Over 20 million students are expected to head off to college this year, perhaps even your young adult. The positive attributes of the college experience can be life-changing on many levels, including quantifiable economic benefits over one’s lifetime. But unfortunately, while colleges offer classes from astrophysics to medieval poetry, there are very few that teach personal financial management.
College provides the perfect opportunity to form critical personal financial management skills that a student can use throughout adulthood because independent decision-making is put to the test, and valuable mistakes can occur with minimal long-term repercussions. Here are the most important personal financial management lessons a college student can develop in this coming-of-age season of life.
1. Budgeting Variable Expenses
What better time to understand the difference between fixed and variable expenses than in college? Their new environment will make prioritizing needs versus wants relevant. Helping your college student create a monthly budget based exclusively on his or her new expenses can be highly effective in reinforcing this foundational finance lesson and helping them appreciate the true cost of their college experience. Fixed expenses will include things like college tuition, housing, meal plans/food allowance, car or transportation. Then whatever money is left over can fund their lifestyle choices.
Budgeting for variable expenses encourages good money habits and teaches how to live within one’s means.(For related reading, see: Budgeting for Essential Variable Expenses.)
Over time, as a student gains more confidence with handling a budget, budgeting apps like Mint or Pocketguard can be used. They are easy to use, effective and free.
2. Use Credit Responsibly
While many parents talk to their kids about money, most skip a key part, which is credit management. In fact, only 32% of parents have explained what a credit score is and why it’s important. Therefore, many millions of students are entering college not prepared to responsibly use a credit card.
I was fortunate to grow up with a father who was committed to educating me about the positives and negatives of money, especially credit. I learned to balance a checkbook before I learned to drive and invested in my first mutual fund before I went off to college. The lessons I learned about using credit responsibly has served me well my entire life and set me on a debt-free path from the start. You can do the same for your child.
All college students should have a basic understanding of how credit works. Be sure you’re sharing this credit wisdom every chance you can:
- Think of every purchase made with a credit card as taking out a high-interest loan.
- Credit cards are a financial tool that must be used responsibly:
- Research the best card with the best benefits. (For related reading, see: Surprising Credit Card Benefits.)
- Only carry one card (no need for multiple lines of credit).
- Pay credit card balances in full each month.
- Know you have enough money to pay off the item(s) before buying.
- On-time credit card payments help build a good credit history.
3. Establish Credit History
Using credit responsibly allows your child to establish a positive credit history. Once they are ready to open their own card, there are two options. The first is to have a traditional credit card with a small credit limit. If the credit card company does not approve their application for this card, a secured credit card could be the next option.
Secured credit cards work like traditional cards in that they help build a credit history and activity is reported to all three credit bureaus. However, the holder must put down collateral in the form of cash or a certificate of deposit as security in case of payment default. Both Discover and Capital One offer these types of secured cards and do not carry an annual fee.
Talk to your student about the importance of credit history and how it affects:
- where you live and how much you pay
- what you drive and your car payment
- your job search (prospective employers will look at credit history)
- your ability to start a business
- your overall stress level
4. Understanding the Powerful Force of Compounding
Albert Einstein allegedly said the most powerful force in the universe is compound interest. If he did say it, he was correct, especially in the world of investments and credit cards. Take the time to explain to your student the concept of positive compounding and how it is the best tool to accumulate wealth over time with investing.
If you engrain this concept in their mind, they will hopefully take their first opportunity to start saving for retirement with an employer-sponsored retirement plan. Arguably, nothing does more for retirement savings than time for principal to grow through the power of compounding interest. If your child starts saving toward retirement in his or her twenties, you know they got the message.
For credit card debt, you can discuss how negative compounding increases the amount of money owed as interest accumulates, typically at 20%+ APR on the unpaid principal and previous interest charges. If this type of negative compounding grows beyond the control of the cardholder, explain how it can affect budgeting, stress and credit history. Arguably, nothing derails financial success like mounting high-interest debt.
College is the ideal time and place to practice budgeting and credit management skills, and when they graduate, students can hopefully transition to full financial independence.
As Robert Frost said, “college is a refuge from hasty judgment.” Hasty judgment almost never ends well, especially in personal financial management. Fortunately, your child has you to help model and teach these pragmatic lessons.
(For more from this author, see: Let the Power of Compounding Increase Your Investments.)
Disclaimer: LCV Advisors LLC is an Investment Adviser registered with the State of Illinois. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this communication's conclusions. Please contact us at (847) 574-8645 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions. Additionally, we recommend you compare any account reports from LCV Advisors with the account statements from your Custodian. Please notify us if you do not receive statements from your Custodian on at least a quarterly basis. Our current disclosure brochure, Form ADV Part 2, is available for your review upon request. This disclosure brochure, or a summary of material changes made, is also provided to our clients on an annual basis.