There are many paths to wealth
I recently had an interesting discussion in the comment section of one of my posts about how much money you need to earn each year to start investing. This Rebel Reader is about to graduate from college, and he wanted to know if a salary of $50,000/yr was enough money to start investing.
My initial response was “Hell yea! and here’s how I’d do it”, but I got to thinking about this question and I’d like to lay out a more comprehensive straight out of college game plan for anyone looking to live frugally, grow wealthy, and stick with it.
Any road to financial independence will be bumpy, but this should serve as a general guideline to getting there safely. So I’m going to throw down some assumptions and see where this plan might take the average college graduate with a $50,000/yr job.
My Assumptions
- Student Debt: Average debt coming out of college is $26,600. There are lots of ways to reduce this number during school, but I’ll keep this assumption for now.
- No other assets: I’m assuming that our intrepid college graduate is hitting the job market with only a few dollars to her name.
- 4% Raises: She’s a go-getter, putting in the extra time at work to average 4% raises.
- Annual spending of $22,000 ($1833/mo): If you want more info on how to do this, check out the rest of my blog
- All investments are in broadly diversified Vanguard stock index funds which return a long-term average of about 6%/yr
Year Number 1
Bright eyed and bushy tailed, our hero (let’s call her Saving Sally) strikes out into the working world to earn her first paycheck. She spends her evenings reading about personal finance and investing, and her weekends hanging out with friends and hiking. Life is good and she is amused by her in-debt friends who go further into debt to buy fancy cars and whatnot.
- Income: $50,000
- Taxes: I’ll assume an overall 20% tax rate so she’s earning a monthly salary of $3,333 after tax- leaving $1,500 left over after living expenses
- For the first 3 months, almost all of this savings goes into an emergency fund – so there’s $4,500 in there by the end of month 3
- Savings: Starting in month 4, $250/mo goes into a savings account until there’s about $10,000 in there
- Student Loans: Sally throws the rest ($1,250) at repaying student loans each week
End of year 1 Results
- Student Loans: ($15,350)
- Savings Account: $5,650
- Net Worth: ($9,700)
Year Number 2
Sally’s been working hard for a year now, putting in a few extra hours, getting to know her new city, and generally enjoying life. She doesn’t have a high net worth (in fact it’s rather negative), but she’s become quite confident financially from all the books and blogs she’s read.
- Income: $52,000 ($3,467/mo AT)
- Savings: She continues her $250/mo savings rate without noticing it because it’s automatic
- Student Loans: Because of the 4% raise, Sally is now able to clobber the her loans by $1,384/mo
- Debt Free:: Since Sally’s student loan balance will hit $0.00 in December, she’ll have $1,258 to add to the savings account for year 2
End of Year 2 Balance
- Student Loans: $0.00
- Savings Account: $9,908 (or 5.4 months living expenses)
- Net Worth: $9,908
Year Number 3
Now Sally’s gonna get a little funky. She’s excelled at work, paid off her massive student loans in 2 years, and built up almost 6 months savings in an emergency fund. Now, since she’s already used to living on $22,000/year, she’ll be able to start investing aggressively to eventually achieve financial independence.
- Income: $54,080 ($3,605/mo AT)
- Savings: I’d cool it on savings for now since 6 months worth of living expenses should be plenty for now
- Student Loans: They are but an unpleasant memory…
- 401K: Hopefully Sally’s employer matches 5% of her contribution, but either way, she wants to max out the $17,500/yr limit with $1,458/ mo contributions.
- Roth IRA (or Traditional IRA, either way is fine): She’s almost able to max out her first IRA with the $314/mo that’s left over ($3,768 out of $5,500) – The snowball IRA Method from Evolving Personal Finance might be useful in this situation…
- Tax implications: I’m over simplifying the tax situation. You get a great benefit from the 401K being tax deductible. For the purposes of keeping it simple I’m going to err on the conservative side and not count those tax savings
End of Year 3 Balance
- Savings Account: $9,908
- 401K: $17,500
- IRA: $3,768
- Net Worth: $31,176
and then a few years passed…
Year Number 10
After years of living frugally, working diligently, and investing the rest in her 401K, IRA, and taxable accounts, Saving Sally is well on her way to financial independence. She climbed out of debt in under 2 years, and now owns significant assets. By my calculations, she won’t be financially independent until about year 15, but she’s definitely got some more options now.
End of Year 10 Balance
- Savings Account: $9,908
- $401K: $173,206
- IRA: $51,825
- Taxable Accounts: $45,555
- Net Worth: $279,493
So what do you think? I know I made some interesting assumptions, like not buying property. Is this similar to your 10 year plan?
You can increase your actual wage by living close to your workplace in affordable housing. Cutting the cost of your commute will save you tons of money over the long-haul. If you could start your professional life in a commuter city like DC, or a bike friendly city like Portland, you could far surpass those savings goals.
Johnny, I couldn’t agree with you more about living near your work. This is something I still don’t do, and it’s totally ridiculous – I have no excuse. Living within walking/biking distance of work is probably one of the smartest moves for someone who’s just starting out.
Fully agree with this! We’re a one car house and I walk to work. We want to buy a house eventually, which will entail moving further out and likely a second car, so for now I’m enjoying my amazing commute.
I think people make themselves miserable waaaaay to much just by living over an hour from work. There’s nothing good about driving an hour each way, it’s dangerous, dirty, and stressful. Hopefully you don’t move too far away. Thanks for commenting!
I’d question the 20% tax assumption – Is that really enough to account for 7.5% FICA + fed income tax + state + local… That seems pretty low… We tend to use higher estimates for future tax liabilities to err on the side of conservatism (and we live in a state with no state income tax!).
But even at higher tax rates, the overall trajectory would be similar and the points still stand.
Mrs. Pop, I appreciate the input. I went back and looked at my paystub and it looks like a little more is withheld (25% for Fed and State), but that’s before I my refund. I might have to adjust that 20% value upwards a little bit but probably not more than 25%.
Personally, I didn’t chart and plan like this when I got my first job. I just started saving right away. That’s why I like percentage-based budgeting – it doesn’t matter how much you make.
I started saving 10% when I was making $24k/yr. Now my husband and I together make about $55k and we save 17%. So YEAH I think $50k is “enough” to start saving!! You can do a lot more than start!
Yea, anyone that is starting at $50,000/yr should have more money than they know what to do with. so even if it’s just a few percent of your salary, it makes sense to start saving and investing.
I’m going to say something unpopular here, but she is over saving. When you are that far in the hole (and have a decent salary which $50K/yr is) there really is not reason she should be saving to get to a $10K emergency fund earning 0.70% interest when the student loans are likely 6.8% interest. The math makes no sense. I think once she gets to $5000 (which I still think is high for someone without a house) she should throw all that money at debt or into investments (if she can beat her loan interest rate).
Once she has killed off her loans she can resume saving for the emergency fund (which I think 10K is entirely too much, but that’s my opinion) and up her investments.
Of course my entire opinion on agressively paying down her loans changes if they are at the 3% or lower rate, but I don’t think you can get loans that low anymore.
I do think, the plan you have set in place is good for someone who wants to “feel good” about themselves because they are risk averse and I totally get that. In the end you are pointing out the real key is just to have a plan and act on it.
Cheers!
Yeah I’m a grown man with a house and two kids and I usually only keep around $15k for emergencies. I don’t put any additional money in that account. Paying off debt should be her first concern after saving maybe $1-2.5k.
Thanks for the input, Johnny. Now I’m going to have to go back and re-examine my own emergency fund. It’s grown to almost 10 months expenses. I’m going to think about investing a little more of it…
Brian, thanks for commenting. It’s interesting to get other people’s perspectives on this issue. I guess I am super conservative when it comes to your emergency budget, and maybe that’s a reflection of my own fears, but I also want to be ready to pounce on the next market disaster.
I guess since it’s possible to pay the loans off in under 2 years, I didn’t worry too much about which order you do it in. But I certainly understand the case for keeping a lower emergency fund and getting rid of that toxic debt sooner.
Great post! I definitely see myself through this article and see that I can reach a financial freedom if I spend my money wisely. I started a spreadsheet to track my monthly expense so it will be easy to budget. Thanks a lot for your blog, I gain so much valuable information by reading it.
I also have a question regarding the 401(k), Are the management fees or commission fees included in the $17,500? If yes, how much are they?
Did you take into account the health insurance as well? I don’t know how much will be debited for that. Is the PPO better than the CDHP (HSA)?
Thanks
Didier, it sounds like you are taking all the right first steps. I’d definitely recommend Mint.com – a huge game changer for me. Now I don’t have to track any of my accounts/purchases manually. That that’s a good thing because I have 10 different accounts now…
Regarding the 401K, I don’t actually know a ton about them because I don’t have one. My work has a unique profit sharing system instead. But I think I might be able to answer your question. If you invest with a company like Vanguard, you could invest the full $17,500 and then they take a chunk off the top each year. This is the expense ratio, and for Vanguard funds it’s between 0.05% and 0.25%. These expense ratios are way lower (like 10X lower) than other actively managed companies. So if you have $10,000 in a fund with an expense ratio of 0.17%, they’ll take $17/yr.
I just counted health insurance as an expense. PPO vs CDHP is a whole other discussion for another day (or for smarter people than me).
Are we assuming that they live in an average city where there is no increased/decreased cost of living? That could impact it to some extent as well as they could end up with more or less money to be throwing at the student loans and saving/investing. Regardless of that, I totally think that $50k is enough to invest, especially considering that they’re likely single on an their own.
Thanks for commenting John. How would you factor in the cost of living? Would you just say that each year expenses will go up 2%-3%? Sometimes I’m too much of an optimist, haha.
I’m always impressed with your very well-thought out financial plans – the comments are interesting, as well. Great job with helping Saving Sally (and myself) out!
Thanks Anna, these comments in particular make some good points. I like when comments make me reconsider my own strategy. For instance, I now think I’ve probably got too much in my emergency fund. I should probably be putting it in one of my index funds…
I can attest that you can invest a decent chunk of money with an income at or below $50k per year, and not live in your parents basement. It all comes down to defeating lifestyle inflation. If you can do that, you’ll be on your way to a nice networth.
Haha, I love the phrase “defeat lifestyle inflation”. I just got an awesome raise at work and I’ve been thinking consciously about not adjusting my lifestyle to spend more now. I know it the past I’ve justified moving to a nice apartment because I got a raise. This year, the whole raise is going to go into index funds each month. Thanks for commenting, Justin!
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