Live Like a Resident (or College Student) Part 2
Ryan’s situation
Now to bring it back to my kids and future grandkids, using Ryan as an example. Ryan is well on his way to graduating in 4 years, but he served a mission and he is planning on getting a masters degree which will take about an extra year before he is in the workplace. So he will probably be 25 years old when he starts making money. I will keep the numbers simple for ease of calculation. Assume he lives on less than $15,000 during his last year as a poor college student at BYU. And assume he starts making $50,000 (after taxes) at his first job. I will recommend to Ryan that he continues to “Live Like a College Student” for a few years. This does not mean I will counsel him to live on less than $15,000. It means I will counsel him to keep the college student frame of mind in order to get a good start on accomplishing his financial goals.
If we are intentional about the way we spend and save, it will be fairly easy to carefully control the lifestyle creep that naturally occurs. It is far easier to keep spending at the same level right after college than it is to drastically cut back spending years later when it is realized that financial goals are not being met.
Retirement investing should be like paying tithing
Ryan has learned to pay tithing without thinking of that as a sacrifice. He doesn’t think about if he can afford to pay tithing, he just pays it and then lives on what is left. Retirement savings should be thought of similarly. The first 10% of his income should go to tithing automatically. The next 20% should go to retirement investing automatically. If Ryan thinks of it this way, it will be easy money to part with and will build him incredible wealth.
Allocation of $50,000 after taxes
$5,000 to tithing
$10,000 to retirement investing
$15,000 to cover his expenses like he was still a college student
This leaves an additional $20,000 to spend or to put toward his financial goals. This might be saved for a future house down payment. This might be saved to pay cash for a newer car. This might be saved for whatever else he thinks is important. And some of it should be spent to improve his lifestyle.
Retirement investment
In regards to the $10,000 of retirement investing, I would counsel Ryan to invest $5,000 in a Roth IRA for himself and $5,000 in a Roth IRA for his spouse. This $10,000/year (a total investment of $350,000) would be worth $903,000 at age 60. And none of that $903,000 would be taxed since it was invested in a Roth account. If he didn’t start investing for his retirement until age 35, a $10,000 per year investment (total investment of $250,000) would only be worth $477,000 at age 60. That extra investment of $100,000 dollars from age 25-34 would give him an extra $426,000 in retirement. This really demonstrates the importance of saving early and the power of compounding interest.
This spreadsheet details what happens to this $10,000 investment over 35 years based upon a 5% investment return.
This demonstrates how powerful compound interest is. The first line indicates how much of Ryan’s money he invested, already established as $10,000 per year. The second line shows the total amount of the retirement account assuming 5% interest. The third line shows how much of the annual increase was from interest. His $10,000 present at the end of year 1 earned him $500 during year 2. The $20,000 total he had contributed during the first 2 years earned him $1,025 during year 3, etc. By year 15, it shows that $150,000 of the total $215,786 is there because he contributed it. Only $65,786 is from interest. However, year 16 is a big year. Ryan invests another $10,000, but the interest he earns during that year will be $10,789 so his invested money is now making him more money than he is contributing. This continues to compound so that by year 24, compound interest is contributing twice as much as Ryan’s $10,000 contribution. By year 30, compound interest is contributing more than three times as much as Ryan. And during his 59th year, this money will earn him over $42,000. The further along you get, the less your savings rate has to do with your total accumulation. This is one of the ways the rich get richer. Once Ryan has saved enough, the compound interest will work very hard for him.
Ryan’s numbers for retirement will actually be much higher if he follows this path because 20% of all future raises will also go towards retirement. And I anticipate he will be making much more than $50,000 as a computer engineer with a masters degree. But even if he only makes $50,000 for the rest of his working career, this would still allow him to build significant wealth if he approaches it the right way by investing 20% of his income.
We lived like college students after Lisa graduated
I outlined some of the mistakes Lisa and I made right after residency, but we actually did a great job during and immediately after college. Thanks to continual employment during school and a half tuition scholarship that I earned, we were both able to graduate with no debt. Lisa worked as a full time teacher during our last 2 years in Provo while I was finishing up my degree. The first year she received half salary because it was an internship. The second year she received a full salary. We decided to save all of her salary and to continue to live on my income as an orderly at the hospital and my income during the summer. Lisa continued to “Live Like a College Student” even after she graduated and started making her teacher salary. In fact, we didn’t touch any of her salary all through medical school, which allowed us to have a decent down payment to purchase a house when we moved to Washington for Residency. This decision paid large dividends for our long term wealth.