Brent Rice '25
Staff Editor
Continuing our series offering readers financial advice from the Law Weekly writer with crippling credit card debt (and who may or may not have finished 1L several thousand dollars in the hole), I decided to head over to the Financial Aid Office’s “Real World Finances” series for the “Saving and Investing Strategies” workshop on February 27. While the series is targeted towards graduating 3Ls who will soon have an income with which to employ these strategies, there was a healthy amount of 2L students presumably hoping to learn some quick strategies to amplify their summer incomes in order to increase their 3LOL bar spending money.
The session was led by UVA Law Professor Paul Mahoney, who previously served as Dean of the Law School and is credited with skillfully leading the School through the 2008 financial crisis, ensuring both its students and finances did not collapse in despair. Professor Mahoney seems to have been the right man at the right time and once again rose to the occasion to assist us helpless law students in escaping the financial crises of our own making.
If you are reading this article in lieu of reading for class (looking at you 3Ls) and only have a few short minutes to spare, one of the most important takeaways of Professor Mahoney’s session was to remember, and leverage in your favor, the power of compounding. At its core, compounding is the idea that interest can build on top of interest, which can work either for or against you.
For example, most of the end value of a person’s retirement accounts is attributable to money invested in the account between the ages of 25-34. For this reason, you can make compounding work for you by saving for retirement early and often. Another way to make compounding work for you is to only borrow assets that will appreciate (i.e., go up) in value, for example a house or your law school education.
Compounding works against you when you borrow money to buy assets that depreciate in value quickly—such as a new car. Or, even more so, when you do not pay your credit card bill in full each month, as interest accumulates on top of interest, which can exponentially increase the amount you owe.
The session next turned to a discussion of the relationship between risk and return, where risk can be estimated by the extent to which the return on an asset varies from one period to the next. Financial professionals know that bonds are less risky than stocks. In addition, the longer your investment time horizon, the more risk you can take in pursuit of higher long-term returns. Finally, it is important to know that diversification within an asset class, if done well, can reduce risk without reducing return.
All of the above sounds great but if you are looking for more ways to put this practical knowledge to use, Professor Mahoney next covered different types of financial professionals we can turn to for help, as well as their fee structures and pros and cons of each.
“Full-Service” Brokers:
These investment professionals are paid on a commission basis and often sell “proprietary” products on which the broker earns additional fees. Because they are not fiduciaries, they are not required to avoid all conflicts of interest when helping you invest. Hence, the broker’s incentive is to sell you investments on which they earn the highest compensation, which can eat substantially into your own returns. That said, if you don’t trade often, a broker can be an inexpensive source of advice.
Registered Investment Advisors:
This type of financial professional usually charges a fee based on the amount of assets under management (e.g. 1.25% per year). Because they are a fiduciary, they are required by law to serve your interests and either avoid or disclose all conflicting interests. In this structure, the incentives and legal duty are well-aligned with your own financial interests. That said, you can pay a lot for this advice if you have a lot of assets under management, and this payment has a compound effect, which works against you in the long run.
Do It Yourself:
While recognizing that many of us came to law school to avoid math and complicated numbers, Professor Mahoney finally shared an investment strategy where you become the financial professional. In this system you decide which mix of asset classes best suits your needs and risk tolerance and you make those investments using a discount broker, mutual fund, or exchange traded fund (ETF). The advantage of this strategy is that it is the lowest cost to you and you are in control of your investments. The disadvantage to this strategy is also that you are in control of your investments, and you may act irrationally or emotionally in a way that reduces your long-term return.
For those interested in a little bit of DIY, the session concluded with a short discussion of the differences between mutual funds and ETFs.
A mutual fund is an investment vehicle that sells shares to investors and uses those proceeds to buy portfolios of securities. They offer daily liquidity as mutual funds will buy back those shares from the investor at the end of any trading day. When evaluating mutual funds, it is important to look at the “Expense Ratio” as many similar funds charge very different expense ratios and, in addition, competition has led some companies to offer a small number of index funds with an expense ratio of zero. One advantage of mutual funds is you can buy it and forget it, but there are some negative tax consequences to mutual fund ownership as they are pass-through entities for tax purposes.
ETFs are a more recent product offering than mutual funds. These investment vehicles hold a portfolio like a mutual fund, but trade on a stock exchange as if they are an individual stock. For this reason, they offer instant liquidity but must be bought/sold through a broker, rather than through the fund itself. Expense ratios for ETFs may be lower than for mutual funds because there are less administrative costs and ETFs may be slightly more tax efficient than mutual funds, since you only pay taxes when you sell. That said, like other products traded on a market, you need to carefully evaluate the bid-ask spread and choose ETFs with lower spreads among similar funds. In addition, most ETFs don’t offer automatic reinvestment of your earnings so it takes more effort in order to get a compounding effect that works in your favor.
All in all, the session was very informative and I, for one, look forward to putting this newfound knowledge to use. That is, if and when I have any money to invest.
---
wrf4bh@virginia.edu