Top 10 Financial Mistakes Every Software Developer Should Avoid

One of my classmates, we’ll call him Ron, graduated out of college with flying colors and joined Microsoft at age 22. Once Ron’s bonus and stock awards kicked in after 9 months, the first thing he bought was a Corvette for around 65K. The car was financed. Ron, also happened to have about 45K in student loans. Sadly, this is true story and one that is often triggered by a lack of financial knowledge.

There is a lot of cookie cutter advise out there regarding financial mistakes to avoid. This is not one of those. I’m not going to lecture you on creating a budget or being frugal or spending less than you earn. These are things that applies to everyone and I hope you’re already doing this. Instead, I’ll focus on things which are unique to software engineers due to their high income, analytical mindset and location of their jobs.

The mistakes below are things I’ve specifically witnessed time and again or learned from making them myself.

Mistake # 1: Not taking advantage of retirement savings accounts.

Maxing out the tax-advantaged retirement accounts is not possible for most people. However, many Software developers, due to their high income, are in a position to do this. The total amount you can invest in tax advantaged accounts is as follows:

• 401k – $18000
• HSA – $3350
• Traditional IRA – $5500

The table below shows how much tax savings this equates to each year and what that tax savings will look like once you’re ready to retire, say in 35 years.

 * Assuming a 7% rate of return compounded monthly.

That's almost an extra $1 Million saved over the span of one's career !!!

The savings reflected above takes into account the money saved on just federal taxes. If you have a state income tax, you’ll save even more.

Not only that, many large software companies match the employee contribution for 401K. As of this writing, Microsoft matches 50% of all employee 401K contribution. That’s an extra $9000 in your pocket.

Surprisingly many software developers do not take advantage of these retirement savings vehicle. One thing many of us realize very late in life is that even if we love our job, we might not be able to do it till the day we die – there might be layoffs, our health might fail us or we might need to take care of a family member. In these situations, you might be better off having the buffer provided by a large retirement account.

So what’s the solution?

The answer is obvious – please take full advantage of your retirement account. Here’s the account funding priority I use:

1.Contribute to the work-based plan (401(k), 403b,) enough to get the full employer match (the match is like free money, your best possible investment),

2.Contribute to a Health Savings Account (HSA)

3.Contribute the maximum to an IRA, traditional or Roth, depending on eligibility and personal circumstances,

4.Contribute the remainder of the maximum employee contribution to the work-based plan,

5.Contribute to a taxable investing account or use the backdoor Roth technique,

6.Non-deductible IRA or after Tax 401k (if available).

Mistake # 2: Keeping all retirement money in company stock

Most of us have a lot of loyalty and faith in the company we work for. So it’s not unusual to find developers who have their entire retirement account in their company stock. In my opinion, this is a HUGE MISTAKE! We all know what happened to folks who had their retirement savings in Enron or Nortel.

Our financial well-being is already heavily intertwined with the company’s fate. The last thing we should do is tie the fate of our retirement with that of the company. 

So what’s the solution?

My personal recommendation is to invest in a low cost diversified Index Fund for your retirement needs. This way even if your company’s stock tanks when you’re close to retirement, your financial future will be secured.

Mistake # 3: Not taking advantage of ESPP

 ESPP stands for Employee Stock Purchase Plan. ESPP is a company-run program in which participating employees can purchase company shares at a discounted price.

This is how it typically works:

                     1. You sign up at the beginning of an open enrollment period with a specific amount you’d like to contribute, usually between 1% – 15% of your pre-tax salary. In Microsoft’s case, it’s 15%.

                     2.The employer keeps the money in a fund for the duration of the purchase period. Usually this is between 3-6 months. Microsoft has a purchase period of 3 months.

                     3.On the last day of the purchase period, the employer uses the money you’ve saved to purchase the company stock and gives you a large discount on it – usually between 5% – 15%. Microsoft gives a discount of 10% at present.

                     4.You can hold the stock or sell it right away.

This 10% discount is FREE MONEY!!! And it makes absolutely no sense to let it go. Let’s take a hypothetical situation of a developer making $150k and his company offering a ESPP discount of 10%. We’ll also assume that the company allows a maximum ESPP contribution of 15% of the pre-tax income. So here’s how it plays out per year:

Maximum ESPP Contribution = Pre-tax compensation * 15% Contribution = $150K * 0.15 = $22,500

%Profit if sold immediately = Contribution amount * percentage discount = $22500 * 0.10 = $2,250

$2250 is a nice chunk of change and can very well pay for a mini vacation or a month’s mortgage or rent – depending on how you look at it.

You’ll of course need to pay short term capital gain tax (at your current income tax rate) on the profit amount, but that’s no different than any additional income you make. A lot of people prefer to hold their ESPP stocks for at least a period of one year to get preferential tax treatment (long term capital gain which is lower) but I’d not recommend it. In my opinion, the ROI is miniscule when compared to the HUGE RISK of holding a large amount of money in any single stock. 

So what’s the solution?

Here’s my personal Rule with ESPP:

1.Contribute the max amount possible.

2.Sell the stock at the purchase date asap.

3.Take the proceeds and invest it in an index fund or diversified mutual fund. 

Mistake # 4: Trading Stocks and trying to beat the market

Most software developers I know are highly intelligent and analytical. A lot of them also believe that their skills in analyzing problems and devising solutions translates into realms beyond software engineering. 

One specific area that often fascinates software developers is “Technical Analysis of Stocks”. It’s a field where you employ complex mathematics and pattern recognition of stock charts to identify best buy and sell points for stocks to make killer profits. 

So what’s the problem?

Well, you see, most of the time it does not work. And for the few times it does, you’ve sunk so much effort and time into it, it’s barely worth it over just dumping your money in a diversified mutual fund and letting it ride. I should know, because I did active day trading for almost 3 years before getting married. I’d wake up at 6:30 am in the morning (PST) – in time to catch the opening bell. Without even having breakfast, I’d be glued to my dual screen monitors for the next 2.5 hours while playing CNBC at high volume. It’s almost like hunting – hunting for that one perfect entry point, that killer opportunity that’ll make your day. I’ll be honest, it was fun and exciting. But when I look back at my personal rate of return, I wasn’t doing all that much better than just dumping my money in index funds using proper asset allocation. And honestly speaking, I got lucky – I know a lot of people who actually lost a significant part of their investments while trading stocks. 

So what’s the solution? 

Everything said and done, trading stock is still fun and exciting while investing is boring. From time to time, we might need to lose some steam or try our luck. I typically keep 5% of assets in a “Fun Money” account that I use to target market opportunities, like buying oil stocks when they’re down etc. You can employ a similar strategy for the amount you set aside to trade stocks – but I’d recommend keeping it under 5% of your assets.

Mistake # 5: Feeling the compulsion to always buy the latest hot gadget or tech item

Many engineers feel that they need to own the latest new smartwatch or latest new tablet to ensure that they’re viewed as someone who lives on the cutting edge of technology. Whether it is buying the latest surface book or the latest iPhone or getting an Ultra 4k curved monitor, it can all cost you a serious chunk of change. I mean, they’re all great products – but I probably don’t need to upgrade to the latest surface book if my 2-year-old Lenovo laptop is still working. 

A lot of people buy these things out of peer pressure as well – known more popularly as “Keeping Up with Joneses”. This is even worse as you’ll end up in a never ending cycle of spending money to just keep up appearances by buying stuff you might not even actually enjoy. I’m not saying don’t buy expensive electronics – by all means buy them if you really enjoy them or think they can boost your productivity – but buying them so that you fit a particular mold is no different than a school girl asking for the latest smartphone because all her cool friends have one. I think we’re a little too grown up for that 🙂

So what’s the solution?

Don’t buy expensive high-tech stuff just because you’re in the software industry. People will judge you based on the skillset you have – and not by the hi-tech gizmos you own. So you can work on improving your skills instead to boost your self-esteem. 🙂

Mistake # 6: Keeping only group life insurance policy and not having individual life insurance

Many employers offer a group life insurance policy through work. It’s usually quite a bit cheaper and easier to get approved for. A lot of people forgo getting their own personal policies in favor of these group insurance policies. In my opinion, this can be very risky if you have dependents who rely on you for income.

On an average, people change jobs every few years. Even if you’re not changing jobs intentionally, there can be layoffs or the company might close down. You cannot take a group insurance policy with you when you leave your employer which can leave you in an unprotected state for quite a while. If you’re middle age, you might find it extremely hard to qualify for reasonable life insurance policies if you do end up leaving your current employer. Even if you do, the policy premium might be unaffordable. This is a situation you don’t not want to be in.

So what’s the solution? 

For most people, it’d make sense to get an individual life insurance policy for an amount that can cover the basic necessities of his family in case of any eventuality. You can use your employer sponsored plan to supplement that basic individual coverage. 

Mistake # 7: Not having adequate liability insurance 

Liability insurance protects you from risks of liabilities imposed by lawsuits and similar claims. For example, if you are in an accident that was deemed your fault, you’ll need to pay for the medical expenses for other people hurt in the accident. This is where your auto liability insurance kicks in and picks up the tab. If you do not have insurance or adequate insurance, you’ll have to pay for the damages to other people’s health/ property from your own assets. If you do not have enough assets to pay for them immediately, you might have your paycheck garnished till the damages are paid off. In Washington state, this can cost you as much as 25% percent of your salary every month. 

United States is often noted as a highly litigious society. People seem to sue each other over seemingly stupid things just to extract cash out of each other. Software engineers are especially juicy targets for liability lawsuits because of their high income and asset level. Don’t give people an opportunity to snatch away your hard earned money – protect them with the right liability insurance.

So what’s the solution?

I recommend bumping up your auto liability insurance to at least 300k per person/ 500k per accident. This is often as high as most insurers will go for auto policies. Most lawsuits are settled well below these limits. If you have significant assets, you should also consider getting an umbrella policy which gives you additional protection beyond the auto coverage limits. Typically, policies cover around 1 million to 3 million in damages and protect you in situations where your fault caused a fatal loss of life or similar situations.  Unlike most other things in life, Insurance is something we buy and hope we never have to use. 

If you’re going to do one thing mentioned in this post, let this be it. Don’t let your decade of hard work to build a life be nullified by the simple mistake of not having adequate liability insurance.

Mistake # 8: Buying too much house

Software developers tend to live in high cost of living areas. This is usually where most of the lucrative jobs are. One of the mistakes you can do that’ll seriously affect your quality of life and your future financial stability is stretching yourself too much to buy a house. I’ve seen two cases:

1. Buying a large house close to work and being house poor: This basically means that you dedicate the largest part of your income to housing leaving you very little money to do other things like invest for retirement, go for vacations or spend on other things you enjoy. This can lead to dissatisfactions in other dimensions of your social and personal life, leading to unhappiness.

2. Buying a large house, you can afford but is far away from work: There is this second camp who’ll but a large house that is 1-2 hours commute from their place of work. If you take an average of 3 hours spent in commute each day, it leads to 720 hours (30 days !!!) spent in commute per year! That is insane. This is time you could have spent with your family and kids or spent on improving your skills or working on a hobby. 

 If you read these two points carefully, you’ll notice that the both these problems arise from the desire of a large house. The word large is subjective to the income level of an individual – but most people do end up stretching themselves. I’ve seen cases where a family of four was living comfortably in a 1200 sq. ft. apartment, but when they decided to buy a house, it was a 3100 sq. ft. mansion. I still fail to understand what exactly triggered an increase in space requirements by 150% overnight. Needless to say, they feel pretty house poor now.

So what’s the solution?

My personal recommendation is to never go beyond 25% of your GROSS income for rent/ mortgage expenses – it should ideally be less than 20%. Start with the bare minimum space you need and work up from there until you hit this 20% or 25% of gross income affordability limit. This’ll leave you sufficient head room to save for retirement and spend on other things in life that you truly enjoy like vacations, hobbies etc. 

Mistake # 9: Not having a written down financial plan

Have you ever started coding without having a proper design or at least think through the problem and considering different solution options? Usually does not end well – does it? 

The same is true for your Financial Life. If you don’t have a well understood plan that is written down, you’re more likely to stray from your primary goals. At the very minimum, you should write down your primary financial goals like buying a house, saving for retirement, funding college for your kids etc. – make a best possible estimate of how much money it’s going to need and calculate the monthly amount you need to save/invest to reach these goals in the correct timeframe. 

Going one level deeper, you should also think about your asset allocation (split between stocks, bonds, cash) based on how much risk/ volatility you can stomach. 

So what’s the solution? 

Don’t be a boat without a rudder. Create a financial plan for yourself and your family today.

The best resource to further educate yourself on the subject is the Boglehead Wiki On Creating a Financial Plan.

Mistake # 10: Trusting someone else with your financial well being

The person who is most interested in your financial well-being is YOU! Not some asset manager or insurance agent. A lot of engineers gravitate towards professional asset managers or insurance agents because they’ve either not taken the time to educate themselves in financial matters or are too busy to look after their own financial well-being. 

But this can cost you. At the very minimum you’ll pay an extra 1% of your asset value per year. This does not sound like much, but equates to $10k for a $1M portfolio. That’s like a family vacation in Hawaii for 15 days. 

In the worst case, they might sign you up for actively managed mutual funds or some other exotic investments where you might lose a significant portion of your investment. 

So what’s the solution?

You know what – it’s really easy to be a good investor where you’re in charge of your own financial future – just read up a few good books on investing like The Bogleheads' Guide to Investing and don’t try to make a killing trading stocks – you’ll do just fine.

So what has your biggest financial mistake been in your career? Please do share so that others can learn and benefit from it.