Teaching Financial Literacy To Teens: Budgeting
A budget, sometimes called a "spending plan," is an outline of anticipated income and expenses that can be used to track actual cash flow and set spending goals. A budget is an important financial tool that can help your teen:
- Plan for expenses. Short-term expenses happen in the next month; mid-term expenses occur in between one month and a year; long-term expenses are longer than one year.
- Cut spending. A budget shows you just how much money you're spending on certain things. When you see this, you might have an incentive to cut spending on certain things.
- Spend wisely. If your teen is spending more than he or she earns, something will have to change; namely, he or she will have to earn more, spend less, or a combination of the two. If your teen earns more than he or she spends, help him or her determine what to do with the surplus (e.g., save money for a car, make an investment, etc.).
- Save for future goals. Help your teen "find" the money to set aside for future expenses. With a budget, you can identify areas of extra spending and reallocate that money towards a future goal.
- Develop lifelong money management skills. It is priceless to learn as a teenager how to save for a goal. For most people, this is not as simple as setting aside a certain chunk of money each paycheck; it usually involves making spending choices, and prioritizing savings over wants.
Creating a Budget
A budget is an outline of income and expenses. In order to create a useful budget, we need to make accurate and realistic projections: how much money is going to come in (in the next X amount of time) versus how much money is going to go out (during that same time period). Typically, expense estimates are based on the past one or two months of spending, so it is a good idea to have your teen record all of his or her expenses - even the tiny ones - for a couple months before sitting down and developing a budget. This will help ensure realistic numbers in the budget.
Your teen can use paper, pencil and a calculator, a spreadsheet program such as Microsoft Excel, free online budgeting software (such as Mint.com) or commercial budgeting software (such as Quicken and Microsoft Money) to create a budget. There are also a number of budgeting apps that may appeal to your tech-savvy and on-the-go teen. The best method is the one that your teen is most enthusiastic about: you want to make the budget process as fun as possible so that your child has the motivation to stick with it over the long term. Keep in mind, too, that as your teen becomes more adept at using budgets, he or she may choose a different method. That's okay; just keep the budgets rolling.
Income and Expense Projections
Your teen's budget should include income projections and expense projections. Income projections should include all sources of income, such as:
- Interest and dividends
- Non-employee compensation (1099)
Note: your child can either include after-tax income projections, or before-tax projections with a corresponding expense category to cover taxes.
Budgeting for expenses may be a bit trickier. Some expenses are known - such as the premium for car insurance (or your child's share of this expense); others require your teen to make a best guess based on history (this is where writing down a few months of spending can be helpful). Your child's expense categories will be unique; the important thing is to help your teen set up enough separate categories to be useful (one category called "bills" won't help your child figure out where his or her money is going; be more specific). You may find that these categories may need to be adjusted in the future. Some common expense categories include:
- Car - loan payment, insurance, gas, maintenance, etc.
- Entertainment - movies, music, concerts, etc.
- Food - groceries, snacks, dining out
- Personal - clothes, toiletries, haircuts, etc.
- Sharing - donations to a favorite charity or cause
- Utilities - share of household bills plus cell phone plans
Your child may have a fixed amount of income each month, or it could change throughout the year. For example, many teens are able to work extra hours (or even multiple jobs) during the summer months when school is not in session. Similarly, spending is likely to differ throughout the year (perhaps a down payment on a car?). Creating a budget that addresses each month can deal with the fluctuations in income and expenses that occur throughout the year; your child may create a separate budget for each month, or a new column for each month as part of a master budget.
To create the budget, help your teen write down (or enter, depending on the method chosen for budgeting) all of the income sources and all of the known expenses for needs: the goods and services that he or she must pay for, such as for car insurance and rent (it is a good idea to think of saving as a need). After those expenses have been accounted for, any surplus can be allocated to the remaining wants. The first try at the budget might look like this:
In this example, several months are shown to illustrate how income and expenses differ from month to month (the rest of the year would be added as time passes). Your child may wish to start with an overall estimate for the entire year (known as an annual or yearly budget) or he or she may want to focus only on each upcoming month - or a combination of the two (for example, look first at the "big picture"; then budget by the month for accuracy).
The last row (Income - Expenses; highlighted in yellow) shows if the budget is balanced for each month. Here, we can see that we have spent more than we earned during four of the six months (where numbers are in red), so we will have to revise our discretionary spending categories to balance the budget. Any surplus from one month can be reallocated during that month (for example, by increasing savings for the month), or carried forward to the next, as shown here in this adjusted budget:
Without this budget, the hypothetical teen in this example may have been unable to meet his or her financial obligations one or more times. With limited income, the budget is tight and expenses such as the car loan, insurance and cell phone, which cannot be changed, have to be paid first. Any surplus can then be divided among the other categories, reallocating as necessary until expenses fall within the income constraints.
The first month's budget may be an eye opener for your teen: a budget really enforces the fact that money is in limited supply (for the vast majority of people) and that, as a result, we have to make spending choices. It may be tough for your teen to realize that he or she can only go out to dinner once during February, for example, but it will be a lot harder to not have the money to pay a required bill, such as the car insurance. Planning, however tough it may be at times, helps ensure that money is intentionally - and well - spent.
Inflation is the steady increase in the price of goods and services. It is usually measured in terms of a specific annual percentage, as in the news headline, "Canada annual inflation rate rises to 1.2%, off a 3-year low."
Inflation helps explain why things cost more over time. Historically, inflation has averaged about 3% each year, although there have been time periods where inflation has reached double digits (such as during the 1970s and early 80s). Your child has probably heard the term inflation in the news, but may not understand how it affects prices for the goods and services he or she may purchase.
There are two points to make: One is that inflation can directly affect his or her buying power. Assume your teen earns $50 per week through allowance and odd jobs. If inflation is at 3%, after one year your teen would need $51.50 to be able to purchase the same goods and services that last year's $50 could buy. The U.S. Bureau of Labor Statistics has an online calculator (go to www.bls.gov and enter "inflation calculator" in the search box) that might be useful when explaining inflation to your teen. You and your teen can enter a dollar amount and select two years to find out the relative buying power. For example, we can find out that $500 in 1997 has the same buying power as $723.26 in 2013:
|Calculator courtesy www.bls.gov.|
The second point is the relation between inflation and salary increases. If your teen has a job, ideally his or her wages will increase more than the rate of inflation. For example, if inflation is 2%, any salary increase should be at least 3% so it's not just keeping pace with inflation (in this case, it really isn't a pay increase at all because he or she will not have increased his or her buying power).
Budgeting should take inflation into consideration: many of the goods and services that your teen is accustomed to purchasing may increase in price next year as a result of inflation. Making sure your child understands this concept can help him or her plan more accurately and avoid going over budget in the future.
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