Ten Things you Need to Know Before you Go to Big Debt Grad School

By Matt Miner

1.       Big debt will change your decision-making process (even if you don’t believe it will)

2.       You don’t know how your desires and abilities will change over ten or forty years

3.       Growing your annual pay from $80,000 to $130,000 results in a ~30% increase in take-home pay after accounting for taxes and loan repayment, not a 62.5% increase.

4.       Borrow no more than absolutely necessary to finish your program.  You’ll have to decide what is absolutely necessary, but it has something to do with “living like a student”, rather than living like a rockstar.

5.       Private and government student lenders can afford for you to default on the loans.  You are part of their overall portfolio of loans.  You cannot afford default, because you are a portfolio of one asset.  You also cannot guarantee in advance that you won’t default on your loans.

6.       You need to buy private disability insurance before you make plans to quit your job.  You are going to school to grow your income.  Don’t fail to insure your income, which is probably your most valuable asset!

7.       You’ve got to control your expenses.  Future earnings are not enough to make up for wasteful spending now.

8.       If you live like a CEO when you’re a student, you can live like a student when you’re a CEO.

9.       If your spouse can work, that will really help

10.   Savings which are earmarked for school or post-school expenses belong in CASH not in mutual funds or other volatile investments.

The borrower is slave to the lender – Proverbs 22:7

According to US News, about 70% of business school students use debt financing to pay for their schooling, and the average loan balance is in the neighborhood of $106,000 when these students graduate.

Big debt will change your decision-making process (even if you don’t believe it will)

When you come out of school with BIG DEBT it will affect your decision process about everything from your monthly budget to the risk you can take in your career to your range of choices for entrepreneurship.

When I emerged from grad school, my minimum monthly student loan payment was about $1600.  My income was too high for any of the interest to be deductible, so every penny of that payment was funded with after tax funds.

You don’t know how your desires and abilities will change over ten or forty years

When you borrow for school, you do not know how your life will unfold over the coming decades.  You are signing up to make that payment, no matter what your desires or abilities become over that time.  Your family will change.  Your interests will change.

You’re also assuming you’ll get the type of job with the pay you want.  While the strength of the school you attend will play a big role here, in every class there are some students that struggle with job placement.  If you graduate into an economic contraction, which realistically affects perhaps three classes in ten (for example, 2001, 2009, 2010), even more members of your class will struggle, regardless of how strong your school is.  And the ones who will struggle most are the ones with the weakest “why” for being at school.

Growing your annual pay from $80,000 to $130,000 results in a ~30% increase in take-home pay after accounting for taxes and loan repayment, not a 62.5% increase

Even if you graduate in a decent or great year and get the job you want, here’s how the math will work.

The average student entering an elite business school is walking away from perhaps $80,000 in annual cash compensation.

My assumptions for the following calculations are:

1.       Single filer

2.       Standard deduction

3.       No dependents

4.       10% of gross pay deferred to 401(K) plan

5.       Ignore state income taxes

At $80,000 per year, you’re paying payroll taxes (employee portion only) of $6120 (6.2% Social Security Tax and 1.45% Medicare Tax) and Federal income taxes of $11,184, leaving you the following to invest, fund your lifestyle, and give away.

Annual Salary: $80,000

Payroll Taxes: ($6120)

Federal Income Taxes ($11,184)

401(K) deferrals: ($8,000)

Take-home pay: $54,696 per year or $4558 per month.  You can reference some of my assumptions here.

The average student graduating from a top-ten business school is will earn in the neighborhood of $130,000 in their first full year out of school.

At $130,000 per year, you’re paying payroll taxes of $9232 (6.2% Social Security Tax on first $118,500 (2016) and 1.45% Medicare Tax on $130,000), and Federal income taxes of $22,899, leaving you the following to invest, spend, or give away.

Annual Salary: $130,000

Payroll Taxes: ($9232)

Federal Income Taxes: ($22,899)

401(K) deferrals: ($13,000)

Take-home pay: $84,869 per year, or $7072 per month.  You can reference some of my assumptions here.

But now, based on an average loan balance of $106,000, you have a monthly loan payment of $1177 ($106K at 6% for ten years).  Your true increase in take-home pay is from $4558 to $5895 ($7072 - $1177).  This is a $1337 increase in monthly pay, and now you have outstanding debt of $106,000.

Also, your family life may be getting more complicated.  You’ll want to find more money to save, either so you can retire someday, or perhaps to invest in a business.  Your career desires may begin to change.

Borrow no more than absolutely necessary to finish your program.  You’ll have to decide what is absolutely necessary, but it has something to do with “living like a student”, rather than living like a rockstar.

When you lever up for school, it is imperative that you borrow no more than absolutely necessary.  Here’s why: Time isn’t money.  Throw that axiom out.  Time is life.  When you give your time to anything (typing some words into a computer, having breakfast with your children, or working at the office for twelve hours) you are spending your life.

For every dollar you borrow, you are trading your future life (with interest!) for that dollar.  And although fancy, high-stakes meetings, four star hotels, and black cars are enticing, let me share one fact and one opinion.

A fact: employers are no more generous with compensation and perquisites than they have to be to get and keep the employees they need.  It’s a pure trade: their money, your life.

An opinion: unless you love the work, the juice is not worth the squeeze.  There is nothing ultimately satisfying about fancy meetings, elite hotels (between midnight and 6 am please!), and car service when you’re apart from those you love, ragged out from long days, and working toward what is ultimately someone else’s goal.

Private and government student lenders can afford for you to default on the loans.  You are part of their overall portfolio of loans.  You cannot afford default, because you are a portfolio of one asset.  You also cannot guarantee in advance that you won’t default on your loans.

Here’s another fact: to the student loan lender, you are part of a portfolio.  If you fail in your money- making game plan, you’re simply a part of the numerator in their loss ratio.  The lender will be OK.

To you, you are the portfolio.  You own a portfolio of one resource.  The one stock in your portfolio is your ability to generate income.

If your money-making game plan fails, you fail.  Your loss ratio can exceed 100%, and your losses are non-bankrupt-able.  When you borrow for school, you gamble on an uncertain future that depends on variables you cannot control.  These variables include but are not limited to: the economy, employer attitudes, your personal and family stability, your willingness to do in the future what you want to do now, and how technology, regulation or taxes may impact your value in the marketplace, to name a few.

For these reasons, the risk of failure can never be 0% for your grad-school endeavor.  You need to minimize the harm any of these failures cause by taking on as little leverage as possible.

Because you are a portfolio of one with little diversification, you need to influence and control the things you can.

You need to buy private disability insurance before you make plans to quit your job.  You are going to school to grow your income.  Don’t fail to insure your income, which is probably your most valuable asset!

You need non-employer-provided disability insurance before you plan to quit your job.  You need this coverage anyway, so get it asap.  But by contract in many cases, if you’ve already committed to quit your job you may not qualify.

Think about it.  You’re investing in this education to raise your income.  Don’t fail to insure your income.

You’ve got to control your expenses.  Future earnings are not enough to make up for wasteful spending now.

You need to control your expenses while you’re in school.   Think in line with the big budget categories: housing, car, food (and drink!), entertainment, utilities, & clothing.  If you’re not yet rich in actual wealth (expected future income doesn’t count), don’t try to spend like you’re Jamie Dimon, Mark Zuckerberg, or Sergey Brin.

If you live like a CEO when you’re a student, you can live like a student when you’re a CEO.

You may be attending school at the alma mater of one of these luminaries.  You may be going to work for them in the future.  You may even become them in the future. But for the moment, have a realistic view of who you are: An (ambitious, bright, good looking) unemployed twenty-something with minimal or negative net worth.

In the words of a student loan counselor, “If you live like a CEO when you’re a student, you can live like a student when you’re a CEO.”  More realistically, if you live like a highly-compensated professional when you’re a student, you can live like a student when you’re a highly-compensated professional.

If your spouse can work, that will really help

If you’re married, having your spouse work while you’re in school can be a huge help.  We failed utterly in this regard.  We were on the extreme side of b-school expenses.  We came to school with my wife at home with our two very young children, and we left school with my wife staying home with our three very young children!

Savings which are earmarked for school or post-school expenses belong in CASH not in mutual funds or other volatile investments

You need to be wise with the designated savings you plan to spend for school.  In addition to not spending your savings wastefully, these resources need to stashed in money-market funds or passbook savings accounts.  They don’t need to be invested in stock or bond mutual funds.  Any money you need in less than five years belongs in cash.

I speak from painful experience here.  I had some untouched reserves set aside all through business school intended to cover a 20% down payment on our home when we came out of school.  And I had these funds invested in stock mutual funds (how far can they really fall?).

Due to the timing of my graduation (May 2009) and the timing of our home purchase (March 2009), I sold out of stock mutual funds in March 2009 to fund the down payment on our home.

Ouch.  I didn’t need that house given my student loan situation at the time, and even if we insisted on buying a house, the down payment money never belonged in stock mutual funds.  This was a $40,000 money-management mistake; a painful, unforced error.  There was nothing wrong with the mutual funds.  What was wrong was parking short-term money in volatile mutual funds.  Do yourself a favor and don’t make this mistake with your savings.