Wednesday, September 15, 2010

Why grad students should think about contributing to an IRA

It's not easy being a graduate student -- chances are, you're not making a lot of money and you're definitely not thinking too much about retirement. Nevertheless, retirement is coming your way, and it's not a terrible idea to start thinking about how you're going to prepare for it. Hopefully, this post will go a little way towards starting a long-term conversation about the 5+ years that people trade for a degree. One of the clearest places where there is a tradeoff is in retirement savings (typically done in the US with 401k plans and IRAs.)

Assume that we have 3 individuals. They all graduate from college the same year, they're all the same age, gender, whatever. At year 0, they decide to take 3 different paths, as shown below:

Chemist A: takes B.S. immediately, goes to work for 50k, gets 1% raise a year, contributes 5% of salary to a 401k, gets a 1.5% match. Chemist A contributes 3k every year to an IRA. All investments get 5% return.
Chemist B: goes to grad school, gets Ph.D. in 5 years, goes to work for 80k, gets 1% raise a year, contributes 5% of salary to a 401k, gets a 1.5% match. After graduating, Chemist B contributes 3k every year to an IRA. All investments get 5% return.
Chemist C: goes to grad school, gets Ph.D. in 5 years, goes to work for 80k, gets 1% raise a year, contributes 5% of salary to a 401k, gets a 1.5% match. In Year 1, Chemist C contributes 3k to an IRA (life savings?) and only $500 a year for the rest of graduate school. All investments get 5% return.

After 25 years, what are their total nest eggs?

Chemist A, B.S. (year 25 total nest egg): $314,125.04
Chemist B, Ph.D. (year 25 total nest egg): $285,501.86
Chemist C, Ph.D. (year 25 total nest egg): $300,895.18

The spreadsheet is here, if you would like to check my figures.

From this point of view, the 5 years in graduate school will "cost" somewhere around 30k in retirement savings (all things being equal.) With a $5,000 investment during graduate school, you can recover about 15k (or about 50%) of those lost retirement savings.

Now, the caveats to this sort of figuring are pretty darn long, but let's list a few. First, it's a little bit unfair to compare a 25 year career with 20 year careers. Also, Chemists B and C could put more of their salaries into their IRAs (you'll note their 401ks end up bigger than Chemist A.) Do remember, their net worths could be very different, too. There aren't big promotions figured into this calculation, or job switches, or layoffs or any of the other things that actually make up real life. Chemist C could have a nasty gambling habit, Chemist A could enjoy investing in real estate in Belize, no investment this side of Bernie Madoff has a steady 5% return with no dips, you get the idea.

Going to graduate school for an extended period (longer than 2 years?) basically puts parts of your life on hold. Whether or not you want to admit it, there are costs associated with that pause; contributing to a very basic IRA (Vanguard Total Stock Market Index, anyone?) might be a way of alleviating some of those costs.

16 comments:

  1. Who the hell makes 80k a year coming out of grad school anymore?

    I know a Ph. D. chemist that happens to be a receptionist, and another who is a baby clothing designer!

    The former is even more depressing, she had a better job BEFORE she got her Ph. D. working in industry.

    Not to mention those scientists that are attempting to raise families on postdoc salaries.

    I'm going to have say, wait and see, because the way things are, these numbers are meaningless. If the government just fesses up and says they are going to maintain the research burden of the nation, then the scientists should be compensated for it. With all of the nutty survival-ism stuff going on ... it's a moot point to discuss "retirement", and it's near insulting to project salaries for those chemists who are coming out of grad school.

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  2. Not to say I don't agree with you in principle ... it's just rough morning to discuss "retirement" for some if not many of us.

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  3. A7:02: Yeah, I feel you. Retirement, for our generation, seems like a pipe dream. Doesn't mean we shouldn't face potential realities, though.

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  4. Well, if you're lucky enough to actually get an offer, be as hard nosed a negotiator as possible- DON'T let them lowball you using a recession as an excuse, that sets a terrible precedent. If you're the best candidate for the job, they'll pay for it. ACS salary survey suggests its perfectly reasonable asking (with a straight face) for 90K.

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  5. Can you actually contribute to an IRA if you are not "working"? I am pretty sure that if you are not married and your Social Security income is $0, you are not allowed to put money into an IRA.

    If you are paid as a TA, maybe that money can be used for your income. But many of the methods for paying graduate students do not result in Social Security income.

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  6. Anon7:09a:

    You know what? You're right! That's kinda tricky!

    (See this thread: http://www.bogleheads.org/forum/viewtopic.php?t=58606&sid=6464abc12edb5c88c18555bd83b38fbf)

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  7. @anon 9/15/10 11:20am

    Hats of to you for having either the cajones or stupidity to negotiate salary for ANY job offer.

    My primary and ancillary research advisers warned against negotiating in this economic climate. They all believe getting a foot in the door is first priority. There are plenty of people in both hemispheres (E and W) who can do Suzuki couplings and DIC amidations. Anyways, $80K plus relocation is still better than $37K at an urban university.

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  8. Nice idea, but where do you get 5% a year from?

    I get that historic norms for the stock market are abt 7%, but look at your return if you put $100 in the S&P 13 years ago? Well, you'd have your $100 still (the market has be net flat), but inflation would have taken $27.

    Sadly, bonds are currently yielding close to nothing. Spend your money and enjoy. if we get to deflation, it will be worse.

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  9. bbooooooya! I'm honored by your presence.

    I'm glad you note that I chose a fairly conservative number for returns; even then, you're right in that, these days, it's tough even to find a measly 5%.

    Deflation aside (where Bernanke will fly to my house and kick down my door to make me spend my cash), do you really think "spend your money and enjoy" is a smart, long-term strategy?

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  10. she had a better job BEFORE she got her Ph. D. working in industry

    That same thing happened to me. My boss jokingly offers to interview me for my old job when I talk to him because the position has been a revolving door of candidates going to some form of graduate program. I have to force myself not to think about how much money I would be making now if I had just stayed instead of going to grad school (incidentally, money was a factor in me going to school, but obviously I didn't do good research about Ph.D prospects).

    Unrelated: Chemjobber, I'm curious what your thoughts are on this article in C&EN on professors who hold joint appointments in the US and another country. I particularly like the part where they say that UCLA grad students work from 9-5.

    http://pubs.acs.org/cen/coverstory/88/8837coverbox2.html?featured=1

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  11. @anon 9/15/10 9:24pm

    Well I mean eventually you have to take the max they're willing to offer, but after the job offer has been made I doubt it would be revoked just because you had the stones to try and negotiate (unless I'm seriously misreading things). The worst they'd do is say no, here's our offer, take it or leave it. You won't get what you asked for, but it might be more than the initial offer....maybe.

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  12. The return of "B.L."September 17, 2010 at 8:03 PM

    Anonymous who mentioned that you are not allowed to contribute to a traditional IRA without social security income is correct. However, you are still allowed to contribute to a Roth IRA, even with 0$ as social security income. This is an excellent way to save for retirement due to the tax-free growth and withdrawals as well as the ability to withdraw your principal without penalty should such a need arise. I personally contributed the maximum for each year that I was a grad student. Granted, in the mid-to-late 90s the maximum per year was about 3000$, so it really wasn't some kind of huge sacrifice...

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  13. "do you really think "spend your money and enjoy" is a smart, long-term strategy?"

    Long term, clearly not. On a grad school stipend, I don't believe that the marginal benefit of 'investing' close to nothing compensates for the loss of (already limited) spending power.

    I (and, most people investing in the market) would have lost mucho $ had I been socking away cash from my measly earnings as a grad student and PDF in the late 90s, and it would have made an already frugal lifestyle even tougher.

    Now that I have a decent income, I do sock away cash, but even here I think that investing broadly in the market is a suckers game. I don't know what the best approach is. For retail investors, trying to pick stocks against folks who spend every working hour researching stocks is not a level playing field.

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    1. If you're investing 'broadly in the market" you're not picking stocks. You're buying indexes, SPDRs and derivative assets of various kinds, not the underlying individual stocks. The idea is that you're getting something close to the overall market's average rate of return rather than engaging in the time-consuming and expensive game of picking winners and losers (and trying to time the market- another great source of loss). There are various algorithms for creating and balancing a portfolio of such assets.

      You don't get rich on this, but you don't lose your shirt either.

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  14. "My primary and ancillary research advisers warned against negotiating in this economic climate"

    And this is a great example of why chemists get paid so poorly: they're happy to be doormats.

    Can you imagine a lawyer or an MBA not negotiating a salary? These folks already make more $ for having completed degrees that, I believe, are not nearly as rigorous as a chemistry Ph.D., and have no trouble speaking up. I guess putting up with a crap salary for 2+ years as PDF (after a scholastic achievement that makes a JD or an MBA seem like a cakewalk) makes one grateful for anything. To be fair, the task they do aren't as easily outsourced to Asia, but chemists have been letting themselves get walked all over for decades.

    The meek ain't gonna inherit squat, cuz a smart 30 year old portfolio manager (making 7 figures) is going to grab it.

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  15. The overall problem with this kind of analysis is that the projections are based on a reality that doesn't really exist.

    You assume constant employment over a 25-year period. Who has this kind of a record anymore? Odds are most individuals will not - five years at a given company is now considered a long time.
    Even really highly skilled and well-educated professionals frequently spend years out of the work force, and don't usually go back to what they spent their earlier careers in.

    As far as I have seen, the average older sciences PhD (including some older chemists) have between 3-4 careers *in different job sectors.* Usually these include work in industry, government, and academia. Most of them are still working (although perhaps past what might in the past have been thought of as 'retirement age'). The average older top-10 school MBA, in comparison, has generally had 3-4 careers in different job sectors, including work in industry, self-employment, government, and non-profits. Many of these have had substantial (years-long) disruptions to their careers occasioned by layoffs, divorce, health, and other domestic issues.

    You assume 50-80K out the door. Fantastic. Not sure how frequently it happens, even in chemistry. I think for the B.S. graduate, odds are much higher that there will be stints flipping burgers, pouring coffee or teaching English as a second language (I've met microbiology grads taking orders at McDonald's). I know one bright B.S. graduate, who took a position helping run a college stockroom, and was very happy to get it (and undoubtedly makes less than 50K - admittedly with a relaxed and relatively undemanding work schedule). For the PhD graduate, there's been some inflation in post-docs, so it's perhaps more realistic to assume 2-3 years of post-docs @ not very much.

    The main issue, though, is the assumption of stability of employment and earnings, and this simply cannot be taken for granted anymore.

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looks like Blogger doesn't work with anonymous comments from Chrome browsers at the moment - works in Microsoft Edge, or from Chrome with a Blogger account - sorry! CJ 3/21/20