Graduation ceremonies are back after the cancellation of most ceremonies last spring due to the pandemic. In recent weeks millions of seniors have walked across stages while their names were called and received their hard-earned diplomas.
While these former students may have learned all about reading, writing and ‘rithmatic, as the old song goes, they probably didn’t learn a whole lot about personal finance during their time in school. This may be threatening the ability of young people to become financially independent.
In fact, only one in four young adults today are financially independent at age 22, according to the Pew Research Center. This is down from one in three who were financially independent at this age in 1980.
Creating a Budget
Given the fact that personal money management courses aren’t taught in most schools today, it’s usually up to parents to teach their children basic money management skills so they can achieve financial independence.
This usually starts with budgeting. Learning how to create a simple household budget is one of the most important personal finance skills for anyone, including young adults, because it will help ensure that they don’t spend more than they earn and get themselves into financial trouble.
A monthly budget will list all income on one side of the ledger and all expenses on the other side. For most young adults, recurring expenses include their mortgage or rent, utilities, cell phone/data plan, insurance, groceries and transportation, such as a car payment or mass transit. In addition to these fixed expenses, there will also probably be variable expenses for things like eating out, going to concerts or movies and other entertainment.
It’s important for young adults to realize that when they first get out on their own, they might not be able to afford “luxuries” like entertainment and eating out as much as they’d like. This presents a good opportunity to talk to them about the importance of delayed gratification and self-sacrifice.
Next, compare the expense side of the ledger to the income side. If expenses exceed income, some cuts will need to be made to bring the budget into balance and avoid overdrawing the checking account or taking on debt. They can start by shaving variable expenses, especially entertainment, eating out and shopping for things like clothing and electronics. If this still doesn’t balance the budget, they might have to take more drastic steps like getting a cheaper car or moving into a less-expensive apartment or house.
Using Debt Responsibly
Irresponsible use of credit and debt is one of the biggest roadblocks to financial independence for many young adults. They often receive unsolicited credit card offers from banks, but without an understanding of how credit works, they can quickly find themselves over their heads in debt. This can make it hard to achieve financial independence.
So take the time to educate your adult children about how to use credit and debt responsibly. For example, you could show them a credit card statement and point out the different components, such as the total amount due, minimum payment due and interest rate on outstanding balances. Then explain how they can avoid paying interest charges by paying the total amount due every month, not just the minimum payment.
Also teach them about building a strong credit rating at this early stage of their lives and how their credit score will impact different areas of their life — from the interest rate they’ll pay on a home mortgage to their ability to rent an apartment. Stress the importance of paying all their bills on time in order to increase their credit score.
The Disciplines of Saving and Investing
Making saving a habit early in life can help set young adults up for a lifetime of financial independence. It will also allow them to benefit from long-term compounding of returns in order to meet future financial goals like ensuring a comfortable retirement and funding their own children’s college educations.
It’s especially important to teach young adults how retirement savings plans like IRAs and 401(k)s work. Retirement may seem like a long way off and a low priority for someone in his or her early 20s, but explain how making regular contributions to a retirement account over a lifetime — and then leaving the funds alone — can help build a substantial retirement nest egg.
Also educate your adult children about the difference between saving and investing. For example, they should strive to build an emergency savings account to help pay for unexpected expenses that come up like home or car repairs. Meanwhile, their retirement funds should be invested to earn the highest possible return given their time horizon and level of risk tolerance.
Impart These Financial Lessons
Take the time now to teach your young adult children about these three keys to financial independence: budgeting, using debt responsibly, and saving and investing. These could be among the most important lessons they’ll ever learn from you.