Invest For Yourself, Invest For Your Future
Having spent several years at university, you've now secured a job at an engineering firm, marking the beginning of your professional career. As you start earning a salary, it's also a crucial moment to begin planning for your financial future. With your newfound income from your engineering position, it's essential to create a budget for your day-to-day expenses while also allocating funds for investing. A prudent approach is to set aside a portion of your income for investment, such as starting with 5% of your salary, and adopting the principle of 'pay yourself first.' This means prioritizing your investments before other expenditures, even if it requires adjusting your lifestyle. Your budget should encompass not only living expenses but also debt repayment and the funds earmarked for investment. In a period when numerous financial priorities compete for your resources, it may be challenging to allocate funds for investment, and there might be a temptation to postpone this to the future, anticipating higher income. Nevertheless, it's crucial to resist this urge and begin setting money aside for investments, even if it's initially a modest amount. Starting your career also means beginning to building for your financial future.
A survey [1] reveals that the top five careers for millionaires, and their median salaries (sourced from the Bureau of Labor Statistics) are:
The survey highlights that these millionaires accumulated their wealth through strategic investments and financial decisions rather than relying solely on substantial salaries.
There are various avenues for investing in your future. Many of these options are provided through your employer, while others are available through external entities like banks or brokerages, or even through family, friends, or private sources. Here are some of those investment options:
Retirement Savings
Most employers large or small offer a retirement program, typically a 401(k) Plan or 401k. Legislative changes in 2022 enabled employers to set up 401(k)s as 'opt-out,' meaning you're automatically enrolled unless you choose to opt out. The minimum contribution is 3%, you can contribute up to 10%, with 6% being the most common deferral rate. Additionally, most plans gradually increase the deferral rate by 1% annually, up to a maximum of 10% [2]. Essentially, investing in your company's 401(k) plan requires minimal effort as it's typically automatically set up for you. The IRS imposes limits on the amount you can contribute to a 401(k). In most cases, doing nothing means you'll automatically be enrolled in your employer's 401(k).
Within 401(k) plans, you typically encounter two types: Traditional and Roth. In a Traditional Plan, money is deducted from your payroll pre-tax, meaning no income tax is withheld, and it grows tax-free until withdrawal. In a Roth Plan, deductions are post-tax, meaning income tax is withheld, but the money grows tax-free and is not taxed upon withdrawal. You can withdraw 401(k) funds beginning at age 59 ?, but early withdrawals may incur a 10% penalty. Your choice between these plans depends on your tax situation, but if you anticipate higher future earnings, the Roth 401(k) could be a suitable option. If you plan offers both options you should have the option to split the money withheld between the two which would allow you to hedge on the best option. Most plans offer various investment options, typically mutual funds, and some even include individual stocks and other assets. For younger participants unsure about their best investment options, most plans offer options based on your expected retirement date (e.g., a 2060 plan) with risk tolerance adjustments. You can often revisit and modify these plans in the future, or they'll automatically follow the plan profile over time.
Another incentive for investing in a 401(k) plan is the employer match. Many employers match a percentage of an employee's 401(k) contribution as an added incentive. In 2023, the average employer match is around 4% to 6% of salary [3]. This match money is essentially 'free' money, in addition to your salary, just for participating in the plan. While the money you contribute is yours and goes with you when you leave, be aware that some matching funds in most plans require vesting over a specific period, often 4 to 5 years, as an incentive to remain with the employer. Investing in your employer's 401(k) plan often comes with the added benefit of matching contributions from your employer. Investing in your employer's 401(k) plan is a prudent step to secure your future.
Health Savings
Some employers offer Health Savings Accounts (HSAs) as part of their benefits package, available for employees with High Deductible Health Plans (HDHPs). HDHPs are usually a good choice for those in good health, as they enable you to direct more funds into an HSA rather than health insurance premiums. Contributions to an HSA are made through pre-tax payroll deductions (no income tax is withheld) and can be withdrawn for medical expenses. These funds grow tax-free, and some HSA accounts offer investment options. The IRS sets annual contribution limits and defines eligible uses. Over time, HSA savings can accumulate significantly, providing a source for covering future medical expenses not covered by insurance. If eligible, an HSA offers a tax-advantaged way to save for both current and future medical costs.
Invest In Your Firm
Engineering firms are businesses, and when run successfully, they generate profits and grow. Profit margins for engineering consulting firms typically range from 10% to 20%, with variations based on the firm's size and specialization [4]. These profits are distributed in the form of bonuses and dividends. Bonus pay is typically allocated by a firm's management based on an individual's value or performance to the firm, while dividends are distributed based on an individual's ownership percentage in the firm. The valuation of a privately-held engineering firm is not set by a market but is valued using valuation multiples of financial metrics typically focused on book value or on revenue and the multiples used in the valuation will range between 2x to 3x. Growing revenue either organically or through acquisition is the key to increasing the valuation of an engineering firm and correspondingly the growth of the equity valuation.
Ownership in a private engineering firm is generally restricted, with some firms having a single individual or a few select owners, while others have a broader distribution of ownership. Here are a couple of options:
ESOP (Employee Stock Ownership Plan): An ESOP is an employee retirement benefit plan that allows employees to own part or all of the company they work for at fair market value. The company makes annual contributions to the ESOP, which eligible employees receive ownership from. The employee's investment in the ESOP is subject to vesting and is not distributed until a qualifying event, such as retirement, followed by a distribution period, usually spanning several years.
Stock Ownership: In a private engineering firm, ownership may be extended to selected individuals who gain a legal and financial stake in the company. In most private firms, ownership is limited to a small number of individuals, though some firms have a structure that allows broader access to ownership for eligible individuals, typically based on factors like years of service or professional qualifications. Ownership includes 'Buy-Sell Agreements' that outline the conditions under which ownership interests can be bought or sold, including scenarios such as an owner's death, disability, retirement, or desire to exit the business. If you work for a publicly traded engineering firm then stock can be bought on the open market or some firms offer purchase plans that allow you to buy stock at a discount, with vesting options, or award stock options tied to specific milestones.
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Ownership in a private engineering firm is a critical aspect of its governance, decision-making, and financial structure. It often reflects the collective contributions and commitments of various stakeholders, and the ownership arrangement can evolve over time as the firm grows and changes. Ownership in the firm allows you to benefit from your contributions to making the firm successful.
Brokerage Account
Establishing a brokerage account provides a means to accumulate savings. A brokerage account typically provides a money-market account for depositing savings, which pays market-rate interest, that is not always available at a bank. As your savings grow, you can begin investing in a wide variety of financial instruments offered by the brokerage, including mutual funds, index funds, exchange-traded funds, individual stocks, certificates of deposit, and numerous other options. There is a multitude of brokerage firms, ranging from large institutions to smaller ones, for you to choose from. Certain investments are insured, while others are not. Most brokerage firms offer financial guidance if you wish to seek advice from them. The choice of a brokerage account should align with your financial goals, risk tolerance, and the types of investments you intend to make. It's also advisable to compare brokerage firms to find one that offers services, tools, and cost structures that best suit your needs and preferences. Investments in a brokerage account will help you build savings that can be used for major expenses, such as buying a home, child's education, or for securing your future retirement.
Buying a Home
Homeownership is a fundamental aspect of financial planning. It provides you with a place to live and can offer the potential for increased equity as you pay off your mortgage and as the property's value appreciates. Saving for a down payment is a significant challenge when purchasing a home, and it may take time or financial assistance from family. Various government programs, including VA and FHA, are available to help with financing beyond conventional options. Develop a budget and establish realistic goals based on what you can afford, and be prepared to make compromises if necessary. Over time, you can expand to a more substantial home or refinance to a better interest rate as you build equity.
Closing
The choices you make today, at the beginning of your career, can have a profound impact on your financial future. By prioritizing savings and investments, you are building a solid foundation for long-term security and prosperity. Remember, wealth accumulation is not solely about the size of your paycheck; it's about making informed financial decisions and diligently working towards your goals. So, seize this moment, plan for your financial future, and set yourself on a path to success and prosperity.
Notes:
[1] Dave Ramsey List the Top 5 Careers of Millionaires – They’re Not What You’d Expect, yahoo finance
The information and content provided in this article is intended only for general informational and educational purposes only. It is not to be construed as professional financial advice. The content provided should not be considered a substitute for seeking advice from a qualified financial professional.
Edwin T. Dean, PE, SE is an engineering consultant and former Client Executive with IMEG.