Time to Ground Flighty Habits : Young Engineer Likes to Treat but Learns She Needs to Save Too
Erma Trinidad wonders where all the money went.
Though she earns about $44,000 a year in salary at Boeing Co. and pays only $250 a month for an apartment she shares with three roommates, the 22-year-old electrical engineer from Irvine has not set aside even a dime since she joined the work force 13 months ago after graduating from UC Irvine.
“I’m not saving at all,” she says.
Trinidad eats out every meal except breakfast--”I don’t have time for breakfast,” she says--and is extremely generous.
“I do a lot of things where I pay for everybody else,” she says. “I just feel bad because I know I make more money than my mom makes--and my roommates. I feel bad when we all go out somewhere for a nice meal or something and they can’t afford it. So I say, ‘OK, I’ll pay.’ ”
She recently bought a Nintendo game for her 11-year-old brother and treated her family to a Dodger game. And she always takes a friend to dinner.
“Just little things here and there,” she says of her free spending, which in the last year has included short trips to New York and Las Vegas and a couple of ski weekends last winter. “I drop a couple hundred dollars here, a couple hundred there.”
“I never say, ‘Oh, this week I’m broke,’ ” she says. “It’s just a matter of going to the ATM and taking some more money out.”
Indeed, she has been able to maintain a balance of about $6,000 in her checking account despite her largess.
It was this style of financial freedom that helped convince Trinidad that she should follow her father into engineering.
“It’s a stable job with a pretty high salary,” she says.
And engineers are in demand.
Only two weeks after graduating from college in June 1996, Trinidad joined Northrop Grumman Corp. at an an annual salary of nearly $37,000. She bought a $21,000 car last August and, a month later, moved out of her mother’s home in Glendale into an apartment in Irvine.
After the first of the year, she learned that her position was going to be eliminated. Stunned, Trinidad quickly distributed her resume and soon landed a new job--and about a $7,000 annual raise--at aerospace giant Boeing’s Anaheim facility.
But the eye-opening experience served as a wake-up call.
“I was lucky enough to get another job,” she says, “but it was kind of scary. I thought at that point that I’d better start saving just in case something like that ever happened again.”
Soon came the realization, however, that instead of saving or investing her added salary, she was spending more than ever.
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That led her to a “money make-over” with Brent Kessel, a fee-only Santa Monica-based financial planner who reviewed her situation and proclaimed that all Trinidad needs to start a successful portfolio is a disciplined, structured approach to saving and investing.
He applauded her habit of paying off her credit card debt in full each month, saying that it’s very tempting to run up huge balances without noticing the lofty interest rates. But he also said she has to think of saving as paying herself first. It’s fine to treat friends and family, but she needs to do it in moderation.
Looking at Trinidad’s expenses, including $559 a month in student and car loan payments, and her financial goals--having a comfortable retirement, buying a house, traveling, purchasing a car for her mother and possibly funding her brother’s education--Kessel says Trinidad first needs to teach herself to save.
He quickly discouraged her first impulse, which was to pay off her loans as quickly as possible, and told her that she would be better off contributing to her company’s 401(k) retirement plan, even though Boeing won’t kick in matching contributions until she has worked there for a year.
For one thing, saving via the 401(k) plan will offer positive reinforcement, Kessel said.
“If she contributes the maximum 11%, she’ll have a $25,000 balance in three years,” he says, assuming that Trinidad’s salary will increase by 4% each year while her investments return 10% annually.
“In five years, she’ll have $52,000. And then when she says to herself that she wants to start saving for a house, it will seem more realistic because she’ll have taught herself that she can save. People tend to be more empowered to save if they have a history of saving.”
Saving via the 401(k) plan (to which Boeing will eventually contribute as well) makes more sense for Trinidad than paying her loans off right away because the interest rates she’s paying are fairly low--5% to her father, and 7% to 8% on automobile and student loans. Stock market investments have historically returned more than 10% a year in the long run.
Nonetheless, once she has a firm savings habit and can’t put more money into the tax-deferred retirement plan, she should get rid of the loans. The interest on her loans is paid with after-tax dollars, so paying off an 8% loan is, essentially, like earning 8% guaranteed and tax-free forever. By any measure, that is a superb, risk-free investment.
“If it were 18% credit card debt,” Kessel said, “I’d be advising to pay off the debt first, but that’s not the case.”
Kessel says that starting a tax-deferred retirement account at such a young age will result in an enormous nest egg for Trinidad.
Assuming that she signs up for the program today and continues to contribute 11% of her salary to her 401(k) plan, the stock market continues to return 10.5% annually over time and her salary increases by 4% each year, Kessel says, Trinidad’s portfolio will be worth nearly $15 million when she’s 70.
“In investing, time is your best friend,” Kessel says. “People think that picking the next Microsoft is going to make or break their future, but these numbers make you realize that you don’t have to be Warren Buffett to leave yourself incredibly well-off financially.”
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By contrast, if Trinidad waits 10 years to start contributing 11% of her salary to a 401(k) plan, says Kessel, she’ll leave herself about $7 million poorer at age 70.
“Even people who don’t think they have excess money at this age should be looking at these numbers,” the financial planner says. “It’s just incredible how much difference time can make.”
Though he would prefer Trinidad to have a more diversified portfolio, Kessel says she should invest her entire 11% contribution in a U.S. blue-chip stock index mutual fund that tracks the Standard & Poor’s 500 index. That’s because the only other stock option within her 401(k) plan is to buy shares in Boeing.
“Boeing’s a great company,” he says, “but you don’t put sizable chunks of your money into one company. It’s taking on too much risk. . . .
“If I worked there, I’d call the benefits administrator and ask to make international and small-stock funds part of the plan. They’re really doing their employees a disservice by keeping it that limited.”
To help make it easier for Trinidad to fund her 401(k) contributions, Kessel says she should increase her payroll exemptions to reduce the income tax withheld from her paychecks. This will result in a lower tax refund each spring, but it will reduce the bite in take-home pay that she’ll realize when she begins making the 401(k) contributions.
“Some people consider tax refunds a nice bonus that they didn’t expect,” Kessel says, “but if you put that money into your 401(k) throughout the year--and it’s earning money for you rather than the government--you’ll end up with the same kind of bonus, but you’ll be less likely to spend it because it will already be in your retirement fund.”
If Trinidad can discipline herself to set aside more than the 11% of her salary that she will be contributing to her 401(k), Kessel says she should follow one of two options:
* Money that she’ll need in five years or less should go into low-risk money market or short-term bond funds such as the Citizens Trust E-Fund (a money market fund), the Vanguard Bond Index Fund Short-Term or the Strong Short Term Global Bond Fund.
That money “shouldn’t be anywhere near the stock market,” Kessel says. “A lot of people are not adhering to that rule because the stock market seems to be endlessly rising. . . . But if you look back to World War II, the market has had 10 corrections of greater than 20%. That’s about one every five years.”
* Trinidad’s long-term savings, Kessel says, should be invested in an aggressive portfolio that includes U.S. blue-chip stock mutual funds, small-company stock mutual funds, international stock mutual funds and real estate investment trusts, or REITs.
He suggested the following mix of funds: 20% in Vanguard Index 500 (which tracks the S&P; 500); 20% in O’Shaugnessy Cornerstone Value stock fund; 20% in Vanguard Index Small Cap Stock fund; 10% in Cohen & Steers Realty Shares fund; 10% in Hotchkis & Wiley International stock fund; 10% in USAA International stock fund; and 10% in Vanguard International Equity Index-Emerging Markets stock fund.
“Once she gets to within five years of her goal,” Kessel says, “she should shift 20% of her portfolio into bond funds each year until she cashes out.”
For emergencies, Kessel says, Trinidad should maintain cash reserves, either in a checking account or money-market fund, to cover about three months’ expenses.
“For someone in a pretty conservative profession in terms of employment stability, we usually recommend keeping three to six months in emergency funds,” he says. “I would say three is probably fine in her case because her health is good and she’s young.”
The planner sees a bright financial future for Trinidad.
“The beauty of starting at this age,” he says, “is that it’s very rare that you run into financial problems you can’t solve, or financial goals that you can’t reach.”
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This Week’s Make-Over
* Investor: Erma Trinidad
* Age: 22
* Occupation: Electrical engineer
* Income: $44,000
* Financial goals: Having a comfortable retirement, buying a house, traveling, purchasing a car for her mother and possibly funding her brother’s education
Current Portfolio
* About $6,000 in checking account
* About $20,000 in student, car and family loans
Recommendations
* Contribute maximum 11% of salary to 401(k), invest in U.S. stock index mutual fund that tracks the S&P; 500.
* Invest short-term savings in money market or short-term bond funds.
* Invest long-term savings in an aggressive portfolio that includes U.S. and international stock mutual funds and REITs.
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Recommended Mutual Fund Purchases
* Citizens Trust E: (800) 223-7010
* Vanguard Bond Index S/T: (800) 662-7447
* Strong Short-Term Global Bond: (800) 368-1030
* Vanguard Index 500: (800) 662-7447
* O’Shaugnessy Cornerstone Value: (800) 797-0773
* Vanguard Index Small Cap Stock: (800) 662-7447
* Cohen & Steers Realty Shares: (800) 437-9912
* Hotchkis & Wiley International: (800) 346-7301
* USAA International: (800) 382-8722
* Vanguard International Equity: (800) 662-7447
Index Emerging Markets
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Meet the Planner
Brent Kessel is a fee-only certified financial planner based in Santa Monica. His firm, Abacus Financial Planning, manages funds for individuals, small companies and charitable foundations
