AP courses, electives and extracurricular activities that help polish a college application are probably more important to your high school senior right now than, say, learning how to budget.
And who can blame them? Only 20 states require students to take basic finance courses before graduation — but that lack of education could be affecting the nation’s financial IQ.
In 2018, the FINRA Investor Education Foundation posed six fundamental finance questions to a sampling of Americans — only 7 percent could answer all six correctly. At the same time, roughly 50 percent of Americans between the ages of 18 and 24 said a money management class would have been most beneficial to their personal lives.
Clearly there’s a knowledge gap, but here’s the good news: It’s not too late to instill some money know-how into your teen. Here are five financial lessons your teen should be familiar with before they fly from the nest.
1. THE IMPORTANCE OF POSITIVE CASH FLOW
It sounds super business-y, but positive cash flow simply means your teen is not spending more than they earn. It’s a simple concept and a cornerstone of financial wellness, yet it’s easy to overlook without a budget.
Help your teen take an accounting of everything they spend their money on each month — from car insurance to video games — and contrast that with their monthly income. Are they living within their means, or are their habits setting themselves up for negative cash flow — and, therefore, future debt? Having them keep track of where their cash goes can be highly illuminating for both teens and parents.
2. HOW INTEREST CAN HELP — AND HURT — THEIR FINANCES
Interest rates have big implications for borrowing and saving money, which makes this a great concept to introduce early. Interest is simply money that you are paid, or pay, regularly at a certain rate based on the total amount borrowed or saved.
Start with the fun part: the magic of compound interest, or interest you earn on interest. Let’s say you have $100 and you earn 5 percent a year on that money. After the first year, you’d have $105, but in Year 2, you’d have $110.25. That extra 25 cents is the interest you earned on the interest you received in the previous year. Sure, a quarter is easy to scoff at today, but here’s what that $100 looks like after 30 years of annual compounding at a 5 percent rate: $446.77. And that’s if you never even contribute another penny. Magical, right? But don’t take our word for it: Have your teen punch some savings goals into our compound interest calculator and watch their jaw hit the floor.
Conversely, you’ll need to explain how interest works when you borrow money, whether that’s through mortgages, student loans or credit card debt. You need to explain that just the way interest can help you save more, it can also make you owe more.
This handy calculator can help your teen see how much more they’ll have to shell out in student loan interest based on how long they take to repay the loan. And a credit card repayment calculator can help illustrate just how long it can take to pay off credit cards with high annual percentage rates if you don’t pay off your balance in full each month.
3. WHY GOOD CREDIT IS KEY
Speaking of credit card balances, when a teen gets their first credit card, they are usually elated — until that first bill comes along. Use the calculator above to drive home how much extra you pay to borrow money, which is one reason to pay off your credit card balance each month. Here’s the other: Maintaining a strong credit history can yield long-term financial benefits.
Explain to your teen that keeping their debt low or nonexistent and paying bills on time, among other factors, affects their credit score, a three-digit number that is sort of like an SAT score for how responsibly they manage their debt and other payment obligations. High scores can help qualify them for better borrowing terms — such as lower interest rates — in the future and show future lenders they are trustworthy borrowers. Lower scores could mean they end up paying more to borrow the next time they are on the market for a new credit card deal, auto loan or mortgage.
And don’t forget to tell them that their good and bad credit moves are recorded in their credit report, which they should keep tabs on annually by requesting a copy via AnnualCreditReport.com from each of the three credit bureaus.
4. HOW TAXES CAN TAKE A BITE OUT OF PAYCHECKS
If your teen has a part-time job, chances are they already know the pinch of paying Uncle Sam. If they haven’t, though, then it might be worth explaining how both the federal and state government will take their share from each future paycheck.
That’s where you can explain the difference between gross pay and net, or take-home, pay, and how the latter is what they’ll actually use to budget. You could even show them your own pay stub so they can see the difference between the salary a company says you’ll be earning versus what you bring home.
5. HOW INVESTING CAN HELP GROW SAVINGS
It’s never too early for teens to start thinking about their long-term savings. Remember the magic of compound interest and that hypothetical 5 percent they could earn on their money? Explain that investing in the stock market is one way they could achieve that — but also explain the risk of potentially losing money, too, as the market can move up or down every day.
If your teen shows interest in putting some of their money into the markets, walk them through the basics and help them choose some investments. They may want to start off simple with a high-yield savings or money market account. You can also open a custodial brokerage account for them, or they can open one themselves if they are 18 or older.
For the truly forward-thinking teen, discuss whether to open up a Roth IRA, which they can contribute to as long as they are earning income. After all, it’s never too early to take advantage of compound growth — and the $25 here and $50 there they contribute over the years could seriously add up by the time they are ready to retire.