By Phil Weiss
As parents, we want the best for our kids. Most schools do not do a good job of teaching personal finance. Helping our kids become more financially savvy can help us have a lasting impact on their lives. It can also allow them to live the lifestyle they desire.
It starts with teaching them to be careful with their money. At its most basic level, this means being sure they decide to save at least a portion of their income. It includes living within or below their means. It also involves helping them understand the value of using credit cards wisely and not paying credit-card interest. While some kids may be minimalists – like my two oldest – others may tend to accumulate unnecessary things.
1. Learn self-control – create a budget.
Help your children learn the art of delaying gratification. It can be easy to purchase an item simply because you want it. Self-control allows you to wait until you can pay for/afford something. Paying credit-card interest on items such as clothing or personal electronic items makes them more expensive in the long run. It can also destroy long-term wealth.
2. Pay yourself first.
When it comes to saving, remember these three words. If you are not familiar with the term, when you “pay yourself first” you automatically route a specified savings contribution from each paycheck to a specific savings or investment account upon receipt. Because your savings contributions come before you even see or touch your money, you are paying yourself first. You pay yourself by saving a portion of your income. You do this before you start paying your monthly living expenses and making discretionary purchases. Paying yourself first helps remove the temptation to skip a contribution and spend your money rather than build your savings.
3. Start saving early – Open a Roth IRA as soon as you can.
Time in the market matters much more than timing the market. Investing for longer time frames allows your money to grow. The more years it can grow, the more potential there is for it to increase to a large sum. If possible, have your children open a Roth IRA as soon as they start working. This applies even if they get their first job in high school.
If you can, consider funding the Roth IRA for your child. Early in their career, their tax rate will likely be low as they haven’t yet maximized their earnings. You don’t pay taxes on the growth in a Roth IRA. You also don’t pay taxes when you make withdrawals. Consider what happens if they Invest $2,000 a year in a Roth IRA from ages 18-20 and keep it in their Roth until they reach age 68. The table below summarizes how much small investments can grow over time.
4. Take advantage of the company match.
If the company you work for has a retirement plan such as a 401k with a company match, contribute at least enough to earn the match. Your company match represents part of your compensation. If you don’t accept it, you’re choosing to accept a lower rate of pay. You’re also passing up additional growth in your investments. A common match is 50% on the first 6% contributed. This means if you contribute 6% of your salary, your total contribution equals 9%. This match increases your contribution by 50%.
Additional benefits come when you regularly contribute to your company retirement plan. First, this represents a way to “pay yourself first” – see #2 above. Second, it allows you to contribute to the market whether stocks are going up or down. Adding money when the market falls is hard. But if you have a long-time horizon, it’s a path to success. It allows you to buy more shares of the same security when the market falls. That will work to your benefit.
5. Plan for the future – set goals.
If you want to achieve financial success you must set goals. Why? You should know what you’re saving for and why.
Goals can include any or all of the following. buying a house or car, going back to school, starting a family, funding your child’s education, or saving enough to allow you to retire early. Knowing your goals gives you a better idea of how much you need to save. It can also help you create a plan that will help turn your dreams into reality.
Remember that goals, especially monetary ones, can change. That’s why when we work with clients on financial plans, we remind them that the path from “Retirement Uncertainty” to an “Informed Retirement” is not a straight line. It can and should be updated when your goals and/or circumstances change.
6. Understand taxes.
You want to understand how income taxes work before you receive your first paycheck. When you get a job offer, you want to have an idea of whether that salary will leave you enough to live on. That means you want to understand how much you will pay in taxes and other obligations.
For example, $50,000 a year in Maryland will leave you with about $38,000 in net or take-home pay. If your salary increases to $60,000, you will have about $44,500 left. You can use this website to estimate your take-home pay. You also want to consider ways in which you can reduce your tax bill. This includes putting money in tax-deferred retirement accounts such as IRAs or 401k’s.
7. Maintain your health
You can pay a lot for health insurance. But paying for an emergency room visit costs a lot more if you don’t have insurance.
You can also keep your costs down by keeping yourself healthy. This means eat right, exercise regularly, and maintain your weight. If you have the opportunity, consider a health savings account (HSA). If you’re relatively healthy, an HSA can be a great way to build your savings. Remember that you can invest the funds in your HSA, which will help them grow. Unused funds roll over year-to-year. HSA’s provide a triple tax benefit.
8. Protect your wealth.
You want to ensure your hard-earned money doesn’t vanish. This means you should take steps to protect it. You want to get renter’s insurance to protect the contents of your place from events such as burglary or fire.
Disability insurance – which you can often get through your employer – protects your most important asset. What’s that? The ability to earn an income. This insurance provides you with a steady income if you can’t work for an extended period due to illness or injury. You also want to make sure you have adequate automobile insurance. In general, you shouldn’t need life insurance until you’re married and have a family. If you want help managing your money, you can hire a fee-only, fiduciary financial planner such as Apprise to provide you with unbiased advice that’s in your best interest.
9. Build a credit history.
Borrowing money doesn’t have to be a bad thing. If you pay your bills on time, you will build a positive credit history. If you want to buy a home of your own, you should expect to borrow money. Having a good credit history can translate into a lower interest rate on your mortgage. You can get a lower rate if you borrow to buy a car, too.
Many credit cards come with attractive incentives. You can earn cash rebates or get points that you can apply toward travel or other purchases. But make sure you pay your balance in full. Credit card interest rates are high. You don’t want to add to the cost of everyday purchases by paying interest on them.
You also want to check your credit score regularly. If your identity is compromised or your personal information is stolen, you want to know as soon as possible. I use Credit Karma as well as updates from the banks that issue my credit cards to keep an eye on my credit score.
If you do have credit card and/or student loan debt, make a plan to repay it. As I discussed in the past, I ended college with a significant debt burden. I crafted a plan to repay it as quickly as I could.
10. Drive your cars for a long time.
Not everyone will agree with this one. Many people like to have a fancy car with the latest features. That can be great. It can also be fun and make you feel good. But it can also be expensive. Consider buying a car with low mileage that’s about three years old and coming off a lease. You’ll pay a lot less. You can get a good warranty if you buy a pre-owned vehicle. Don’t replace the car once it’s paid off either. Drive it as long as you can. Once you pay off your car, save the money that went to your car payments instead. Those savings can add up.
I leased a car once in my life. It was a good deal. The payment was affordable, and the car didn’t need much maintenance. I thought about leasing my next car, but when I ran the numbers, I decided that buying made more sense. It was going to cost me less. I paid that car off in four years. I owned it for about 14 years and drove it over 200,000 miles. That meant I went 10 years without a car payment. Regular oil changes and other maintenance helped me avoid major repairs. Buying that car and all the cars my wife and I have owned since we got married has served us well.
11. Save and invest.
Don’t wait to save and invest. Saving and investing can be challenging at the start. But putting away even a few dollars a week can have a big long-term impact. Create a budget to see how much money you can save each month. If you’re not sure how much you spend, try tracking your expenses. I did that before I bought my first house. Knowing exactly what I spent my money on convinced me I could afford it.
You can save for many things:
- An emergency fund. You want to have money set aside to cover any unexpected expenses. Doing so can help you avoid credit card debt. While I understand that current interest rates are low, you should put your money someplace where there is little risk. For example, a high-interest online savings account or a money market account. You can also consider a certificate of deposit (CD), but if you need the money before the CD matures, you may forfeit some of your interest income. Ideally, your emergency fund should hold enough to cover three-to-six months of expenses.
- Expensive purchases.
- A house
- A new car
- The future.
- Your retirement
- Education costs for you or your children
- Items on your bucket list
Saving and investing allow you to take advantage of compounding. When your money compounds it works for you. This is a key element of finance. You want to earn money on your money. If you can save $10,000 a year for 40 years, how much do you think you’ll have? Without any compounding or growth, you would end up with $400,000. That’s not bad. If you earn 5% a year, you will end up with more than $1.2 million. If you earn 7% a year, you will end up with nearly $2 million. The extra growth shows the value of compounding. It’s what happens when you let your money work for you.
By sharing these tips with your kids, you’ll make a big impact in helping them financially for the long term.
Philip H. Weiss, CPA, CFA is a principal with Apprise Wealth Management providing investment management, retirement planning, and comprehensive financial planning and is a subscriber to MyPerfectFinancialAdvisor.