Financial planning can be a headache. It’s tempting to keep your financial plan as simple as possible by putting aside a few dollars of each paycheck in your 401(k) and calling it a day. This strategy may successfully avoid many of the inconveniences of financial planning but does so by trading efficiency for simplicity.
Now is an exceptionally good time to revamp your financial plan: this July consumer prices rose 5.4% from a year ago. If you’re not managing your finances effectively, you’re not only leaving returns on the table. You’re losing purchasing power, fast.
Let’s look at seven factors to consider while developing your own financial plan.
1. Cash Flow
Every financial plan needs funding. As a lawyer, you’re likely making a significantly higher salary than the national average. A higher income unfortunately doesn’t always translate to a higher savings rate. Long hours in the office often lead to high entertainment spending, lots of takeout, and the need for housekeepers and other assistants. To meet savings goals, you need to minimize unnecessary spending while taking advantage of all the benefits your firm provides. You might be making tons of money, but if you’re spending even more you’re not saving anything.
Even if you are saving a significant percentage of your income, it may not be enough to meet your long-term financial goals. Lawyers on average spend less time in the workforce than a typical college-grad, giving compound interest less time to work for you. Imagine two professionals. The first is an accountant who graduates at 22 and averages saving $1,000 per month until retiring at 62. The other is a lawyer who graduates at 27 and contributes the same $1,000 monthly until retiring at 62. If each professional’s investments returns 8 percent annually, the lawyer will have a nest egg of $2.1 million at 62, while the accountant will have almost 50 percent more at $3.1 million.
The average law school graduate owes $160,000 in debt. With the median income of new law school graduates being $72,500 in 2019, your financial plan needs to include a student loan repayment strategy. Otherwise, you will likely be stuck making payments longer than the typical 10-year term.
Any borrower has three basic options for getting out of debt: repayment, forgiveness, or bankruptcy. Discharging student loans through bankruptcy has historically been nearly impossible and is by far the most drastic of your options. Repayment or participating in a forgiveness plan is often a better course of action.
There are a variety of available student loan forgiveness programs. Plans such as the Public Service Loan Forgiveness (PSLF) and Forgiveness with Income-Based Repayment (IBR) aid students in repaying their federal loans. Many schools also offer their own loan repayment assistance program (LRAP), which provides financial aid to graduates in low-paying fields.
When loan forgiveness is not an option, you’ll want to develop a plan for paying down your debt. Different strategies for repayment are viable depending on your circumstances and philosophy on debt. During this process, keep in mind that high interest rates can often be lowered by refinancing and multiple loans can be consolidated, often at a discounted interest rate.
While repaying your student loans, you’ll also need to consider how to manage your mortgage, car loan, or any other debt you may have incurred. Your financial plan should include a repayment plan for each.
3. Asset selection
Once you’ve finished maximizing your savings and developed a plan for servicing your debt, you need to select an asset allocation strategy that will build your net worth. For any investor, the correct portfolio is the one that maximizes returns relative to the amount of risk the investor is comfortable taking on.
Your risk tolerance paired with your desired return will dictate which assets are the best fit for your portfolio. Once you’ve determined your risk tolerance, you can then decide which assets you’re willing to hold—whether they be stocks, bonds, index and other mutual funds, or real estate.
As a lawyer, your salary likely will be high enough to cover expenses without tapping into your investments. This often means you can take on additional risk as you don’t need to worry about short term fluctuations in your portfolio’s value. However, if you’re planning on purchasing a home or paying for your child’s college education, you may need to liquidate assets. At that point, you will need to more carefully consider short-term price fluctuation.
Taxes are among the largest drags on investment performance. A financial plan with ineffective tax planning can forfeit 40 cents on the dollar or more if you’re in the highest tax bracket. Contributing to tax-advantaged accounts such as a 401(k), IRA, or HSA allows for thousands of dollars in additional tax savings.
Beyond contributing to tax-advantaged accounts, you can further optimize returns by timing the realization of your capital gains. Selling assets in years where your income places you in a lower tax bracket allows you to minimize taxes. For lawyers, these low income years often come at the beginning of your career and after retirement. And don’t forget about the possibility of extended leaves for childcare or health concerns.
Holding assets for over a year to avoid the increased tax liability associated with short-term capital gains is another tax strategy for you to consider. Short-term capital gains are included in your ordinary income and can push you into a higher tax bracket. Long-term gains, on the other hand, are not included in your ordinary income and will not push you into a higher bracket.
Expense ratios—a close relative to taxes—are another important consideration when investing in assets such as mutual funds. Impressive nominal returns are irrelevant if the fees and taxes associated with the fund are substantial.
The tax code is immensely complex and there are many more advanced tax strategies that stem from its complexity.
In retirement your primary source of income will switch from your salary to your investments. Assuming a stable 4-percent withdrawal rate on your investments, you’ll need to have an account balance 25 times your desired annual retirement income to avoid outliving your savings. Lawyers often have above-average expenses and a late start to investing, so a significant savings rate is needed to achieve the 25-times mark. A more modest nest egg can still allow for a comfortable retirement, but, again, you run the risk of outliving your savings.
Lawyers’ large salaries make them excellent candidates for the FIRE (i.e., financial independence, retire early) movement. Biglaw associates who commit to a frugal lifestyle can retire after only a decade of working.
Consider the retirement accounts available to you. A 401(k) or IRA can help you avoid paying unnecessary taxes, allowing you to maximize your earnings. In addition, 401(k) accounts often come with additional firm-specific benefits, such as matching employer contributions.
Account for the volatility of the assets you select. Since your investments are the primary source of income during your retirement, holding volatile assets that do not produce consistent returns can force you to liquidate at an undesirable price. Your retirement portfolio should be adjusted to hold assets that will provide you with the necessary income and the appropriate amount of volatility.
During retirement, you also will have access to resources that were previously unavailable, such as Social Security, Medicare, and other employer provided benefits. Identify and account for these potential sources of income in your financial plan.
6. Estate planning
In the event of your death or incapacitation, an estate plan ensures the proper distribution of the wealth you’ve accumulated. An estate plan should include a will that designates your beneficiaries, establish power of attorney, and minimize estate taxes. Due to the complexity of estate planning, consider consulting an attorney who specializes in this field.
Even with the perfect financial plan, unexpected setbacks can occur. Consider purchasing separate or umbrella insurance policies for health, automobile, home, disability, and life insurance. Adjust the level of coverage to suit your tolerance for risk. The correct combination of policies depends on your personal circumstances: where you live, your ability to cover expenses, etc.
Lawyers have the extra consideration of malpractice insurance. Four out of five lawyers will face at least one malpractice claim during their career, according to the American Bar Association. While only several states require lawyers to have malpractice insurance, consider purchasing a plan if your law firm doesn’t already provide one.
At this point, you’re either excited or drained. In either case, there are plenty of resources on Biglaw Investor to help you on your journey.
If the idea of building your own financial plan excites you, I’ve provided links in each section of this article. Now is the time to click these links and explore some of these topics in more detail.
If you instead find yourself in the latter group and the idea of spending your precious free time reading up on the tax code horrifies you, a trusted financial advisor or certified financial planner (CFP) may be the solution.
Biglaw Investor has taken the time to vet financial advisors, many of whom have a legal background. These investment advisors have a fiduciary responsibility to give the best financial advice possible and work full-time in the financial services and wealth management industry.
Joseph Parise is a junior at the University of Buffalo. Joseph grew up in New York and is majoring in Philosophy and Economics. He is currently taking a gap year to study for the LSAT exam and to serve in the US Air Force Reserves.