously performed. And don’t even get started on how the market will perform going forward. For the rest of your lives, the talking head experts are going to be making predictions, including some that I respect. Tune out the noise. Nobody has a crystal ball.

But back to historical returns. If someone asked you, “What’s the historical return of the stock market,” what would you say?

Let’s start with the correct answer. The Compound Annual Growth Rate (CAGR) of the market from 1871 to 2016 is 9.07%.

Concerned that numbers from 1872 aren’t relevant to the modern world? Me too. The CAGR of the market rom 1900 to 2016 is 9.71%. (All market data provided by Nobel-prize Economist Robert Shiller, which uses S&P 500 data from 1926 and data from  Cowles and associates for period pre-1926).

Both of the above numbers include dividends, which means that you count the dividends you receive as part of your return. While this may seem obvious, many internet charts and calculations fail to consider this important distinction.

The above returns do not adjust for inflation. They are nominal returns. More on that later.

What’s CAGR and Why Should I Use It?

The Compound Annual Growth Rate is a “smoothed” interest rate that tells you an investment’s yield on an annually compounded basis. In other words, it’s the number you’d actually need to see every year in order to achieve the growth of your investment over the measured time period.

It helps to first understand what CAGR is not.

CAGR isn’t an “average” return. Why? Because average can be very misleading and unhelpful.

Example 1. Larry invests $1,000 in Year 1. By Year 2, his investment is worth $2,000, a gain of 100%. Unfortunately, his investment tumbles 50% in the second year and so at the start of Year 3 he’s back to holding $1,000. His average return is (100% + -50% / 2 = 25%). Larry would look pretty silly if he bragged about his 25% average annual investment returns. Under CAGR, Larry’s return equals 0%, as it should be.

Let’s see an example of CAGR in action.

Example 2. Larry invests $1,000 in Year 1. By Year 2, his investment is worth $1,200, a gain of 20%. By Year 3, his investment is worth $1,080, a loss of 10%. His average return is (20% + -10% / 2 = 5%). But if you apply the math directly, it doesn’t make sense. $1,000 + 5% = $1,050. $1,050 + 5% = $1,102.5, which is $22.50 more than Larry actually earned. Under CAGR, Larry’s return equals 3.92%, which is accurate to explain why he held $1,080 at the end of two years.

Calculating CAGR is straightforward for small periods of times, but gets more complicated over longer periods. Here’s a simple CAGR calculator to help.

By now I hope you’re convinced that when someone is vaguely asking for the annual return of the market, what they’re really asking for is the CAGR calculation.

It seems obvious to me, but people get it wrong all the time. One example of getting it wrong is Dave Ramsey who stands by his misleading written advice and then gets into a bizarre argument with Brian Stoffel as to whether the market’s historical returns are 12% or not. While yes, it’s true that the S&P’s average annual returns are around 12%, it’s also true that the S&P returned 6.41% in 1978. Neither number is very helpful to you.

Nominal vs Inflation-Adjusted Returns

A nominal return is the actual return you’d need to achieve an investment’s growth. A measly $1 bill invested in the S&P 500 in 1900 grew into a staggering $51,406 in 2016 achieving a nominal return of 9.71% each year.

If you wanted to calculate the growth of your $10,000 investment over the next 80 years and you decided to use the S&P’s historical return of 9.71%, you’d be able to quickly calculate that in 2097 you could expect an account with a balance of $16,584,302.

While $16.5 million seems like a lot of money, it’s pretty difficult to understand what $16.5 million could buy you in the year 2097. It might just be a 1-bedroom in Williamsburg. Of course that’s not too shabby for a $10,000 investment today, but it’d be helpful to know whether we’re talking yacht money or condo money.

If you adjust for inflation, the CAGR of the S&P 500 from 1900 to 2016 is 6.55%. This means that a $1 investment in 1900 grew into $1,682 by 2016. But – and here’s the key – you had 1,682 1900 dollars, each of which could buy you the same amount of stuff that you could buy in 1900 for $1.

Now, I have no idea what you could buy in 1900 for a $1. You certainly couldn’t buy an iPhone. But whatever $1 got you, you now have 1,682 of them.

First, this just shows the power of compounding interest. It’s truly great, even when you’re adjusting for inflation.

Second, this is useless because as humans there’s no way we can conceptualize what a $1 bought someone in 1900, even if I do the research to tell you that could have purchased four boxes of “tooth soap” at $0.25 each. It just doesn’t mean anything to you today.

We can use this number going forward to get an idea of how much money we’d have in the future. Of course, now we have two big flaws in our calculation: (1) we’re assuming future returns will be similar to historical returns and (2) we’re assuming future inflation will be similar to historical inflation. However, it’s still somewhat helpful.

If those assumptions are true, the growth of your $10,000 investment over the next 80 years at an inflation-adjusted rate of 6.55% would leave us with an account balance of $1,600,576. So there you have it – we’re talking about a pretty sweet 2bd/2ba in Williamsburg.

And now I hope you’re convinced that inflation-adjusted CAGR returns are the best way to project forward when you’re thinking about the buying power of your investments in the future.

Why the S&P 500?

The final piece to the puzzle is translating someone asking for the “market” return into something that we can calculate. Obviously the S&P 500 isn’t the total market. Why not use the DJIA or some other metric?

Unfortunately, we don’t have good data for the “total market”. Over the next 80 years we certainly will, but index funds didn’t exist in 1900 and there’s no reliable data for the return of the “overall” market since 1900. We just didn’t have computers capable of calculating and story that information.

The other candidates include the Dow Jones Industrial Average, but the Dow only consists of 30 stocks published by Dow Jones and so would be an inferior proxy for the S&P 500.

In the end, the S&P 500 is the best data we have and the best way to approximate the “market” return. The S&P 500 was created in 1926. For periods prior to that, Robert Schiller relies on data from Cowles and associates.

Takeaways

  • The Compound Annual Growth Rate (CAGR) of the market from 1871 to 2016 is 9.07%.
  • The inflation-adjusted CAGR of the market from 1871 to 2016 is 6.88%
  • The CAGR of the market from 1900 to 2016 is 9.71%
  • The inflation-adjusted CAGR of the market from 1900 to 2016 is 6.55%

Let’s talk about it. Do you have another way to calculate historical market returns? I’d love to hear about it. Leave a comment below!

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How To Think About Money http://www.biglawinvestor.com/how-to-think-about-money/ http://www.biglawinvestor.com/how-to-think-about-money/#comments Mon, 06 Feb 2017 11:00:00 +0000 http://www.biglawinvestor.com/?p=2096 Check out The Biglaw Investor or read How To Think About Money

As part of your Continuing Financial Education (CFE), you should get in the habit of picking up 1-2 books a year on financial topics. I know. They’re boring. It’s dull. But you made it through 1L year and Supreme Court cases from the 1800s. You can handle some personal finance books. If you don’t learn […]

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As part of your Continuing Financial Education (CFE), you should get in the habit of picking up 1-2 books a year on financial topics.

I know. They’re boring. It’s dull.

But you made it through 1L year and Supreme Court cases from the 1800s. You can handle some personal finance books.

If you don’t learn about money on your behalf, who will? Even if you’re working with a financial advisor, you at least need to know the basic vocabulary.

Today’s book is How to Think About Money by Jonathan Clements.

As always, these are my actual notes from reading the book.

Jonathan Clements is the former personal-finance columnist for The Wall Street Journal, where he wrote for almost 20 years (we have no financial relationship). Previous to the WSJ, he wrote for Euromoney and Forbes and spent six years at Citigroup as Director of Financial Education for the bank’s U.S. wealth-management business.

His latest book is about the relationship we have with money and more specifically how we should think about it. He divides the world into two types of people: Those who think the goal of investing is to beat the market and amass as much wealth as possible, that street smarts and hard work ensure investment success, and that the road to happiness is paved with more of everything. And then there are those who get it.

Want a more prosperous, less stressful financial life?

Growing wealthy is actually embarrassingly simple: We save as much as we reasonably can, take on debt cautiously, limit our exposure to major financial risks and try not to be too clever with our investing. Early in our adult life, progress can be agonizingly slow, and it’s easy to get discouraged. That first $100,000 can take many years to amass. If we stick to the simple, prudent path, however, the results can be astonishing. After a few decades, we might have $500,000—and that $500,000 can quickly become $1 million and maybe $2 million.

That’s nothing new to readers of this blog, but it’s worth remembering that the path to wealth is pretty simple. However, as Biggie said, mo money, mo problems. The first is the paradox of choice. Once you start accumulating money, you open up a lot of doors. While having options can be good, it can also be bad for your mental health.

If we don’t like where we live but we can’t afford to move, we adapt. But if we have enough money to move tomorrow, we might never adapt and instead wrestle with the decision every day, trying to figure out whether we should stay put or buy a home somewhere else. Happiness lies not in the choice, but in making a decision and eliminating the choice.

I always say that if you go to the store and look at 60 different types of jam, there’s a high probability you leave without any jam.

Another problem is projecting happiness.

“Does Living in California Make People Happy?” For a study with that title, almost 2,000 undergraduates were surveyed at four colleges, two in the Midwest and two in California. Students in the two regions reported no difference in their overall satisfaction with their lives—and yet they both expected someone living in California to be more satisfied than someone living in the Midwest. What’s going on here? When students imagined living in the Midwest and living in California, they focused on easily observed differences between the two regions, notably the better California weather. Their mistake: They failed to appreciate that happiness with the weather isn’t that important to satisfaction with one’s overall life.

So how to we make decisions, stop projecting and actually achieve happiness with money? For starters, Clements wants us to embrace humility.

It’s the great Wall Street fantasy: With hard work, street smarts and maybe a little luck, we can pick the right stocks and mutual funds, and thereby beat the market. This fantasy is so powerful that it sustains an entire industry—one that encompasses investment newsletters, professional money managers, financial websites, cable business channels, market strategists, securities analysts, boutique investment research firms, financial talk radio shows and more. These folks are desperate to keep the fantasy alive, because their livelihoods depend on it.

So, step off the financial ferris wheel and concentrate on increasing your savings rate. The money will take care of itself. Then your goal is to make sure you don’t lose it (which also happens to be Warren Buffett’s first rule of investing).

How is a lawyer going to lose their hard-earned wealth? Here are just some of the nightmare scenarios:

(1) We become disabled and can’t work, we don’t have much in savings—and yet we never bothered to buy disability insurance. Can’t imagine doing anything so dangerous that you would suffer a disability? Keep in mind that the vast majority of disabilities are caused by illness, not accidents.

The truth is that you’re much more likely to become disabled than to die an early death. Disability insurance is top of my mind for a 2017 goal, so expect to see more writing on that in the future.

(2) We load up on our employer’s stock in our 401(k) plan—and our employer turns out to be the next AIG, Bear Stearns, Enron, Lehman Brothers or WorldCom, all major companies that suffered spectacular collapses in the last 15 years.

Thankfully, most lawyers are unlikely to make this mistake but there’s certainly no reason to take uncompensated risk.

(3) Our spouse, who is the family’s main breadwinner, dies suddenly. We have neither life insurance to collect on nor much in savings—but we do have three children and a hefty mortgage.

Until you’re financially independent, term life insurance is a cheap solution to what would be a catastrophic problem.

(4) A booming stock market boosts our self-confidence, we load up on stocks, we get a repeat of 2007–09’s 57 percent decline—and we panic and sell when our stocks are worth half what we paid.

This is pretty typical. A rising tide lifts all boats, convincing people that they’re great at picking stocks. This is why it’s a good idea to write an Investment Policy Statement to help you stay the course.

(5) We pour our savings into a few rental properties, we have trouble finding tenants, we can’t make the mortgage payments—and we wind up in foreclosure.

Leverage works both ways.

(6) We don’t have health insurance—and we get diagnosed with cancer.

Medical costs are responsible for a large number of bankruptcies.

(7) We bet everything on one country’s stock market—and that country turns out to be the next Japan.  At year-end 1989, the Nikkei 225 hit its all-time high. More than a quarter century later, Japanese stocks remain stalled at less than half their 1989 level. Can’t see that happening here in the U.S.? In 1989, no economy was more admired than Japan’s, and ambitious American businessmen and women were regularly exhorted to learn Japanese.

I can’t see this happening in the US, but I suppose you can’t argue with his point. I’d like to think that US company’s broad international exposure mitigates this risk somewhere as compared to Japan. The US economy is more than four times as large as Japan.

The point is that you can take steps to mitigate “losing” your money and you should be doing so.

If you save more than you earn and take steps to reduce or eliminate risk, the last part of the puzzle is simply redefining retirement and your career.

My contention: Retirement should be redefined, so it is viewed not as a chance to relax after four exhausting decades, but rather as an opportunity to take on new challenges, without worrying so much about whether those challenges come with a paycheck. We might even take a phased approach to retirement. As our wealth grows, we could use the resulting financial freedom to focus less on pulling in a big paycheck and more on doing work we find fulfilling. That might mean switching to a less lucrative career in our 40s or 50s, or perhaps working fewer hours so we can devote more time to hobbies we are passionate about. In our 60s, we might take this a step further, working part-time and eventually quitting paid work entirely.

Given the abundance of books on investing, I found How to Think About Money a refreshing take on the philosophical side of how we save, spend and enjoy our money (full of lots of references to research about money and happiness).

After all, you should have a reason why you’re saving all this money and how you plan to live the “good life”.

Editor’s Note: This post contains affiliate links. This means I get paid a tiny amount of money if you choose to click through one of my links. If you do, THANK YOU. I greatly appreciate it. If you don’t, no sweat. It’s more important that you learn about finance. See my disclosure policy to learn about how I’m working to be transparent to my readers on any conflict of interest.

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PSLF: The Lawyer’s Loophole http://www.biglawinvestor.com/pslf-the-lawyers-loophole/ http://www.biglawinvestor.com/pslf-the-lawyers-loophole/#respond Fri, 03 Feb 2017 11:00:00 +0000 http://www.biglawinvestor.com/?p=2086 Check out The Biglaw Investor or read PSLF: The Lawyer’s Loophole

Recently, I’ve written about how doctors are taking advantage of PSLF in what’s been described as the doctor’s loophole. Simply put, doctors begin making PSLF payments during residency (while they usually work for a hospital) and sometimes stretch the qualifying payments through internships, such that they might begin an attending job after having made 4-7 […]

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The Convair B-36 Peacemaker at the Pima Air & Space Museum.

Recently, I’ve written about how doctors are taking advantage of PSLF in what’s been described as the doctor’s loophole. Simply put, doctors begin making PSLF payments during residency (while they usually work for a hospital) and sometimes stretch the qualifying payments through internships, such that they might begin an attending job after having made 4-7 years of qualifying PSLF payments. From that position, it’s an easy decision to stay in PSLF (if eligible) and watch the entire student loan balance be forgiven tax-free in as little as three years. It may be an unintended consequence of the PSLF forgiveness program, but it’s squarely within the rules, so it’s hard to find fault with doctors pursuing this route.

I always thought that lawyers (who wrote the laws) had no such luck. That was until I learned about the Georgetown Loan Repayment Assistance Program (LRAP), which apparently has now been replicated at a number of law schools across the country. It works like this: if you pursue a career in public interest, the Georgetown LRAP program will make your minimum student loan payments under PAYE or IBR for 10 years, at which point your loans will be forgiven under PSLF. The end result: if you pursue a career in public interest, you can attend Georgetown law for free.

At first glance, this might appear to be Georgetown making a partial contribution to help payoff a student’s loans. If that’s all that is going on, it is a pretty impressive use of the PSLF program. If you’re working in public interest and making less than $75,000, your loan payments would be quite minimal over 10 years (in fact, your balance could be higher upon forgiveness than it was when you started making payments). For Georgetown to offer students the opportunity to wipe away loan balances that could start at $200K by making 10 years of minimal PSLF payments on your behalf is a smart move on their part. It also helps support the state and city governments that cannot offer competitive salaries to lawyers without the existence of PSLF.

The truly clever part of the plan is how Georgetown may be paying for LRAP. According to the Washington Post, LRAP funding may be coming from tuition paid by new students – tuition they’re often paying with federal loans.

If so, Georgetown is ultimately paying for the LRAP program (which is making the minimum payments on the student’s loans) with more money borrowed from the federal government. That’s money that could ultimately be forgiven by the very same PSLF program 10 years after the student graduates. Are you seeing a circle of federal money? That’s what I’m seeing.

Now, this only works perfectly in theory if you could charge students who wanted to pursue public interest a higher amount than you charge other students. The reality is that tuition is raised across the board for all students to pay for the LRAP program. But it’s clever in that at least a portion of those students paying a higher amount of tuition (thanks to the LRAP program) should see those amounts forgiven by the federal government through PSLF. And, because IBR/PAYE is based on income and not student loan balance, it’s immaterial whether the student graduates with $200,000 in debt or $200,000 + any increase required to fund LRAP, as LRAP’s minimal payment will always be tied to a percentage of discretionary income.

The Washington Post article even links to a video showing a financial aid session where Georgetown administration dismisses the thought that people currently in PSLF won’t be grandfathered into the program, noting that PSLF is written into the promissory note.

Using government money to pay for a government program which results in forgiveness at the end qualifies as a loophole in my book.

The main criticism of this loophole seems to be questioning whether the government should be picking up the entire tab for a Georgetown legal education. Putting aside whether law school tuition is too high in general (I think it is), I’m not sure it makes much of a difference either way. If you run the PSLF program, the government picks up the tab for your legal education. If you end PSLF, you’re forcing thousands of lawyers to abandon government jobs because those jobs don’t pay enough to both cover student loans and the cost of living. In order to attract lawyers back to the government jobs, they will have to raise salaries. Who will pay for the salary increase? Obviously, the government. So in the end, for lawyers at least, PSLF is largely just a reallocation of government funds.

The truly clever part is how Georgetown figured out a way to spread the cost among its students, including students that will eventually receive forgiveness themselves. Now, if I were a student at Georgetown that paid a higher tuition price than I otherwise would have on account of the LRAP program who wasn’t seeking forgiveness, I might be a little upset …

Further Reading:

Let’s talk about it. Is this the PSLF Lawyer’s Loophole?

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5-Year Roth IRA Rules http://www.biglawinvestor.com/5-year-roth-ira-rules/ http://www.biglawinvestor.com/5-year-roth-ira-rules/#comments Wed, 01 Feb 2017 11:00:00 +0000 http://www.biglawinvestor.com/?p=2078 Check out The Biglaw Investor or read 5-Year Roth IRA Rules

Roth IRAs are a great retirement savings vehicle. You pay tax up front and then watch your money grow tax-free. However, they have a couple of confusing rules that unfortunately are lumped together as a “Roth 5-year rule” which generally leads people to think you need to wait a minimum of five years before you […]

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Snapping some photos from the Pima Air & Space Museum.

Roth IRAs are a great retirement savings vehicle. You pay tax up front and then watch your money grow tax-free. However, they have a couple of confusing rules that unfortunately are lumped together as a “Roth 5-year rule” which generally leads people to think you need to wait a minimum of five years before you can withdraw money in a Roth IRA account.

There’s really two “Roth 5-year rules”. The first 5-year rule (and the one more likely to be applicable to lawyers) applies to Roth conversions and determines whether the withdrawal of converted principal will be penalty-free (the “5-year conversion rule”). The second 5-year rule applies to Roth contributions and determines whether the withdrawal of earnings will be tax-free (the “5-year contribution rule”).

So let’s take it one step at a time.

The 5-Year Contribution Rule

Roth contributions are direct “front door” deposits into your Roth account. Depending on your income, you may not be eligible to make direct Roth contributions. Roth contributions can be withdrawn at any time, with no penalties or taxes due. You can make a direct Roth contribution on January 1st and withdraw the contribution on January 2nd. This is one of the reasons why Roth IRA contributions can be used as an emergency fund. If you worked for a couple of years before law school, you could make direct Roth IRA contributions and then withdraw the money later should some type of personal disaster require access to the money. Some enterprising law students even make sure to contribute to a Roth IRA during law school, which you can do as long as you have enough earned income each tax year.

Just to emphasize: You can withdraw Roth IRA contributions at any time.

You cannot withdraw the earnings without meeting two tests: (1) it needs to be a qualified distribution, which generally means you must be over age 59 ½ (see IRC Section 408(d)(2)(A)); and (2) the earnings can’t be withdrawn during the 5-taxable-year period beginning with the first taxable year for which an individual made a contribution to a Roth IRA (see IRC Section 408(d)(2)(b)).

So this 5-year contribution rule only applies to earnings and not to the original principal contributions.

The strange quality of this rule is that the clock starts once any money is funded into your Roth IRA (whether by contribution or conversion). This is explained in detail in Treasury Regulation 1.408A-6, Q-2. So, if you’ve had your Roth IRA for longer than 5 years, this rule isn’t an issue for you, which I suspect is the case for the vast majority of readers of this site.

This 5-year-rule makes intuitive sense. The government wants you to use a Roth IRA for long-term retirement planning, so they’ve eliminated any possibility of opening up a new Roth IRA account and withdrawing the earnings during the first five years of the Roth’s existence. So long as you’ve opened up a Roth IRA account early in your investment career, this rule isn’t going to apply to you.

The 5-Year Conversion Rule

Now, let’s tackle Roth conversions. These are made when you convert money from a Traditional IRA to a Roth IRA, therefore it covers all “backdoor” Roth IRA contributions (which are really non-deductible contributions made to a Traditional IRA which are then converted to a Roth IRA). Roth conversions are subject to a separate 5-year rule. Under this rule, you cannot withdraw Roth IRA conversions until five taxable years have passed. Roth conversions are deemed to have occurred as of January 1st of the year in which the conversion happened (see Treasury Regulation 1.408A-6, A-5(b)).

This 5-year rule applies to each Roth conversion (see Treasury Regulation 1.408A-6, A-5(c)). So, if you’re making a backdoor Roth IRA contribution each calendar year, each backdoor contribution has a 5-year clock that starts running on January 1st. You cannot withdraw the contribution without penalty until five taxable years have elapsed. Thankfully, the IRS deems withdrawals to be on a first-in, first-out basis (see IRC Section 408A(d)(4)(B)(ii)(II)), so the oldest conversions are withdrawn first.

In practical terms, it’s ineffective to use backdoor Roth IRA contributions as an emergency fund since you have to wait five years before you can withdraw the funds.

It helps to understand the purpose of this rule by thinking through an example.

Example. Lawyer Larry has a $100,000 Traditional IRA balance. He cannot withdraw the balance because he’s not yet 59 ½. If Larry converts his Traditional IRA to a Roth IRA he will pay income taxes on the conversion. Without the 5-year conversion rule, Larry would then be free to withdraw his entire conversion amount. The result of this would be a complete circumvention of the 59 ½ age requirement. While the 5-year conversion rule doesn’t eliminate this loophole entirely, it means Larry will have to wait five years before he can withdraw his contribution. Note: This is one of the many ways to get access to retirement funds before hitting the age limits, so long as you can plan for the 5-year waiting period.

The bottom line here is that it’s important to understand that we have two 5-year rules. The 5-year conversion rule prevents you from taking a penalty-free withdrawal of converted principal. The 5-year contribution rule prevents you have taking a tax-free withdrawal of Roth earnings.

The 5-year conversion rule is more likely to impact you, although if you’re using your Roth IRA as a retirement vehicle, it won’t be a problem because you won’t be making withdrawals until many years in the future.

Further Reading: Understanding the Two 5-Year Rules for Roth IRA Contributions and Conversions by Michael Kitces.

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Guest Post: Your Lawyer Survival Kit http://www.biglawinvestor.com/guest-post-your-lawyer-survival-kit/ http://www.biglawinvestor.com/guest-post-your-lawyer-survival-kit/#comments Mon, 30 Jan 2017 11:00:00 +0000 http://www.biglawinvestor.com/?p=1999 Check out The Biglaw Investor or read Guest Post: Your Lawyer Survival Kit

(Editor: Today’s post comes from reader Alex in Chicago. We have no financial relationship.) As many of you are about to embark on your Biglaw associate career, you are no doubt thinking that the demands on your time might be great. Many times, they will be. As I started my own career, I spent a […]

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Lawyer Survival Kit

(Editor: Today’s post comes from reader Alex in Chicago. We have no financial relationship.)

As many of you are about to embark on your Biglaw associate career, you are no doubt thinking that the demands on your time might be great. Many times, they will be. As I started my own career, I spent a lot of time thinking about how to “buy back” time–that is, what tasks or products are worth optimizing/outsourcing compared to their cost? Money might not be able to buy happiness, but money sure can whittle down your to-do list. Which makes me happy.

Wait a Sec, I Thought The Biglaw Investor Told Us to Cut Expenses?

As BLI has described already in detail, getting a handle on your expenses and jacking up your savings rate is the simplest way achieve control over your financial fate. To achieve this, some financial bloggers take a slash-and-burn approach to expenses that some might say approaches comical. (See Early Retirement Extreme [just live in an RV!].)

Of course, to each his own–who are any of us to judge. But, for a variety of reasons, it simply will not be feasible to live in an RV, can your own food, or re-wash Ziploc bags, etc., as a Biglaw associate, even though doing so would achieve a some effect on your savings rate.

Personally, I’ve found that small “splurges” can free up some hours in your week, which you can then use to spend time with loved ones or whatever else you desire. (“Splurge” is in quotes because none of these are as financially obscene as a lease on a new BMW, for example.) In turn, this “time off” lets you to focus more at work and relax when you are not there. Thus, I look at it as though you are spending small sums of money to do a better job at your job. Obviously, only you can prevent forest fires / decide what trade-offs are right for you, but there are many things that I think are worth spending money to not think about.

I Give You … My Lawyer Survival Kit

So, what do I personally find worthwhile to “splurge” on? Here are some things that I’ve found give me more benefit (time) than their cost …

Blue Apron. I’ve used it for about a year. I love it. I find cooking really relaxing but shopping for a week’s worth of meals to be dreadful. So, for me, this is perfect. At about $10/meal/person, it frankly is usually a deal compared to the quality you get back compared to what you could get from take out. Obviously, if you have different preferences on cooking, YMMV, but at minimum figuring out some sort of plan for eating during the week can help you avoid chasing a lot of unhealthy options.

Dollar Shave Club. I’ve used it for over three years. Totally reasonable price, and I have not had to expend mental energy thinking about purchasing razors since I started the Club. Definitely beats how I used to manage this item, which was the following scientific process–use the last of the razors in the box until it became too painful to shave, then rush to the nearest convenience store to overspend on another box of three.

Dryv. I’ve used it regularly for about two years. For pick-up and delivery dry cleaning service in Chicago, LA, and Detroit, and I hope it expands. Their prices are comparable to storefront dry cleaners (without having to schlepp), they are flexible about scheduling pick ups and deliveries, and their minimums seem reasonable.

Handy. I’ve used it sporadically for about two years. For apartment cleanings, the prices are really reasonable, and I’ve had generally good experiences with the service. What a great feeling to walk into a clean apartment.

Jet. I’ve used it regularly for about a year. I generally stock up on cleaning and laundry supplies and grooming essentials like soap and shampoo, among other items. This is a definite time saver for me in Chicago, and I imagine that would be even more valuable to someone in NYC. I previously used Amazon Subscribe-and-Save, but it became too byzantine with price and stock changes, and bottles at times were not packaged with anything, so items leaked on arrival. (Jet takes the time to tape bottle caps shut, God bless them.) Its app makes it easy to shop while on public transit, with low minimums for free shipping.

That’s my list. I’d love to hear from you on these and other ideas. What services or products to you splurge on in order to get some time back? What’s in your Lawyer Survival Kit?

(Editor: I’ll go first. I’ve had good experiences with Jet, as mentioned above. I’m a big fan of Munchery for meals, Alfred for all kinds of home management, TaskRabbit for one-off tasks. I’m sure there’s more.)

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How to Write an Investing Plan http://www.biglawinvestor.com/how-to-write-an-investment-policy-statement/ http://www.biglawinvestor.com/how-to-write-an-investment-policy-statement/#comments Fri, 27 Jan 2017 11:00:00 +0000 http://www.biglawinvestor.com/?p=1953 Check out The Biglaw Investor or read How to Write an Investing Plan

Every lawyer, law student, professional and investor needs an Investment Policy Statement. Investment Policy Statements don’t have to be long or complicated. In my opinion, some of the best Investment Policy Statements are less than two pages. Remember back in law school when the Torts professor allowed you to bring one page of notes into […]

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Every lawyer, law student, professional and investor needs an Investment Policy Statement.

Investment Policy Statements don’t have to be long or complicated. In my opinion, some of the best Investment Policy Statements are less than two pages.

Remember back in law school when the Torts professor allowed you to bring one page of notes into the final exam? That’s exactly how your IPS should look. It contains only the essential facts. It’s everything you need to know about your financial life and where you’re going.

There are several benefits to having an Investment Policy Statement.

First, it’s the one document to answer all of your investing questions. By far, the most common post you’ll see on financial forums runs something like this, “I have $50K sitting in cash in my bank account, how should I invest it?”

The only reasonable answer is: Invest it according to your Investment Policy Statement.

There are too many circumstances specific to you for there to be one universal answer as to how you should invest your money, most of which would never be disclosed on an internet forum anyway.

That’s because an IPS is a rather personal document. It contains your values. You write down what you’re hoping to achieve with your (financial) life. It contains a lot of things most people aren’t comfortable sharing with just anyone.

For those reasons, it’s something you need to figure out. Whether you take the time to write it down or not, you’ll be grappling with the questions in life anyway, so you might as well write it down.

Second, it will keep you on the straight and narrow. You’re a high achiever. You’ve worked hard to get where you are and now you’re reading a personal finance blog directed at lawyers. I know your type. In a couple of years you’re going to still be thinking about this stuff and you’ll come across the latest trend in personal finance (peer-to-peer lending, robo-advisors, etc.) Should you invest? Your Investment Policy Statement will guide you. It will remind you of your goals and objectives and the best way to accomplish them.

Third, especially if you work with a financial advisor, your IPS will ensure that the advisor and you are working together to invest your money in a way that’s consistent with your goals. This applies to couples as well, which can benefit from having an IPS to confirm that they’re “on the same page” when it comes to finances.

I strongly believe that those investors that take the time write out an IPS are far less likely to make serious investment errors.

Luckily, your IPS only needs a few things:

  1. Goals
  2. Investment choices to achieve those goals
  3. Cheat Sheet with Tax/Insurance information

I especially like keeping the cheat sheet with my tax/insurance information in my IPS. It’s probably the part I use most frequently, since otherwise it’s difficult to remember things like your marginal rate, the amount of your renter insurance coverage or how much you’d get paid if you had a short-term disability. The cheat sheet lets me keep up with those important details at a glance.

Here’s a look at a basic IPS I put together for this post:

The first page functions as an executive summary. There are two important parts. First, there’s a simple reminder that I believe in the simple approach to investing. I want to buy-and-hold, get the market return and minimize fees and taxes. Second, I’ve listed objectives in order of priority.

The second page contains a summary of accounts, contribution limits and various saving goals.

The third page contains an asset allocation:

And finally, the fourth page has your insurance coverage details:

As you can see, you could easily consolidate this to two pages if you want. But I like the simplicity of having each page contain a theme.

Precedent Investment Policy Statements

Because I know lawyers like templates (we call them precedent), I’ve collected quite a few examples you can click through and use when making your own. Don’t worry – I’m just as lazy as you are and would never try to draft from scratch.

Some from around the web:

A few from the Bogleheads:

Let’s talk about it. Have you drafted an IPS? What is in yours and what do you leave out? Comment below!

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