Inquiring Minds Want to Know

pong

We are back from a rowdy New Year celebration at my sister’s house. This time my 23 year old nephew invited a bunch of his friends which resulted in what can only be described as a big frat party. Drinking, dancing, yelling and screaming was happening on the first floor of the house while my son was somehow sound asleep on the second oblivious to all the noise. Midnight was punctuated by the sounds of popping champagne bottles, with contents of several ending up all over the walls and the ceiling. My brother-in-law was not happy…

The Aftermath

ceiling

Beer pong and other festivities aside there was serious business at hand. My nephew is about to graduate from a prestigious university after a 6 year program to become a pharmacist. He did very well in his studies and internships and already has 2 job offers with starting salaries around $130,000 per year plus benefits. At the same time we all know that a degree from one of the top schools doesn’t come cheap.  Despite securing several scholarships he will start out his professional life settled with about $150,000 in college loan debt carrying interest rates anywhere between 4 and 8 percent.

My nephew lives with his parents and commutes to school to save on housing and food costs. He’s been working in pharmacies part time for several years now to have some cash to pay for his expenses. He has a good grasp on finances but there are a couple of things that are not helping at this point.

The biggest issue is that my sister and her husband lead a typical consumer life. Both work long hours but whatever they make is immediately spent on stuff with very little saved for the future. Money flows like sand through the fingers committed to housing, car leases, commuting, food, HD cable, cell phones and data plans for 5 people, Apple products, decade long home renovations, incandescent lighting, “throwaway and replace” SOP, heating, cooling and on and on. They both admit that they “have no plan” and will have to work till they drop, yet eyes become glossy when the subject of finances and expenses comes up. I still try to drop hints like gifting CFL light bulbs and plugging holes in their drafty house insulation, but it appears that they are set in their ways and not looking to change.

While they are some of the most loving and caring parents I have ever met, this is a challenging environment to learn about finances. Looking at my nephew I’m proud of what he’s accomplished at such a young age and get excited talking with him about the opportunities that he now has. Earning six figures in his early 20’s can set him free in a decade, but only if he can do a 180 from his parents lifestyle.

When he started college I offered help with any financial questions that he might have. This led to conversations about credit, houses, cars, taxes and many other big topics that I wish I had someone to talk with at his age. I showed him how I could’ve been financially free by 40 if I only tweaked a couple of variables in my early 20’s: saving, investing and spending. He does not have to follow the path chosen by his parents; there is another way.

A while back I got him “The Millionaire Next Door” book as a present hoping that it will help to cut through all the “Keeping up with the…” bullshit. He is surrounded by the rich kids predictably flaunting their “wealth” with designer clothing, jewelry, cars and other material possessions. He was surprised to find that statistically these kids and their parents are destined to work till they die to support their treadmill lifestyles. I was glad when he brought up the book and shared his thoughts some time later saying that it was an eye-opening read. To be honest, I thought that he would never even read this book.

Sensing the opening, I gave him the “Automatic Wealth for Grads” book about a year ago. He was getting closer to graduating and I felt that it would give him a good foundation in what it takes to become and stay financially independent. I picked up the book from a shelf in his room and was happy to see highlighted paragraphs and dog-eared pages.

His birthday is coming up and I plan on getting him “Your Money or Your Life” book to really drive home the point that there is another way. YMOYL really opened my eyes on what is it worth working for and hopefully it will do the same for my nephew.

While at my sister’s house, I was happy to hear my nephew mentioning that he found a couple of finance blogs on his own. I recommended some other ones and he jotted them down. He was also proud to show off his Mint.com account where he started keeping track of expenses. He also admitted that it was probably a mistake to lease a $40,000 car even if his parents pay for half and even subsidise insurance.

Building on the momentum we came up with a high level game plan for the next few years.

  • Continue living with parents for 3-4 more years to save on living expenses. Parents are encouraging him to stay anyway.

  • Pay off 150K in student loans within 3 years after graduation.

  • Max out 401(k) at work. Keep it simple and invest everything in one target date fund like a Vanguard 2055.

  • Save up 20% down payment and purchase a duplex. My nephew is really interested in owning an income producing property at some point and this is a great way to get into rentals. Live in one apartment and rent out the other while learning how to DIY maintenance and repairs.

  • Open a brokerage account and start building a taxable portfolio. This one is done as we set up an account at Vanguard while I was at my sister’s. They wanted a $3,000 initial investment to fund the brokerage account which my nephew did not have. We called Vanguard and found a loophole where if you send a paper check for any amount, they will deposit it into your brokerage account allowing you to make a trade bypassing the minimum. My nephew wrote a check for $200 and mailed it in.

  • Use any extra money to buy shares in Vanguard funds. At this point I recommended putting everything into VTI for simplicity and cost reasons. This ETF index fund represents 100% of the US stock market and carries a super low 0.05% fee. We will revisit investment allocations at a later time when there is a substantial buildup in capital. *I just got a text from my nephew saying that the check has cleared and he bought 2 shares of VTI today!

  • Continue using Mint.com to track expenses and net worth. I find it extremely motivating to be able to look at all the pretty graphs showing progress and I know my nephew will love it too.

  • Once the car lease is over get an older model, preferably a low maintenance Japanese 4 cylinder hatch or sedan. After a no-fault accident and random scratches just from parking his leased car in a big city and the associated costs and hassles, my nephew is on board with this.

  • Watch out for lifestyle creep as big paychecks start coming in. This should be mitigated by the second bullet point as large part of each paycheck will be committed to paying off student loans. We talked about continuing “living like a student” and my nephew reluctantly agreed… This area will need to be watched closely.

  • Design a lifestyle where saving at least 50% comes naturally without any hardship. This should be relatively easy given a six figure starting salary.

Based on our conversations I’m confident that my nephew is serious about starting his journey to financial freedom. Looking back to when I was his age it’s obvious that he is already ahead of the game. While I can’t go back in time to change a couple of things for myself, it’s great to watch and be part of this adventure in the making.

I also see now why mentoring can be so fulfilling… In a way, mentors see a shadow of themselves and get a chance to re-write history.

Readers: Do you think that we came up with a good financial plan for a six figure earning, six figure debt-laden 23 year old? Would you add or change anything?

 

11 thoughts on “Inquiring Minds Want to Know

  1. There are two other things I’d add
    1 – he should figure out a way to pay rent to mom and dad. Even if they don’t take a check now, setting aside $500 -$1000 each month in an account to be given to them at a later date would be very good, since it seems they haven’t saved anything for their own retirement and probably feel they have sacrificed much for their kid.
    2 – Spend some free time finding a passion beyond beer pong. What’s the point of checking out of the working world early unless there’s something you really want to do with your time.

    • Agreed. We talked about setting aside at least $500 to give to his parents for rent. I told him that he should also start paying all of his bills like car insurance and the lease payment. Buying groceries for the family once in a while would be nice too.

      As far as finding a passion – great point. I think it takes time to get that figured out, especially after an intense 6 year pharmacy program. I’ll need to remember to bring up this topic once in a while to keep him thinking.

  2. With a six figure salary and an Uncle like you to guide him this kid is set up for life! Nice one on the mentoring and providing a solid example for the younger generation!

  3. Great article – I wish someone had sat down with me and told me about this while I was in college. I was interested, but had no clue where to start or what to do so I just went with the colony mindset of spend spend spend! I’ve learned, though, because I read The Millionaire Next Door and Your Money Or Your Life and they both helped change my life.

    If you don’t mind my asking, if Vanguard allowed you to open an account with less than their typical minimum balance of $3,000, why did you choose to go with VTI instead of the mutual fund VTSMX? It’s my current understanding that if someone is going to be making regular contributions (let’s say once a month), it’s easier to do it in a MF; If you just want to do a lump sum, then you’d go with the ETF. I would like to open an account with a few hundred dollars, like your nephew, then make monthly contributions after I open, so I’d think going with the mutual fund would be the better way..but the ETF is also commission free, which I assume makes a difference?

    • You and me both, Jamie! If only I knew then what I know now I would be FI by 35. Oh well, in a way we all get second chances through having kids or mentoring nephews 🙂

      To answer your question – I personally invest in VTI in my brokerage account because it has the lowest expense ratio compared to other ETFs and mutual funds. VTSMX has exactly the same stocks as VTI but a higher 0.17% expense ratio rather than VTI’s dirt cheap 0.05%. I would much rather pay 70% less in management fees for exactly the same performance. It might not matter as much in the beginning, but as your investment amount grows, management fees quickly add up. One of the very few variables you and I can actually control while investing is cost and minimizing investment fees will make a huge difference over our investing lives.

      As far as ease of investing in VTI vs. VTSMX – I don’t really notice any difference. Yes, you have to buy full shares of VTI instead of partial shares allowed in mutual funds, but that never bothered me. ETFs are traded like stocks and it’s actually kind of fun buying full share(s) in the middle of the day as prices fluctuate vs. end of day close prices for mutual funds. Obviously, don’t get distracted with “day trading” ETFs! I prefer doing my regular contributions by buying manually once or twice a month anyway. Having said that, I have both ETFs and mutual funds at Vanguard and I like them all. My retirement account is mostly in target date fund 2040.

      So that’s what I recommended to my nephew. Invest your 401K in a target date fund offered by his employer (they don’t offer Vanguard) and invest in VTI in his Vanguard brokerage account. As he learns more he can diversify into other Vanguard funds but for now VTI will offer THE cheapest option of getting some skin in the game.

      • Cool, thank you so much for the input! I can see how the lower expense ratio makes the ETF more enticing, and I take your word for it that the investment fees do matter as the invested amount grows (it’s hard to accept with my small introductory dollar amount staring at me, but when I do the math, it makes total sense). I don’t mind buying in full shares, either.

        What about the admiral shares (VTSAX)? The expense ratio is 0.05% for that fund as well. While the minimum is higher at $10,000, if someone actually had that dollar amount to invest, does it truly become just a matter of wanting to buy during the day VS buying at a set price at the end of the day, to decide between the fund (admiral shares) and the ETF? (Also, I just realized the NAV is almost double for the ETF – I suppose this also comes into the equation)

        Sorry to be the question monster here, but you have shed some light on a question I have been pondering for weeks already and I’m so excited to have some opinion/advice about it!

        • VTSAX is a great option IF you have that $10,000. As far as the difference between ETFs and mutual funds – it’s a bit more complicated than just wanting to buy during the day vs. 4PM at a set price. For one, there is no restriction on frequent trading with ETFs. They can also be traded just like stocks with stop/limit/short orders and on margin. This flexibility might be important to some people…. Here is a good starting point to help you decide what works best for you: http://www.bogleheads.org/wiki/ETFs_vs_Mutual_Funds. Note the two links at the bottom of the page that will give you Vanguard’s view on both options along with general investor profiles for each.

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