Personal Finance for PhDs

Live a financially balanced life - no Real Job required

Emily

Values, Goals, and Tactics

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Personal finance is personal. The root reason that there is so much variety in how people handle (or don’t handle) their money is because we all have a slightly different constellation of values. What we value in life influences the kinds of goals we set for ourselves, and our individual goals will determine the tactics or strategies we choose to reach them. If you choose your tactics, like cutting expenses in certain areas or picking an account type, before examining your values and setting your goals, you will be acting inefficiently and may even give up on your system.

Further Reading: Determining Your Values and Financial Goals while in Graduate School (a Grad Student Finances Guide)

Values

Take a few minutes to think about what few concepts you value most in life – what brings you the most joy, what you’re striving for, what you would do if you knew you had a short time to live. Then, if possible, identify how money relates to those values or add more that are money-specific.

David Bach has a wonderful exercise in Smart Couples Finish Rich on determining your top five money-related values by asking yourself the question “What is the purpose of money in your life?” Some examples of values are spirituality, balance, health, marriage, security, freedom, creativity, family, making a difference, fun, and happiness, but you should generate your own unique list.  You can read the chapter on this exercise from his book on his website (it’s for everyone, not just couples).

Goals

Once you have determined your values, take an inventory of the goals you’re currently working toward and where your money is going. Do you see that your current financial practices are in harmony or in conflict with your values? If you have never examined this before, you are likely to find there is some room for improvement. Now you can set new goals that align with your values and start making changes to how you direct your cash flow to achieve those goals.

Here are some common values and examples of goals that someone with those values might set that have financial implications.

  • Value: security; Goal: have a fully funded emergency fund, save for retirement
  • Value: freedom; Goal: achieve financial independence ASAP by cutting living expenses and increasing income/savings rate
  • Value: travel; Goal: save monthly for one big trip per year
  • Value: homemaking; Goal: save a down payment, improve credit score
  • Value: family; Goal: live on one income so one parent can be at home full-time
  • Value: health; Goal: pay for a gym membership and healthy food by cutting expenses in other areas
  • Value: helping others; Goal: give a certain amount of money each month to an organization

It may be the case that you are making a short-term sacrifice to be able to more fully align yourself with your values later, but it will be helpful for you to know that your dissonance has an end date. For example, perhaps ‘family’ is one of your top values, but you moved away from your family to attend grad school. That is a limited-time situation, and identifying ‘family’ as a top value lets you know that it is important to you to find long-term work near your family after you graduate. Perhaps you are in a phase of debt repayment, and it feels like all of the things you value are being neglected because you have to funnel everything possible toward paying off debt. In that case, what you are really doing is positioning your life to be even more in line with your values after you are done paying the debt because you will have much more control over your cash flow.

Some other useful questions to ask yourself alongside determining your values is to examine some other aspects of your personality that will affect how you view and handle money. Are you a spender or a saver? What is your risk tolerance? How important is it to you to live within your means? Your answers to these questions will greatly influence the tactics that you choose. For example, a spender and a saver might have the same goal of being financially secure by saving for retirement, but they will go about it in different ways because what comes naturally to the saver may need to be carefully orchestrated by the spender. Likewise, if two people have a goal of having a certain amount of money in savings in 10 years, but one is risk-averse and one embraces risk, the risk-averse person will likely have to commit to a higher savings rate (but she’ll be able to sleep at night).

Further reading: Investing in Experiences Is Better than Buying Stuff; How to Stop Procrastinating Your Personal Finances

Tactics

Once you have a goal, you can pick one or more tactics or strategies that will help you achieve that goal. People often access personal finance at the level of tactics or goals instead of values, which is a mistake because not every tactic will maximally support each goal and value, and tactics are not necessarily appealing to all personalities. However, some tactics will support many different types of financial goals for a broad spectrum of personalities, which is why you will find them commonly discussed. Such tactics include tracking your spending, paying off debt, saving for the long-term, and having access to cash. But that doesn’t mean that you won’t need to come up with additional, less-used tactics to meet your goals.

Further reading: First Values and Goals, Then Strategies; Americans Are Broke: Here’s Why, Conquer Your Financial FOSO (Fear of Starting Out)

Roth vs. Traditional

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You will often hear about traditional vs. Roth IRAs and 401(k)s. In both cases, your contributed money grows tax-free, so the chief difference between the two is when the money is taxed. In the case of a traditional account, you take an income tax break when you contribute the money and are taxed when you take distributions from the account. The Roth is the reverse – you pay income tax on the money when you contribute it, but the distributions are tax-free. The main question to ask is whether you believe your income tax rate is currently higher or lower than it will be when you take the distributions. While this answer cannot be predicted perfectly because tax rates are subject to the political process, many graduate students are sacrificing income in the short-term for long-term income potential, so it is likely that their incomes and tax rates will jump after grad school and increase with time. Therefore, the Roth seems to be the better choice for most graduate students and young people in general. Even the most tax-break-enthusiastic professionals will tell people to contribute to Roth IRAs when they are in the 15% tax bracket or lower.

The other noteworthy differences between the Roth and traditional options are:

  • there are income limits for contributions to Roth IRAs for high earners (contributions start being phased out with a modified AGI above $114,000 for single filers and $181,000 for married filing jointly)
  • you must start taking required minimum distributions from a traditional IRA by April 1 of the year after the year you turn 70.5, whereas there are no required minimum distributions from a Roth IRA
  • you can withdraw Roth IRA contributions at any time without penalty (but not earnings)
  • you can withdraw Roth earnings without penalty in certain situations such as for qualified educational expenses or a first-time home purchase

You should also consider tax diversification. If you are likely to have a higher-paying job in the future and plan to contribute to a traditional 401(k) or similar, you can diversify your tax situation by contributing to a Roth IRA now. That way, in retirement, you will have more flexibility with your distributions, paying tax on some of your income but getting some income tax-free.

Further Reading: Roth Vs. Traditional IRA: Which Is Right For You?; Traditional vs. Roth IRA: Some Unconventional Wisdom on Which is Better for Young Investors; Roth IRA Basics, In a Question & Answer Format; Roth IRA vs. Traditional IRA: The Complete Guide for Wise Investors

Long-Term Savings

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Long-term savings are on a time horizon of at least five to ten years and should be invested to avoid interest rate risk in taxable investment accounts. An example of a long-term savings goal is children’s education funds, which can be invested in tax-advantaged vehicles.

 

Mid-Term Savings

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Mid-term savings have a time horizon of a few years and are larger in scope than short-term savings. Examples of mid-term savings might be a car replacement fund or a down payment on a house. This money may be conservatively invested or kept in cash-equivalents depending on the timeline and the risk tolerance of the investor.

Retirement Savings

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Retirement savings is likely the longest-term savings goal you can set, and yet it is so beneficial to save for it early and continually because of the time value of money. The time horizon for the goal is so long that you can invest the money aggressively when you are younger and gradually shift the asset allocation to be more conservative as you near your retirement date. It is advantageous to invest your retirement savings in a tax-advantaged account like an IRA or 401(k) so that the money can grow tax-free.

As a graduate student, you likely do not have access to a workplace-based retirement fund like a 401(k), 403(b), TSP, or 457. If you have taxable compensation, though, you can contribute to an IRA. In 2015, the most a person under 50 can contribute is $5,500 or the amount of earned income, whichever is lower. Additionally, if you have a side hustle and are self-employed, you may want to set up a retirement account for self-employed individuals (solo 401(k), SEP IRA).

Once you decide to save for retirement such as in an IRA and confirmed that you have earned income, you will have to decide whether to open a Roth or a traditional version.

Further reading: Even Grad Students Should Have a Roth IRA

Short-Term Savings

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Short-term savings accounts come by many names and can have many purposes. The money in a short-term savings account is likely to be used within one or two years and therefore should be kept in cash-equivalents like savings or money market accounts.

Emergency funds are a type of short-term account that are set aside for use in emergencies only.

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You can save regularly into a system of sinking funds or targeted savings accounts to help smooth out large, irregular expenses.  An example is to save a certain amount every month for travel expenses, though you only travel a few times per year. That way, the cost of a flight or lodging does not overwhelm your cash flow in a given month.

Goal-based savings are straightforward to set up. You set a goal to make a certain kind of purchase at a certain time and estimate the cost. Just divide the cost by the number of months you have to save up for it and set your monthly savings rate accordingly.

An opportunity fund or general savings account is another stash of money that can have a more flexible purpose than an emergency fund or the other short-term types of accounts. This money could be used for unexpected opportunities or expenses that don’t qualify as emergencies or as a slush fund for when your cash flow is short in a given month.