Investment decisions, and therefore personal financial planning, has two main points of focus: risk and reward. These risks and rewards are balanced and usually move in tandem. Higher risk investments tend to have higher returns over the long term due to the need to compensate an investor for taking on the increased risk.
The level of risky investments the investor’s portfolio should hold is chosen based on two components: ability and willingness to take risk.
- Ability to take risk: High portfolio values, stable income, high savings rate, etc. all increase an investor’s ability to take risk.
- Willingness to take risk: An investor who is risk averse will seek lower risk investments and an investor who is risk seeking will…well…seek risk.
A professor who has been granted tenure experiences a shift in the ability to take risk. Whether or not the willingness has changed, the way the professor thinks about cash flow, employment risk, and savings has been positively affected by the tenure.
Unique Constraints
A financial plan balances these risks and rewards based on the investor’s needs, constraints, and goals. Common constraints would be tax concerns, how much time is left until retirement, legal issues, liquidity needs such as purchasing a home or paying for your child’s education, and finally any unique circumstances that the investor faces.
University professors rank high on the unique circumstances scale. The job security of a professor is shakey in the beginning. Mid-tenure reviews, job switching, and short contracts for new instructors or lecturers all make for high uncertainty. However, after 6 (ish) years things change drastically. The tenure review is here and instead of shaky job security, new associate professors are now in one of the most stable jobs anyone can get: a tenured professor.
Long Term Thinking
This 180-degree change in job security creates the need for an updated financial plan to account for the substantial change in employment risk.
Risk of unemployment is now very low. For the most part, if you are no longer working your tenured professor job, it was your choice which means you could prepare for it. Teaching faculty who are promoted to a position where contracts are extended to 5+ years are in a similar boat.
With the reduction in unemployment risk, professors can increase the risk of their portfolio and focus less on saving for potential unemployment. In addition, non investment questions like “Should I pay off my mortgage?” are discussed from a new point of view.
A Financial Plan fit for a Tenured Professor
Investors should increase their risk to the level they are most comfortable with. For conservative investors, this bar is low. Unfortunately, due to the relationship between risk and reward, investors who set a low-risk bar are not rewarded with higher returns over time. In situations where an investor has a high-risk job and the likelihood of the next paycheck is unknown, having a large savings account (very low risk) and stable investments work to balance out the high-risk job.
For a tenured professor, the job security is very high making the next paycheck highly predictable. With a predictable paycheck, there is always cash coming in and therefore the blow of an unforeseen emergency is softened by a new stack of cash hitting the bank account every two weeks. Assuming proper budgeting, each paycheck will have money left over that could easily be shifted from retirement contributions to this emergency situation. This consistent cash flow makes a very large emergency fund unnecessary. (Clarifying point: an emergency fund is still neccessary, but the amount does not to be as high)
Instead of keeping large amounts of money in a savings account that earns very little, if any, interest, professors can move more money toward investments that offer a higher return. These higher returns lead to larger retirement balances upon retirement or even earlier retirement.
Academics have a unique employment timeline that includes a drastic shift in job security. This is an important part of a financial plan and should be taking into account by your financial advisor when discussing budgeting, cash flow, retirement savings, and investments.