Managing Debt and Budgeting for Success

“One day a new runner showed up for our Friday dawn run.  He was a medical specialist entering the retirement phase of his career.  When he found out I was a financial advisor, he said that he had little understanding or patience for finance, but over his career, he’d made sure that each month he spent a little less than he had put in his bank account.  I told him that he’d taught himself the most fundamental advice a financial advisor can give:  spend less than you earn.”

That’s how Laura Walton, Executive Director of the TCI Foundation, opened the UA Graduate Center and TCI Foundation co-hosted seminar, Managing Debt and Budgeting for Success, on October 27 in the Student Union.  This article summarizes some of the tips and tenets Walton delivered over the following hour.

Informing everything Walton said were two precepts.  First: “Wealth is built on the margins, not the home runs”; in other words, repeated small movements in the right direction add up over time to a huge difference.  Second: “It’s never too early to start.”  Whether saving for retirement or cutting costs in graduate school, the time to start is now, and again it can have a significant impact. 

Budget

How can you reduce costs?  Walton asked for suggestions from the attendees and approved of all the responses:

• Pack your lunch every day
• No cable
• Live off-campus
• Share accommodations rather than live alone

Walton’s prime advice was to budget. The budget is the ground on which your financial plan rests.  She recommended a simple formula: the 50-20-30 plan. Allot 50% to fixed costs, 20% to financial goals, and 30% to flexible spending (“wants” rather than “needs”). And if you don’t need to spend that 30% on “wants,” plough it back into financial goals.

The 20% for “financial goals” should include Savings—money you might need in the next five to ten years, in case of a financial crisis.  You should have three months or more of “fixed costs” in Savings, depending on how the job market is in your field.  It needs to be available, and it needs to be safe.  Walton suggested exploring online banks; they are just as secure as brick-and-mortar banks, but they pay higher interest.  Investment is long-term, and for this Walton suggested considering mutual funds.  These are a “basket” of stocks that offer individual investors the diversity that would be difficult to achieve on their own.  But watch out for administration fees!  On a principal of $100K, a fund with a 3% annual fee will leave you with $280,679 over 30 years, while with a 1% fee you’d have nearly half a million.  Walton suggested looking for fund families that charge fees lower than 1%. And make sure to consider opening a Roth IRA, which accumulates interest tax-free. 

Walton explained the Rule of 72.  Divide 72 by your interest rate, and you get the years until the money doubles.  This can work for you or against you.

Student Debt
At the start of almost every graduate student’s career, education debt will be part of “fixed costs.” The average for graduate students is $57,600. A college grad’s average monthly student loan payment is $351.  Education loan payments should not be more than 8% of your salary.  Or another way to look at it is that your total student loan debt should not be more than you can expect to earn in your first year on the job. A good source for starting salaries is http://www.naceweb.org/salary-resources/starting-salaries.aspx.

The following strategies can shorten your repayment time and reduce interest costs. 

• Refinancing: depending on the interest rate environment, it may be advantageous at some point to refinance your (federal) student loan with a private lender.  This strategy requires a credit score of 700 or better -–or proof of $2K/mo in disposable income; be aware that if you refinance with a private lender, you give up the advantages of federal loans.
• Early inheritance:  if you can expect an inheritance in the foreseeable future, consider asking for an advance on it to pay down your student debt. 
• Debt payment snowball strategy: pay off highest interest loans first. Doing so will reduce repayment time, and your total interest expense will be smaller.  Alternatively, if you need a psychological boost, pay off your smallest loan first, reducing your list of loans by one in the shortest possible time.
• If the terms of your loan allow, make extra payments to principal.

Credit
Your Credit Score maters!  It affects your ability to get credit, and it might cost you more in interest.  For example, the additional interest costs due to taking out a mortgage when your credit score is poor could cost you hundreds of thousands of dollars over the life of a 30-year mortgage.  And credit scores affect other costs such as insurance.

There are three main credit bureaus: Equifax, Experian, and TransUnion. You can request one free credit report from each per year.   A good strategy is to check your credit every four months with a different agency.  This is also a good hedge against identity theft.

The two biggest factors in your credit score, accounting for two-thirds of the score, are your having used credit and your having paid it back in a timely manner.  If you have best credit (781-850), a single 30-day late payment on your credit card can knock your score down 90-110 points, or 10-14%.  Length of credit history is also a factor, so if you plan to restrict your use of credit cards (a good idea!), don’t close the accounts down; just use them more strategically and less impulsively.

If you hire a financial advisor, make sure she or he is a fiduciary.  You may have heard about upcoming legislation that will require advisors to work in their clients’ interest.  These regulations apply only to retirement accounts, so even after they come into force, an advisor can still legally sell you products that serve the firm’s best interests, not yours. 

Q & A  Follow Up
Q: A lot of your presentation concerned financial decisions after one begins a career.  What are three of the best suggestions for graduate students who are still in school?

A: Minimize debt, minimize debt, minimize debt! Live within your means.  Debt at graduation affects many decisions from that point on: where you live (with parents?), buying a house, buying a car, travel plans, etc. Most importantly, debt impacts your ability to save, invest, and take advantage of compounding. Remember the Rule of 72 (see above).

Q: What is the single tax break that students most neglect?

A: Check out the Lifetime Learning Credit and deducting student loan interest.

Q:  Is there a good technique for avoiding excessive and impulsive discretionary spending?

A:  That's all about self-discipline and delayed gratification. Know your spending triggers; build new habits to avoid them.  Check out the Marshmallow Study conducted by psychologist Walter Mischel while at Stanford. Also, the very low-tech strategy of using envelopes to control spending works like magic: search "envelope spending."

Q:  Here in Tucson, real estate is still quite cheap, and interest rates are still low.  Is real estate a realistic strategy for students with some cash on hand?

A:  We would like to see you have (a) an emergency fund, (b) debt under control, and (c) a healthy investment account balance before you think about buying a house. The sooner you have an investment balance, the sooner compound interest can start working for you. Again, consider the Rule of 72. Until you're sure about your future plans, renting is a better choice.

Q:  Tell us more about the TCI Foundation and how you came to be involved. 

A:  Bob Swift, the founder of TCI Wealth Advisors, started the TCI Foundation, a 501c3 non-profit, in 2014 to provide financial education and advisory services to individuals who would not typically consult a financial advisor. I am the Executive Director of the Foundation. Recognizing that decisions made in your twenties have the greatest impact on your financial well-being over your life time, we started the 3rd Decade Program to offer individuals in this demographic solid financial education and one-on-one advisory services.  We also offer the incentive of a Roth IRA match on successful completion of the program.

Here is Laura’s Budget Template.

Want to watch the presentation? Visit the Graduate Center Videos page.

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