“You want to sock away as much as you possibly can.”
Ever wanted to talk to a Wharton professor about your finances? Each week Prof. Kent Smetters, the most recent winner of the TIAA Paul A. Samuelson Award for Outstanding Scholarly Writing on Lifelong Financial Security, gives out personal financial advice on Your Money, his call-in show broadcast on Wharton Business Radio on SiriusXM channel 111. Last week he was joined by Tom Meyer, CEO of Meyer Capital Group, to answer three top questions from listeners.

Listen to the Podcast on Soundcloud, or read the answers below.

1. Should I consolidate or refinance my student loans?

Caller 1 has just finished grad school with $40,000 in student loans at 6 percent fixed interest for a payment of around $400 a month. He reports annual income of around $35,000, a car payment of $600 a month, and spotty credit.

Meyer: Most loan consolidation companies say they are nonprofits but they are not. If they can get the loan payment down, it’s often by stretching out the loan and you pay a lot of fees. Given that you’re fresh out of school, they’re not going to be able to lower the payments much.

It’s about tightening the belt. You’re very liquidity constrained. Try to figure out how to keep expenses very, very low. Other than that there are not a lot of options, unless you want to have the nicest Uber car on the block. Figure out how to be very miserly over your spending over the next couple years.

2. How much should I save before I buy a home?

Caller 2 has paid off his student debt. He and his wife have one car payment at a 1.9 percent interest rate. After taxes, they make $10,000 a month, paying $1,500 in rent and spending $1,500 on expenses. They have saved $45,000 towards a house.

Meyer: You have to understand that a house is always a money pit. I’ve been there – you don’t want to believe it but it’s true. You can’t put every dime of that $45,000 in savings into a house. Your hot water heater is going to blow up. You’re going to need a new roof. There’s always something, and then you’ve got to furnish it.

Smetters: Put aside $20,000 as your safety money. It’s really there in case things go south – the water heater goes or you lose your job. If you’re in a risky profession, you might want to have nine months of expenses set aside.

So after setting that aside, you want another $60,000 for your down payment. If you can get at least 20 percent down, that will save you a couple hundred dollars a month in useless payments toward PMI [Private Mortgage Insurance]. You can waive PMI if you have 20 percent down, and PMI doesn’t contribute anything toward building equity so you want to avoid it

Taking that $20,000 off the table, you have $25,000 available toward your house. You’re going to want another $35,000 for a down payment and another $5,000 for closing costs. As Tom points out, you’ll need another $10,000 for furniture and other home expenses.

With $10,000 in cash flow, I recommend that you spend another year with your parents and really scale back the $1,500 in expenses you’re currently spending. You could probably cut that in half and do pretty well. Try that for a year while you look at houses and save up that $50,000.

3. How do I start planning for retirement now that I’ve graduated from business school?

Caller 3 is earning $100,000 per year at a large telecommunications company after getting her MBA. She doesn’t have student debt and her monthly expenses including housing are about $1,000.

Smetters: Only 19 percent of graduates come of all school with no debt. You’re in brilliant saver mode. You almost certainly have access to a 401k. You want to sock away as much as you possibly can.

Meyer: Use your 401k and max out. Take advantage of something money can’t buy, and that’s your age. You’re coming out of the gate five lengths ahead of everyone else. You could be putting $18,000 a year, the contribution limit for 2016, into your 401k.

On top of your 401k, you could open up a Roth IRA and put $5,500 in that per year. Chances are your income is going to go up in the future and you’ll be in a pretty decent tax bracket even when you’re withdrawing money 40 years from now, so you might as well pay the taxes today with a Roth IRA.

Now you’re going to find you have even more money left over. Open up a taxable brokerage account and invest in something like a total stock market fund. If you don’t like taking stock market risk, that’s fine because you’re going to hold bonds in your 401k. Given your age, try 80 percent stocks, 20 percent bonds with all of the bonds in your 401k. That’s very tax efficient.

Smetters: You’re going to have a lot of options when you go into the 401k and you might want to go into a target age fund.

You’ll find a fund that has your target retirement date. It rebalances you between stocks and bonds as you get older. If you have a bunch of money in your taxable brokerage account, you might want to be a little more conservative in your 401k. If you want to retire in 2045, you could sign up for 2035 fund and overall have the right allocation.

Posted: January 18, 2017

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