A Young Lawyer's Financial Guide for the Future I Part 1: Budgeting

Kitch's Corner: A Young Lawyer's

Financial Guide for the Future

Part 1 - Budgeting

Introduction

No matter what area of the law you plan to practice in after graduation, having an understanding of how to efficiently control your spending and budget your finances will have a direct impact on both your current and future quality of life.

For many people, just the thought of creating a budget, saving money, or investing for retirement is stressful. This is not surprising as many of us were never taught these concepts in school and we did not grow up with exposure to financial planning.

Regardless of how difficult the idea of budgeting might be for you, it is crucial that you learn these skills early on in your career.

Understanding Opportunity Cost

Before you begin creating a workable budget, it is important to understand the idea of “opportunity cost.” From a basic economic perspective, when you choose an option from a list of alternatives, the opportunity cost is the cost incurred by not realizing the benefit of the other alternative.

In reality, this simply means that every dollar you spend on X cannot be spent on Y and vice-versa. This simple concept, when applied to budgeting, is a powerful tool that can help you determine the areas of your budget where you will need to spend more money. Everyone is different. For instance, I personally like to keep my budget for rent at or below 15% of my after-tax salary because it leaves me with more money to save and invest; but having a larger space, or a home closer to the office might be more important to you.

Before you begin drafting your budget, I suggest that you start by ranking the things that you would spend the most money on. Of course, try your best to be honest with yourself and avoid the nonessentials, but if you truly cannot function without an expensive apartment or designer clothes, just know that some other areas in your budget will suffer for that.

How to Start Budgeting

Pick a budget tracking method. There is no one size fits all as far as budgeting methods go. Some people like to hand write their budgets, others create their own spreadsheets, and some will use budgeting apps.

My preferred budgeting method is to use Money in Excel, which is great because I am able to design all of my balances, connect my bank and brokerage accounts, and I can use the spreadsheet to analyze the data. Other easy-to-use budgeting apps can be viewed here, on Nerdwallet’s website.

I recommend using an app that feels user friendly and one that gives you the ability to upload and connect all of your accounts. Try to choose an app that can quickly download your most recent transactions. Additionally, it is crucial that you take the time to read the fine print and determine the safety of the app and your privacy (I know that this is cumbersome, but let’s not forget that we are future attorneys!) If you are someone that only uses one bank for all of your accounts, then it may be easier to just use that bank’s budgeting app if you already do online banking with them.

Create separate accounts. One of the things that can make budgeting easier is to keep your money in separate accounts and establish automatic payments. Once you have the accounts set up, then you should make the appropriate allocations to your direct deposit form, so each month your money automatically goes to the right place.

Much like the prudent investor rule, diversification is still important when talking about bank accounts. As a general rule of thumb, try to keep your savings or emergency fund in high yield savings accounts (preferably at banks with high credit ratings and FDIC insurance). For accounts that you use to pay fixed expenses such as rent and student loans, pay close attention to account balance minimums so that you do not rack up unnecessary fees. If possible, check if your employer pays for private banking or any other premium banking perks, and try to take advantage of these benefits.

Creating and Maintaining a Budget

Calculate your monthly after-tax income. When creating your budget, the starting point needs to be your monthly after-tax income (include all sources of income in this calculation). For some, this calculation may be difficult, especially if you are not paid an annual salary, but since the vast majority of junior attorney jobs are paid annually, you should be able to ascertain this amount. You could try searching online for income tax calculators or reach out to your employer’s HR department and ask them for an estimate. This is your budget’s base and from here you will need to determine the most appropriate allocation of your funds.

Simple allocations. The 50/30/20 rule is a simple budgeting rule to begin with: 50% for your needs, 30% for the things you want (shopping, travel, etc.) and 20% for saving and debt repayments. Personally, I think this rule is good to start with, but my only caveat is that you devote 30% of your salary to saving and repaying debts and only 20% to your wants. Whatever allocation you choose, make sure that it takes into consideration your average cost of living. As you get better at budgeting overtime, your allocations should become more granular.

Stay on track. It is useful to start simple because this way you will begin to notice patterns in your spending, plus the more you practice, the better you will get at achieving your budgeting goals. I recommend that at the end of each week, you check your spending to make sure that you are on track to maintain your budget for the month. For any excess funds that have not been spent, my advice would be to roll that over into an emergency fund at the end of every month or to allocate more money to your savings. Unfortunately, after a period of disciplined spending, most people are tempted to “reward themselves” by using the excess cash that they did not spend to purchase something. Instead, think about rewarding yourself by putting money towards your future, which is exactly what an emergency fund allocation will do for you. You could also decide to split that excess 50/50, with one half going to an emergency fund and the other half going to savings, debt repayments, or even miscellaneous payments (such as money for Christmas or birthday gifts).

Use your deductibles. Remember, when starting with your after-tax budget, the first thing that you need to account for are before tax-deductions that I recommend everyone (with only limited exceptions) take advantage of. For most people, the major deductibles that you will need to consider are 401(k)/IRA contributions, insurance (health, life, etc.), Health Savings Accounts, and commuter reimbursement benefits. Each of these contributions needs to be properly accounted for and allocated in your budget. I recommend that you schedule a meeting with your HR department to thoroughly discuss your benefits. In particular, pay close attention to health and wellness programs, reimbursements for professional associations, and employer matching programs.

Always review and re-evaluate your budget. Like most things, budgets are flexible, therefore you should be revisiting your budget at the end of every month and making adjustments as you deem necessary. You should also think about doing an annual review and consider rebalancing your budget allocations as necessary. For those of you interested in working in law firms in major cities, I recommend that you try your best to maintain your budget allocations as your income increases over the years, and that you allocate more of the excess income into savings, investments, repaying debt or your emergency fund. It might also be helpful to create a separate “bonus budget” that will only be applied to your annual bonuses.

The Bottom-Line

The process of creating a budget is not just important for the financial rewards that it promises but it is also a great opportunity to learn more about yourself. I recommend that each time you work on your budget, that you use it as a moment of self-reflection. Think about where you are at that moment in time and how your budgeting will help you achieve the things you want in the future.

Social media is also a great place to learn more about budgeting; I recommend following people like Dave Ramsey, or sites like Nerdwallet and Bankrate. Whether you want to achieve financial freedom, start a charity, purchase a home, or support your family, a great budget is a critical tool that will give you the support you need to attain these goals.

Stay tuned for the next installment in this series, which will focus on investing for future success, in February.