I am often asked my opinion on the best ways to educate children about money and personal finances. There are many excellent resources on ways to introduce children of various ages to saving and managing money, with most reinforcing the concept of delayed gratification as the holy grail. There are also guides to the terminology and intricacies of various financial products and services, which can be very useful once an adult child is on his or her own. These guides are often less meaningful without a solid conceptual framework, so here is a road map for parents to help their children get off to a good start as financially responsible adults.
Accept limitations – These days it is not uncommon, and is quite likely, that young adults will not be able to afford the luxuries and standard of living they enjoyed while supported by their parents. If they are not able to acknowledge and accept the simple (and foreign) fact that there will be financial limitations, they are doomed to financial struggle. An important benefit of accepting these limitations is the opportunity to make independent decisions without the interference of others who are offering financial support (usually the parents).
It is equally critical that parents cut the financial cord and practice “healthy neglect”. If parents are incapable of seeing their adult child struggle with financial limits or experience some minor financial discomfort, the young adult will naturally take the easy way out and seek their assistance. Even worse, the parents will never be able to transition to a carefree, unencumbered retirement.
Identify priorities – The simple answer is to identify wants versus needs, but it is difficult to limit life’s pleasures. The reality is that, regardless of what they should be, priorities are where the most time, money and effort are spent. After using this practical test to initially identify priorities, challenge them with the help of an objective friend or family member. This narrowing process forces an examination of the cost of many discretionary items and makes living with limitations easier to handle. It is important that the final decision on priorities be made by the person living with the decision and not based on some artificial standard or guideline.
Create a “budget” – Begin by recording all expenditures for two months as a starting point (this will also highlight the easy areas to reduce spending, like the daily $5 coffee). Ideally, the budget is not so tight that every penny is carefully allocated; trying to go from no limits to severe restrictions is a sure path to frustration and failure. It’s better to revisit and revise priorities to create a budget that has a reasonable chance of success. The essentials – housing, loan payments, food, utilities – should be carved in stone, and if possible the next item should be some form of regular savings (employer retirement plans or Roth IRA’s are the best vehicles). Other expenses can simply be noted as ranges to allow for some flexibility, but some discipline is always necessary to avoid overspending. For potentially large expenses such as travel, plan ahead and accumulate the cash rather than using a credit card and paying over time.
Understand terms – While this may sound simple and obvious, the recent mortgage woes show that it is neither. Lengths of contracts or service agreements, payment terms, potential changes over time, and especially penalties can have a dramatic impact on ability to pay and, potentially, on credit scores. If there are any terms that are not fully understood, walk away and make other arrangements. In particular, be wary of any subscriptions that begin with a free trial or low introductory fees.
Pay attention – This seems equally obvious, but keeping accurate checkbook balances, paying bills on time, monitoring the mail, reading notices and responding promptly to any problems is new to many young adults. An easy way to keep credit card spending under control is to immediately write all credit card purchases in the checkbook register, and when the credit card bill is paid the money will have already been accounted for and made available.
The payoff – The benefits of living within one’s means will soon be apparent – the security of knowing bills can be paid, the enjoyment of an occasional luxury without financial stress, and the growing confidence of controlling financial decisions. As additional income becomes available, it can be used to pay down debt, increase savings or even assume new debt but with the experience of working within a budget. In the long run, accumulated savings and a strong credit history will reduce financial constraints and will make possible a broader range of career, family and lifestyle choices.
Resources for younger children:
from the Northwestern Mutual Foundation.
topics including goals by age, basic money concepts, etc.
Personal finance guides for young adults:
The Motley Fool Money Guide by Selena Maranjian, and You Have More Than You Think by David and Tom Gardner.
The Wall Street Journal Guide to Understanding Personal Finance and the Personal Finance Workbook.
50 Simple Things You Can Do to Improve Your Personal Finances: How to Spend Less, Save More, and Make the Most of What You Have by Ilyce Glink
Get A Financial Life: Personal Finance In Your Twenties And Thirties by Beth Kobliner.