Even if we don’t have children of our own, we want children to thrive as they grow into adulthood. After all, they are our future leaders. We provide our youth with learning and guidance in many areas throughout their education, yet one area is often missing or only minimally covered during these formative years: financial literacy. Having a solid understanding of what it takes to be financially successful, recognizing that this means different things to different people, is a skill that can provide benefits not only to our own children, but to our local and global communities. Financial stability is linked to better health outcomes, improved education leading to more career and job prospects, lower stress and anxiety, and greater options in life.
Financial literacy is a broad topic, covering many aspects of both personal finance and the larger economy. This discussion focuses on some key areas that are especially relevant to teens and young adults who are just starting their paths as financially independent people.
Building a Plan
Just as some of us are introverts and others are extroverts, some of us are “planners” and others are more “spontaneous”. Neither is good or bad, and regardless, there are some important benefits to developing a financial plan for yourself. A plan can provide a framework or road map, offering guidance on prioritizing goals, milestones for checking progress, and an ability to know where you are going. In the absence of a plan, it can be difficult, maybe even impossible, to know how close you are to achieving a goal, such as readiness for purchase of a new car or even your first home. In addition, a solid financial plan can pinpoint areas that may need greater attention such as having adequate cash reserves or appropriate types of insurance coverage. Finally, a robust financial plan can help you “model” various scenarios for decision making purposes. These may include changing jobs, going back to school, or purchasing a major asset like a boat or a home.
When developing a financial plan, it is good to incorporate the following:
- Short term goals – what do you want or need in the next 12 to 36 months? Will you be making any large purchases, traveling on a vacation, or paying off a debt or loan?
- Long term goals – These are financial goals that you would like to achieve roughly 3 years out and beyond, and may include things like wedding expenses, purchasing a home, establishing a college fund for a child, and also retiring.
Whether it is a short or a long term goal, it is important to include an estimate of the cost associated with that goal in your plan. For instance, if your goal is to go back to school and obtain a master’s degree, what is the estimated cost for tuition, books and supplies? Will you be working while obtaining the degree? If not, what are your anticipated living expenses during that time?
- Budget – Another important part of a financial plan is anticipated income and expenses, or put another way, a “budget”. If you are currently earning income, what is that amount? Will it grow over time and if so, by how much and how often? Expenses would typically include your housing costs, utilities, food and entertainment, and other general living expenses. Don’t forget to add in an expense category for “savings”! By thinking of savings as a necessity that you must pay for just like your food or phone bill, you will soon begin to save automatically, and won’t view this as an optional use for your dollars.
You might also want to add any “extraordinary” expenses that you are planning for, even those you may not be planning for. Examples would be a major car repair, a new piece of furniture or a special vacation. Adding in a category for these types of expenses will keep them on your radar, helping you to know how long you may need to save up to cover the expense.
Similar to estimating your income over time, projecting changes to expenses over a longer time period helps you to avoid surprises around extra costs associated with owning a home, or taking an extended period of time off work. Again, a financial plan is a roadmap that helps you to look at both the short and the long term, and to assess your progress toward reaching your financial goals along the way.
- Discretionary Income – Once you have identified income and expenses, including savings, you can then determine how much discretionary income you have.Discretionary income is money left over that can be used for non-necessary items such as entertainment, travel, or a new cell phone. We all deserve to enjoy “today” and pursue passions and hobbies that are important to us. Identifying the amount of discretionary dollars you have, how you might use them, and whether some of these dollars can be used for your financial goals will help you to reward yourself now, and also make progress toward future goals.
At some point, purchasing a car, renting an apartment, or having a credit card for travel away from home will be important. All of these involve borrowing from someone else, and in order to do this, you must be “qualified” as a good borrower – this means the lender believes that you will be able to repay what is borrowed. As you begin to successfully pay your monthly rent, credit card balances, or car loan payments in a timely manner, you will build a good credit history. However, this doesn’t happen automatically or overnight. Often, lenders will require a co-signer, perhaps a parent or other individual who has a good credit history, to be added as a borrower on a credit card application or an apartment lease. Over time, as the new borrower builds their own good credit history, there won’t be a need for a co-signor.
In addition to establishing good credit for purposes such as renting an apartment or buying a car, credit reports can also be reviewed by potential employers, landlords, and insurance companies. Further, the better your credit history, the lower interest rate you might receive on a car loan, or even a mortgage, which will save money on interest payments over time.
Receiving your first paycheck is an exciting milestone! Investing dollars from that paycheck is equally exciting. Investing provides the opportunity to see the value of the dollar earned grow over time, and with it, your wealth.
People have been investing for centuries – in gold, real estate, bonds, stocks, and more recently, crypto-currencies! With this long history of investing, there are some success strategies worth considering. These include:
- Start early – for those who are working part time while still in high school or college, or those just beginning their first “career” position, it is not too early to start saving and investing. The concept we all learned in our math classes of the power of time and compounding is true! The earlier you start investing, the more time and compounding can work for you.
- Diversify – We’ve heard the saying “don’t put all of your eggs in one basket”, and this is especially true for our investments. Diversifying your investments means owning things that behave differently from one another, such as different types of stocks, bonds and other investment vehicles. One great way to do this is to invest in mutual funds which typically own hundreds of bonds, stocks or combinations of both within one fund. Having diversification among your investments is way to reduce the overall volatility and create a more consistent return experience.
- Tax Deferred Growth – One of the great features of an IRA, 401k, or other type of retirement plan is the tax benefit it provides. All retirement plans defer current taxes on any growth of the investments in that account. In addition, Traditional IRA’s, 401k/403b plans, Simple IRA’s and SEP IRA’s also offer a tax deduction of your contribution. This means that you can deduct your contribution from your gross income in the year you made the contribution (note: there are deductible contribution limits for each type of account). Double tax savings! Again, you receive a deduction for your contribution amount and tax deferred growth over time! Roth IRA’s work a little differently in that you do not receive a deduction in the year you make your contribution; however, you will never pay taxes on the growth – you get tax deferred growth, and are then able to take a withdrawal from your Roth IRA that is tax free!
Teens and young adults are often targets of identity theft because they often don’t pay close attention to this as a risk. However, using public wi-fi’s, using the same password for multiple sites, not checking credit reports, and sharing personal information online are some of the more common reasons why young adults become victims of identity theft. Having your identity stolen can affect your affect your ability to qualify for student loans, rent an apartment, or even purchase a new cell phone. Here are some ways to protect your identity:
- Don’t share your personal information with strangers online!
- Don’t use a debit card for online purchases. Instead, use a credit card. This can add protection in the event of fraud and your credit card company may provide a credit against the false charges.
- Don’t use public wi-fi’s for any transactions or online activities that require sensitive information. Airports, shopping malls, coffee shops and other similar locations are prime places for fraudsters to intercept information.
- Don’t click on unknown weblinks sent by email or shown on various websites, and don’t participate on online quizzes. Both of these are ways that your personal information can be gathered for fraudulent purposes.
Thinking about estate planning in our early 20’s or early 30’s may seem strange. However, there are important “to-do’s” in this area of your financial life. Specifically, three vital documents all adults, regardless of age, should have are:
- Durable Power of Attorney – this document allows someone to act on your behalf regarding financial matters if you are incapacitated. It can also be used for college students who are living away from home, particularly out of state or abroad.
- Health Care Proxy – this document gives a designated adult the authority to make health decisions on your behalf if you are unable to.
- HIPAA Authorization – this document gives your physician the authority to discuss your medical situation with family and other loved ones.
If you have assets outside of an IRA or other type of retirement plan, you may also want to have a will to specify who should receive those assets in the event of your death. A simple will does not need to be lengthy or complicated, and can provide an opportunity to designate your wishes for your belongings.
Just like other subjects you may have studied in school, financial literacy is something that builds over time and becomes more important as we mature in our lives. Having a foundation of understanding and experience in each of the areas of above is a great way to launch a young person toward financial success and independence in their life. Start building your foundation now!