My answer is almost always the same—“They need to start out correctly to finish well.” I’m referring to the first laps around the professional track, which are crucial. Running a race, you need to be able to sustain the pace you set at the beginning; otherwise, you may run out of stamina later on and face devastating consequences. The same is true for newly-minted associates.

Understand The History Of Associate Compensation

Over the last 15 years, the lives of associates have changed drastically. In the 1990s, salaries began to soar, first in high-tech firms, and then everywhere else. I remember several conversations I had with managing partners at three of the largest law firms in the southeast. Everyone was talking about soaring associate salaries. “We’re going to have to pay starting associates $115,000-$135,000 just to stay competitive,” these partners told me. “This is going to have a serious effect on the profitability of our firm. It will affect our ability to attract and retain talented associates.” This salary shift was eventually passed on to clients in the form of increased billing rates.

Although the speculative technology bubble burst a few years later and associate salaries moderated, the die was cast. Associates expected more than their predecessors had. They began to feel that they could “have it all now”—which was in stark contrast to previous generations of lawyers who waited until they “made partner” to make major financial commitments.

These changed expectations caused many problems—which you can avoid by following these five strategies.

Set Written Financial And Life Goals

To succeed in law school, you had to map out your goals; designing a successful law career requires the same planning. All business owners use goal-setting methodology to chart their vision of their business. As a licensed professional, you are in business for yourself. Create realistic expectations with care, remembering that it’s easiest to make personal sacrifices early in your career. At the same time, keep all your other goals in balance so that you attain the best quality of life. In other words, make sure you’re running in the correct lane of the track. To change lanes later on is both time-consuming and expensive.

A Spending Plan Sets Your Pace

Once you develop written goals and determine that you are running in the correct lane, you need to check your pace. Create a written spending plan that outlines
short-, intermediate- and long-term saving/investing goals to help you see how much disposable income you have available for discretionary purchases. If you set capital and cash flow goals first, you’ll avert the common pitfall of not having enough to save for long-term goals because you’ve spent all of your income on short-term needs and wants. Review your status each month. Define your progress towards your goals, and change your pace accordingly. If you can’t defer gratification now, you won’t reach your goals later.

Put Time On Your Side—Maximize Your 401K

As part of your written spending plan, defer as much as possible ($15,500 for 2008) into a defined benefit plan. This will enable you to take advantage of the tax deferral on the income contributed into the plan, and allow you to compound your investments. In addition, if you are making under $160,000 joint income, you should also contribute to a ROTH IRA. Then as income increases, start saving money outside of these vehicles in addition to—not instead of—the plans already mentioned.

Do Not Over Spend On Homes And Cars

Homes have become this generation’s status symbol. It is not unusual for an associate’s first home to cost between $450,000 and $700,000. However, new home buyers bite off more than they can chew, much less swallow, because they don’t factor in the operating costs of a home. Just ask any of the partners at your firm how much it costs to replace a roof or finish a basement, especially in a large home. Distinguish between how much a bank is willing to lend you and how much you can afford: Often, these amounts are very different. In short, do not over spend on homes and cars (most people do not realize that over their lifetime they will often spend more on vehicles than they do on a primary residence). Buy what you need, not what you want. Ego can be very expensive.

Avoid Consumer Debt

Many people who grow up during prosperous times feel as if they should be entitled to the same standard of living as their parents. Rather than follow the time-honored sequence of amassing wealth—Earn, Save, Buy—they Earn, Buy and then Save. But true prosperity is based on the gradual sustainability of consumption. Sustainable by its definition means that you do not ever have to “back up.” The Earn, Save, Buy equation has a self-limiting factor that promotes sustainable consumption; it keeps us from getting ahead of ourselves. To do this, avoid credit card debt.

Keep in mind that the first seven years of your professional career will have a disproportionate effect on your long term wealth. By following these five simple strategies, associates will be following in the footsteps of their wealthier elders, and will be helping to ensure that their lives are not only prosperous but also sustainable.

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Strategy#1: Maximize Your Retirement Plan Options

Calculate how much you are saving in your firm’s retirement plan. Associates and partners should be deferring the maximum into any plan for which they are eligible. In my opinion, the biggest mistake made in employee deferrals to retirement plans is that many attorneys still only defer up to the amount of the firm’s match each year. This is very shortsighted. You should maximize your retirement plan by deferring the maximum into your firm’s retirement plan. This will increase your retirement quality of life in the future and save on taxes now. The following are 2007 employee deferral limits unless otherwise noted:

401(k) Plans – $15,500 (PLUS $5,000 more if you are 50 or over for a total of $20,500)

403(b) Plan – $15,500 (Plus $5,000 more if you are 50 or older for a total of $20,500)

Simple IRA – $10,500 (Plus $2,500 more if you are 50 or older for a total of $13,000)

SEP – $45,000 (Employer funded 100%) Primarily smaller boutique firms and sole practitioners.

Employers may match with additional amounts or profit sharing depending on the retirement plan’s Summary Plan Description. (Limit on total employer and employee additions to qualified plans is $45,000)

Result: Increase your 401(k) employee deferral by $3,000. Tax savings (federal and state) +/- $1,000.

Strategy #2: Cut The Costs Of The Funds In Your Investment Portfolio

The two biggest drags on a long term investment portfolio performance are taxes and fees. Both are controllable.

1. Fees: Examine all of the expenses that go into the expense ratio of the mutual funds you own. Check an online analysis site like Morningstar for publicly available information on fund expense ratios. When you review your portfolio avoid sales loads (commissions) like the plague. Avoid funds that have “A” shares – front load commissions which can run as high as 5%. (Sometimes these loads/commissions are waived inside of large 4019k plans). Avoid “B” shares – back loaded commissions – also as high as 5%. This “B” share class commission increases along with the value of your investment. Also avoid “C” class shares. They have much higher annual fees than a different class share holder of the same fund.

2. Taxes: Avoid funds with a high turnover ratio. This is the amount of the assets in the fund that is sold each year. For example, a fund with a turnover ratio of 30% will sell 30% of its assets each year. By contrast, a fund with a turnover ratio of 120% sells all of the assets in the fund an average of 1.2 times each year resulting in constantly realized and recognized short term capital gains. This approach is very tax inefficient which costs you unnecessary taxes each year. The answer? Look instead at index funds. There are hundreds of index mutual funds. We all know the Dow Jones Industrial Average, the S&P 500 and the Russell 2000. Index funds are not actively managed. Instead they follow a passive approach—allowing the investor to receive the return that the market is willing to give with much less risk of the “human element.” Numerous studies show that index investing outperforms active investment management 7-8 times out of 10. Additional research has shown that when consistent asset allocation strategies are followed using a portfolio of US, and international indexes, passive index investing outperforms active investment management 8-9.3 times out of 10. Because most index funds reconstitute on an infrequent basis, they are inherently more tax efficient than actively managed funds. This tax efficiency saves you money in taxable accounts (those outside of retirement plans). It also saves on trade costs on both non-taxable and taxable accounts.

Result: Avoid commission funds and choose lower cost indexes that are tax efficient. Aggregate cost savings per year based on research studies equate to 2% annually. On a very modest portfolio, for example $250,000, results in an annual savings of at least $5,000.

Strategy #3 Get A Realistic Idea Of How Much Retirement Nest Egg You Will Need

Some years ago, a very successful business owner from Boston asked me a question. “How much do I need to have to be able to retire?” I asked him how much he wanted to spend each month. He answered “I’m not sure.” I then asked him how much he now makes. His taxable income was in the $400,000 range. (Remember this was a few years ago) I asked if he saved much of his annual income. He then mentioned that he saved about half of his after tax income, which netted to a pre-tax income of approximately $200K. My recommendation? “You’ll need between $4 and $5 million dollars to fund your retirement, adjusted for inflation.” Depending on whether he was willing to assume a 4% or a 5% annual rate of return he had his answer.

Note: For our investing lifecycles there are two very different phases. Phase #1 is the accumulation phase during the earning years when 50-80% of your portfolio is invested in equity investments. Phase #2 is the retirement preservation phase when 10-30% of your portfolio is invested in equity investments. Retirement is always Phase #2. The quick math works like this:

Assume 4% annual rate of return in retirement, which means you need 25 times your pre-tax income. Assume 5% annual rate of return in retirement, and then you need 20 times your pre-tax income. For example a partner who makes and spends $300,000 per year now (including tax payments) and who wants the same income in retirement will need approximately $6,000,000 (5% return) adjusted for inflation. This assumes that just the interest is spent and the principal is kept in tact. While this may sound like a lot of money (it is), let’s keep in perspective that historic rates of return during the earning years in the equity market have averaged over 10% in 15-25 year spans of time. So getting to this number takes discipline and time.

Most partners in their late 30’s to early 40’s usually need to save $40,000-$65,000 per year in addition to their contributions to firm retirement plans to have enough in retirement.

Result: Reviewing the above information will usually motivate you into saving at least another $2,500 this year.

Strategy #4 Be Charitable This Year? And The Next… And The Next

One of the fastest ways to increase your quality of life and decrease the tax burden is to be charitable. While donating money is a wonderful thing to do, I am sure you will not give me credit for saving you or making you more money in 2007 by just writing a check to your favorite church, synagogue, or charity. Consider this tact that will not cost you anything and will give you a significant tax deduction, resulting in often-significant tax savings.

Start by examining Schedule A—Itemized Deductions: Non-Cash Charitable Contributions—an often-misunderstood area of the personal tax return. This part of the personal tax return is where you put the value of the used clothing, furniture, and old computer you donated to the local women’s shelter, Goodwill, Salvation Army, or Veterans with Disabilities. Most people have no idea how to value the items that they donate. Typically, they guess and put $450 on the non-cash charitable line of their tax return. About eight years ago, our firm started using a valuation guide to value non-cash items. For most of our comprehensive financial planning clients we also prepare their individual tax returns. We found that using a well designed and up-to-date valuation guide resulted in a significant increase in the amount of non-cash donations.

Now in the first year that a new client uses the guide, the result is that they clean out and de-clutter their homes (better quality of life) and generate a deduction in the $5,000-$6,000 range. Note: Be certain that you put this level of donation on form 8283 of the individual tax return. For tax documentation purposes, always make a detailed list of the items before they are donated, take a quick digital picture of each, then staple the donation receipt to the list and picture. Finally, place the documentation in your permanent tax records to verify your non-cash charitable donations.

Result: Properly valued non-cash donations motivating you to donate all of the unused clutter around your basement, closets, and garage =$6,000 non-cash charitable donation or $2,000 in cash tax savings for most taxpayers.

Strategy #5 Track What You Spend Against A Goal

People are so turned off by the word “budget” that our firm most often doesn’t use the term any more. Instead, we use the term “spending plan” or cash flow projection. We talk in terms familiar to most attorneys when we ask clients about “current” spending versus “target.” People are much more receptive to this method of tracking spending. Most of our clients track their spending in Quicken. These days Quicken will interface with your bank, brokerage, and credit card issuer to electronically download reports of spending. The download has complete information on the payee and the amount of each transaction. All you have to do is allocate the expense to a category to be able to track your monthly spending. I believe it was renowned efficiency guru, W. Edwards Deming, who said “If it can be measured, it can be tracked, if it can be tracked, it can be managed.”

The result of knowing what we spend in each category gives us the power to control how we balance financial wants and needs. When we require clients to validate their spending over a 3 to 12 month period, their spending naturally begins to align with their goals, not just their wants. Over time, cash flow (income) becomes a more concrete resource that is then used strategically to allocate for expenses and specific retirement savings and investing targets. Once these annual targets are met, then the remaining disposable income is either used for whatever the client wants or to accelerate their progress towards retirement. Their spending becomes a means to an end and not an end in itself. This high level knowledge becomes very powerful in helping attorneys focus on the long view in the midst of very long hours and demanding clients. The documented change in spending is from 2-6% of gross taxable income depending on the income range of the attorney. The higher the attorney’s income, the higher the percentage will be. If this “surplus unallocated spending” is used to fund a specific individual or family goal, then the excess amount will remain available. Once the goal is reached, there is a behavioral aversion to spending the excess on non-target things unless the goal is a long-term one requiring consistent focus (like retirement). Use human behavior to your advantage by: 1) reviewing your spending, 2) setting reasonable spending goals, 3) determine how much you need to invest annually toward your eventual retirement, 4) consistently set aside the funds needed to reach your goals.

Result: Cash Flow analysis results in a change in spending over an intermediate time of 3-6 months of 2-6% of gross taxable income saving $3,000-$50,000 annually.

Conclusions

These five quick financial planning strategies will save you money and make you money over the next 12 months and beyond. My experience is that when an attorney clearly understands where he is financially, he will implement meaningful changes. For 2007, I hope you will: 1) maximize your retirement plan options, 2) cut the costs of the funds in your investment portfolio, 3) get a realistic idea of how much retirement nest egg you will need, 4) be charitable this year… and the next…and the next and finally, 5) track what you spend against a goal.

May you have a happy and prosperous 2007 and beyond.
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NOTE:
As with all my recommendations, please discuss these strategies with your tax and financial advisor to determine their applicability in your individual situation.

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