In my last post, I introduced the concept of Optionality,

meaning the ability to take ownership of our lives and choose the life we want to live.  Said another way, having your finances in order allows you better choices than having to continue going to a job you hate.

I also talked about my own decision to take a job that paid less because it brought me more happiness and less stress.  And how having a Cash Management Plan (CMP) was instrumental in creating that opportunity.

Today we are going to explore what an average new graduate pharmacist could plan to have for a CMP and then we will dig into the title of this post in more detail.

Example CMP for someone making a $100,000 per year Salary

Monthly Earnings / Income
Job Income	$                                8,333
Taxes
Taxes – Federal, State, etc.	$                                2,333
Total Income (Income minus taxes)	$                                6,000
Monthly Expenses
Employer Retirement (401k or 403b)	$                                   800
Roth IRA	$                                   450
Charity / Gifts
Charitable Contributions	$                                   150
Housing
Mortgage/Rent	$                                1,000
Property Taxes
Home Insurance
Home Utilities
Transportation
Auto – Gas	$                                   100
Auto Insurance Premium	$                                   100
Car Loan / Lease Payment	$                                   350
Dependent Expenses
Child Support Payments	$                                       –
Children’s Education	$                                       –
Lifestyle Normal Expenses
Cable Internet / Television	$                                      75
Miscellaneous Personal Expenses	$                                   500
Food / Groceries	$                                   700
Disability Insurance	$                                      75
Health Insurance	$                                   250
Cellphone	$                                      65
Lifestyle Large Ticket – Pre-saving
Travel / Vacations	$                                   200
Debts / Loans / Credit Cards, etc
Student Loan Payment	$                                1,150
Total Income	$                                6,000
Total Expenses	$                                5,965
Surplus Cash Flow	$                                35

What are some key items from the above example?

• Saving 15% for retirement ($800 in the 401k and $450 in a Roth – both per month)
  • It’s a lot of money!  I hit this point more in depth here.
  • You might be able to save a little less if you get an employer retirement match, but it’s best to estimate saving 15% until you know your numbers definitively.

• Student Loan payment – $1150/month would pay off $150,000 loan @ 6.8% in ~20 years
  • I actually recommend trying to pay the loan off faster, but each situation will be a bit different
  • Your loan debt may be less (or more) depending on your specific situation.  Sofi says the average is ~$150,000

• Only $1000/month budget for housing and this is assuming a $350/month car payment and no other credit card debt
  • The best idea to have a reasonably priced car and pay it off (rather than a lease, or carry a payment – but again your situation may differ)
  • I’m also not counting the $300-500/month you might be paying in State Income Taxes (if you live in a State that has them)
  • $1000/month isn’t much for housing

• Bottom line: $1000/month isn’t going to net you a $350,000 home.

 

But I need a $350,000+ house!!

 

Nearly every new graduate I speak to wants to buy a house as soon after graduation as possible.  I’m not sure what drives this need since a new pharmacist’s living situation might never be as unstable.

 

• We’ve just finished school – are we going to move for work?  Move for a residency?
• We are getting the biggest raise in salary/wage we’ll likely ever see – LET’S SPEND IT ALL IN ONE DAY!
• Assuming we land a job – are we going to stay at it?  Are we going to like it in 2 years, 5 years, 10 years?

 

The concept of the Hedonic Treadmill is a concept we’ll explore another day, but is another reason to delay or slow our increases in spending or life style – despite a large windfall or  change in income.

Even if your CMP is a different than my example above (e.g. you don’t have student loans or decline my advice on saving 15% for retirement) – you would be looking at big Mortgage Payment for a $350k house

• Putting 5% down on a $350k house the payment would be near $1750/month
  • That doesn’t include Property Taxes or Insurance – at least another $5000/year, even in a cheap Property Tax area)
  • Not to mention costs of heating, cooling, fixing, improving, etc

 

Let’s explore some key reasons to delay or decrease our home purchase

 

• You likely already have a Mortgage Payment-sized debt….. Student Loans!

  • $150,000 or $200,000 is a ton of debt to pay down already

• Homes are NOT investments – they are a consumption item

  • Yes, they appreciate (usually only at the rate of inflation) – but that isn’t guaranteed.  2008 isn’t that long ago
  • They are hard to sell (or at least expensive to sell)
  • They are illiquid; you can’t sell off one room if times get tough or you don’t want the 3rd bathroom anymore…
  • Counterpoint?  It’s hard to sleep inside a mutual fund or other investment

• I was told locking in a home loan today at a low rate is really good for the future!  Because…. inflation?

  • I see this most often in reference to how wages will go up and tomorrow’s money is “cheaper” due to inflation.
  • Pharmacists don’t get as much benefit from this idea
    • Our wage starts out good (~$100-125k), but basically stays there
    • Inflation will help, but we can’t expect our wage to double or triple in 5-10 years like other professions might

• Buy vs Rent ratio thought mechanic – actually thinking of a home like an investment

  • Use a quick estimate of “Cap Rate” to see if it would be a good “investment”
    • Net Operating Income / Current Market Value = Cap Rate
    • We’ll call something above 4.5% “good,” for this scenario
    • This is just an example and does exist in my investment market – yours may be different

 

Home Purchase Price	$     350,000
Could Rent similar house for about:	$        1,800
Net Operating Income (rough estimate = Annual rent x 0.55)	$       11,880
Cap Rate	3.4%
Home Purchase Price	$     175,000
Could Rent similar house for about:	$        1,350
Net Operating Income (rough estimate = Annual rent x 0.55)	$        8,910
Cap Rate	5.1%

• Dr. William Bernstein, in his book the The Investor’s Manifesto – on page 37, has another way to quickly estimate this that is very similar to the above:
  • Take the the reasonable rent for the house you want to buy and multiply by 150
  • If that number is higher than the asking price = better to rent.
    • Lower = might be worth buying over renting.

 

• Other Miscellaneous Home Owner Issues

  • Do you like unclogging toilets?
  • Paying for house repairs?
  • Weeding the garden and mowing the lawn?
  • Paying nearly 12% of the value of your house (nearly $42,000 for a $350,000 house!!!) to fees and closing costs when you sell?

 

Ok, let’s bring this home… this is too much of a downer.  Can I see that dog again?

I’ve been pretty negative towards home ownership in this post.  It’s not all bad – but I’m going to tell you two paragraphs of story before I try to wrap this up.

I bought my first home almost immediately after I got my residency job.  I hated that house.  It didn’t have a pantry closet for my food.  It didn’t have a closet for my bathroom towels.  It had a crappy garage that refused to securely shut.  It had the original sewer line that needed $10,000 in repairs.  I had no idea what I wanted in a house and it showed…

Luckily, I bought in 2007 so I had a bunch of appreciation that I gai—– oh wait, that was the peak of the market so my house lost 30% of its value in 2008 and took until 2015 to get back to even…

 

Take Home Point Time

 

My point is to try and take a reasoned approach to home ownership.  Do you have your financial ducks in a row?  Are you going to derail your financial security so you can have a fancy house with rooms you probably won’t even go in?  Are you paying off your student loans, saving for retirement, and still living below your means to create your own Optionality?

 

What do you think?  Are you still going to buy the biggest house you can find?  Live in your friend’s closet?  Tell me below!  I read every comment and email I receive.