Wednesday, December 23, 2009

Financial Choices As An Associate Determine Your Future

I'll never forget a conversation that I had as a young associate with another associate a few years more senior than me - who I will call Senior Associate or "SA" for short.  I had been working at the firm (a large law firm with top compensation in the city) for a few months and had come to realize that even though my salary seemed high, after taxes, social security, health insurace, student loan payments, and car payment, there did not seem to be much left over.  At the time, I did not yet have a lot of insight into personal finance, so I came up with the idea of trying to figure out what more senior associates were doing so that I could potentially copy that.

A Picture Of Luxury
One person that I made a point to talk to was SA.  I knew generally how much SA made - the salaries were lockstep between years although bonuses varied.  However, SA seemed to always have more money than others and be able to afford things that other associates could not.  SA was about a 4th year associate and had the following things:
  1. SA had recently gotten married and he had bought his wife a $16,000 ring and paid for the ceremony himself.  His wife worked, but at an entry-level publishing job making around $30K.
  2. SA and his wife were moving from their 2-bedroom condo that cost about $350K (average price for a home in the metropolitan area was about $180K at this time) to a new townhouse that cost around $700K
  3. SA was a snappy/expensive dresser and always seemed to have new suits/shoes/work clothes.  His wife was even more inclined in the fashion direction.
  4. SA and wife went on an expensive honeymoon, in addition to at least one expensive vacation a year - and often two.  Of course, because his schedule was uncertain, they ended up buying plane tickets at the last minute at a premium price.
  5. SA and his wife both dove foreign luxury cars that were less than a year old - well, certainly less than two years old, at least.
  6. SA and his wife seemed to shop and spend for anything and everything, yet always have money for more. 
Thus, to all outward appearances, SA and his wife were a picture of luxury.  A very pretty picture - in which I thought that I could easily picture myself!   Thus, I resolved to talk to him to figure out how he did it - how was it that he had all this stuff when others making about the same money did not?  Here's my general recollection about how the conversation went:

ME: How is it that you can afford all of this stuff?

SA: Debt is just a number.  All you have to worry about is whether you can afford the monthly payments.  As long as you can afford the payments, you are absolutely fine.

ME:  But aren't you worried about paying it back?

SA:  Nope!  I just focus on the monthly payment and getting that as low as possible.  I don't worry about owning anything, I just want to be able to USE it.  Along those lines, I:
  1. Consolidated my student loans (and my wife's) to lower the payment.  Now the loans are amortized over 30 years instead of 10, but the monthly payment is lower!
  2. Both of our cars are leased because leasing was the lowest cost per month
  3. We had to juggle the numbers a little bit to get the mortgage, but I don't care about the price of the house, just how much it costs per month.  Consequently, we have a 40-year interest-only loan.
  4. The clothes and homewares that my wife and I buy go on credit cards from those stores.  You can buy thousands of dollars of stuff and it only costs you tens of dollars per month.
  5. The same goes for restaurants and vacations - we put them on credit cards because even a $10,000 vacation only costs about $200/month.  
  6. In fact, we even got a line of credit with our new house so that we do some remodeling - and we can go on vacation with the rest!
ME: Aren't you worried about something happening?

SA: Not really, as it is right now, only about 75% of my take-home is eaten up by "payments," so I can still buy plenty more stuff. I still have about 25% of my take-home that I can devote to "payments."

ME: What about if something happens and you are not making as much money?

SA:  What am I going to be doing? Not working?  You are going to be working forever, so you may as well enjoy it.
ME: What about the 401k or any other investments?

SA: I can't really afford that right now.  I'll save for retirment when I am older.

Seductive Reasoning
This conversation frankly just blew my mind.  SA was approaching the whole issue of pesonal finance and spending in a way that I had never even considered. I remeber specifically that he called them "payments" instead of "debts" - that 75% of his take home pay "went to payments" instead of "was eaten up servicing his debts."

In reality however, although SA and his wife were living a very high lifestyle, they were digging themselves further and further into debt.  Their current course was not sustainable - at some point they would be denied future credit and would have to start paying off what they owed.  However, SA figured that he would just keep making more and more money as an attorney so the amount of credit that they could get would just keep growing.  Also, at some point in the future he would be able to pay off all of his debts very easily - while still living an expensive lifestyle- in his mind it was a forgone conclusion that his salary would eventually be that gigantic.

SA had an answer for everything - some reasoning that justified his expenses and seemed to provide him with a reasoned basis for living large.  In his mind, the bills were never really going to come due.  Something was always going to happen that would allow him to sustain his liestyle forever.

There is something so very seductive about SA's reasoning.  Who wouldn't want to have everything right now?  Who doesn't believe that they will be the one to make partner and have huge clients and compensation?  You have to have FAITH in yourself, right?  In that regard, if you tried to question SA's assumptions about his finances, he took it as you questioning him and your belief in him or his belief in himself - and he would react very negatively.

What ended up happening to SA?  SA did not make partner.  He ended up lateraling to another big firm, but was soon gone from there as well.  He eventually left the practice of law entirely.

A Picture of Consumption, Not Luxury
After my conversation with SA, I realized that SA was living a life of consumption, not luxury.  Although SA "had everything," there was a pricetag to be paid - and SA had not escaped the price tag, merely delayed its payment and made it tremendously more expensive.

Also, SA's consumption decisions were limiting his opportunities later in life.  For example, becase SA was not saving for retirment, once he finally did start saving he would be starting in a big hole.  That is, not only would he have to save for retirment, he would have to pay off a mountain of debt before he could even start saving.

Further, what if SA's wife wanted to have kids?  Her salary was not a large portion of their combined income, but the loss of it would be felt when 75% of their combined income already went to paying off debt.  Also, having kids would result not only in a loss of income, but increased expenses - where would that money come from?  What about saving for his kid's college?  Further, even if he had been offered partnership, I don't know how he would have saved up enough to buy a partnership share.

After our talk, SA's lifestyle struck me as "being chained to the wheel" - that SA was "enslaved" or an "indentured servant" to his need to consume.  SA was making about $250K in today's dollars, but his net worth at the end of the year was worse than at the beginning.  SA was having some great experiences, but he was really just "spinning his wheels" and sinking further into the mud of his personal financial morass.

An Attitude Adjustment
It was very helpful for me to talk to SA.  As I pondered the conversation for the next several weeks, the stark contrast between the destination that SA's financial decisions were driving him toward vs. where I wanted to be in my future really helped me to readjust me attitude toward consumption. 

For example, instead of being envious of SA's possessions and experiences - and wanting them for myself - I was now more aware of the price tag.  That is, I recognized that I had the power to buy everything that SA bought, but in choosing to devote my limited financial resources toward consumption I was necessarily taking financial support away from other goals.

Thus, a few weeks later when SA started talking about acquiring another even more luxurious foreign car, instead of thinking "Wow, I really wish I had that,"  my thoughts were more along the lines of "Well, there goes his retirement" or "There goes his ability to buy his partnership share."  As well as "I really hope that he enjoys the hell out of that car, because it is going to cost him so very much in the future."

The Bottom Line
SA's story is not unique.  There are people making $250K, even $350K, per year that can not seem to make ends meet or can not come up with $16K (pre-tax!) for their 401k.  In nearly every case, their problems arise from their personal choices to live a larger lifetyle than they can pay for. 

Instead of being seduced by SA's reasoning, refuse to finance your lifestyle.  Live on a current income basis rather than pushing your current over-spending onto the shoulders of your future self - your future self may not be able to afford it.  Also, even if they CAN afford it, pushing it forward just makes it larger and deprives you of other opportunities.

I recommend that you choose freedom, even if it means that you don't get everything you want right now.  From my own experience and those of many others, living responsibly and well within your means allows you to accumulate wealth, which gives you a sense of confidence and security that really makes you feel really good.  It's a far better feeling than you ever get from owning any foreign car.

SA was always a nice guy.  I hope that he is happy with the financial life that he has made for himself.  As for me, I went in the opposite direction - I traveled the path untraveled by SA - and that has made all the difference.


  1. Is this a hypothetical person created for the purposes of instruction? This can't possibly be real.

  2. 3:34 - Nope, this is real - at least as far as I can remember (it's been 10 years). I remember his attitude and situation very clearly, but I could be off a little on specific amounts. For example, it might have been a $15K ring rather than a $16K ring.

    This is certainly the most extreme example of this attitude that I have seen, but I have seen several people making $250-$350K/year who can't "afford" to make a 401K contribution. They may not be accumulating massive debt like SA, but they are not really making any progress toward financial freedom.

  3. This is a classic case-study in "keepin' up with the Joneses". Far too many people abuse the easy credit available to today's generations.

    People over-extending themselves on credit just makes it worse for everyone else because it artificially jacks up the prices of just about everything (home prices being the prime example IMHO).

  4. 5:05 - I think that you are right and that SA's lifestyle is not one to emulate. It is certainly not the life I want to live. I don't know if I can call is "abuse," though - it seems a little more complex to me. He did have the income to support the payments (at least at that time). SA certainly made a choice on how he wanted to live his life - and his choice brought him a mountain of debt from which he would not easily be able to escape. It also brought him a lifestyle where he ended up paying far more for his possessions because he bought them on credit and has to pay interest. It also bought him a far more "risky" life in that if he stumbled, then the debt would eat him.

    One of the weirdest things to me was that he made his choices consciously. It wasn't a case of just using the credit card and not looking at the balance. He knew exactly how much his debts and payments were. He was just living a lifestyle that was pretty much completely alien to me.

  5. Thanks, I appreciate this post. As a new associate, it's good to be scared straight every now and then. This is high octane nightmare fuel. I cannot imagine earning biglaw money for five years and not managing to pay off my student loans and maximize 401(k) contributions.

  6. 10:48 - Thanks for commenting! It's good to know that associates are reading this and it is helping them. Actually, I think I am going to do a post on how easy it is for new lawyers to miss out on paying off their loans, even at biglaw salary.

  7. The general lifestyle seemed a bit too much, but in my opinion, there were actual nuggets of smart moves in what SA did:

    1. Leasing vehicles is sometimes the smarter thing to do compared to buying the vehicle on a car loan. As with everything, it depends on the particular vehicle and the prices.

    2. Lengthening your student loans to 20 years (or 30, which I've never really seen) can be beneficial depending on your rate. I know of law grads who have consolidated their loans and their rates are at or lower than 2%. There's no reason to pay those loans back in a hurry as opposed to dragging out the payment period and using your money wisely to invest in something.

    3. Although I probably wouldn't play around with interest only loans, his tack might be okay as long as those interest only payments are less than what he would've paid out as rent anyway. In a sense, he's just renting his home. This guy might get foreclosed on, but he would be in no worse a situation than if he had rented his home in the first place. Though, I would've stayed in the 350k condo.

    Debt is not always a bad thing. I know I sound like a typical American by saying that. Although I was born in America, I come from an Asian family. For whatever reason, Asians are obsessed with debt. There's smart debt and there's idiotic debt, and the key in life is to differentiate between the two. Many Asians I know are constantly looking into getting debt at low rates and then pumping their income into high return opportunities instead of paying down the debt. It's not always the stereotypical "pay down your debt right now!!" mentality.

    p.s. I know I will regret saying this if I ever get married in the future, but is $16k ring really that extravagant for SA? I've always heard that the rule of thumb is 3 months salary.

  8. Hi Coder Emeritus,
    Thanks for your comments! Here are some thoughts:
    With regard to 1, you mention that leasing can be less expensive than buying. That is certainly true in the first year of new car ownership when the new car loses a lot of value as you drive it off the lot. Further, over the first three years, you are right that either one could be cheaper depending on how the numbers break down. By the time you get to 5 years, though, I have not see a single lease that beats buying new. In that regard, possibly more important than the lease/buy question was SA's selection of expensive foreign car as opposed to less expensive domestic, and SA's decision to upgrade the cars frequently.

    With regard to 2 - yep, if you can drop your interest rate then lengthening your student loans can lower your monthly payment. It may increase the total interest paid, but you will be paying that interest with future dollars (assuming that you have them). If instead of putting the money toward the loan, the attorney invested the money for a higher return, then that would be great. However, in practice most associates are not that disciplined. The money that is freed up is instead used as play money - which is certainly what SA was doing.

    With regard to 3, from an initial financial standpoint, you are right. However, if SA got foreclosed on, then that would likely impact his rates on several of his existing credit lines - or at least the availability and rate on any new credit line. Getting foreclosed on will be on his credit report for a long, long time.

    With regard to your comments about debt, I think that you are right that there is "smart" debt and "dumb" debt. Smart debt buys assets. Dumb debt buy consumption. That being said, I admit that I carry a mortgage. I could cash out investments and pay it off today, but the rate on the mortgage is so low (especially considering that it is deductible) that I get a higher return on investing.

    One interesting thought here, though. Mortgages (in my state and most states) are not personally secured. That is, the mortgage debt does not follow me. If something happens, I can walk away and all they get is the house. Conversely, you can't walk away from student loan debt.

    Admittedly, the rates were higher when I was paying off my student loans, but I don't regret paying them off for 1 minute.

    Finally, the whole "X month's salary" is apparently advertising by DeBeers, the diamond cartel that supplies most of the market. It started out at one month and has been raised as people become greater suckers,... er, consumers.

    See here, for example:

    (As an aside - Man, I wish I had a business where I could just jack up the prices like that!)

    Let me rephrase your question - is it extravagant for a person with a negative net worth - who can't even contribute to a 401K - to buy an engagement ring costing $16K? Answer - YES! Yes it is. As I mention in a later post, associates should base their determination of financial reasonableness on their net worth, not their income. They really don't know how many years they are going to get that income - and the sad truth is that 70% of them in big firms are going to be kicked out in 5 years - and their compensation at that time will likely be less.

    Alternatively, instead of using the advertiser's valuation method, we can value our purchase price based on the average spent - which is $3200 from the articles.