Over 20 million students are expected to head off to college later this summer, perhaps even your young adult. The positive attributes of the college experience can be life-changing on many levels and includes quantifiable economic benefits over one’s lifetime. Unfortunately, while colleges offer classes from astrophysics to medieval poetry, there are very few classes available that deal with personal financial management.
College is also an opportunity to form critical personal financial management skills that a student can use throughout adulthood. This is a moment in one’s life when independent decision-making is put to the test and where valuable mistakes can occur with minimal long-term repercussions. With your gentle guidance, you can help your child apply smart money lessons you’ve likely been teaching for years now.
Here are the most important personal financial management lessons that a college student can develop in this coming-of-age season of life. Here’s what you can do (or not do) to help your child succeed.
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. By helping your college student create a monthly budget based exclusively on his or her new expenses can be highly effective in reinforcing this strong financial foundation lesson, not to mention help 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 that anticipate, and is prepared for, cost of living expenses and how to live within one’s means.
Over time, as a student gains more confidence with handling a budget, budgeting apps like Mint or Pocketguard can be used given their simplicity and effectiveness at basic budgeting. Plus, these apps are free (no variable expense).
2. USE CREDIT RESPONSIBLY
While many parents talk to their kids about money, most skip a key part of money management, 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 open and 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. From him, I learned to balance a checkbook before I learned to drive and invest 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 your credit wisdom every chance you can:
• To think of every purchase made with a credit card as taking out a high-interest loan
• Credit cards are a sharp financial tool that must be used responsibly:
- Research the best card (Nerdwallet) with the best 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 record
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.
Lastly, talk to your student about the importance of good credit history and how a good (bad) credit history 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
UNDERSTANDING THE POWERFUL FORCE OF COMPOUNDING
Albert Einstein said that the most powerful force in the universe is compound interest. He was correct especially in the world of investments AND credit cards. Take the time to explain to your student about 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 the first opportunity they have 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 both budgeting, stress and, credit history. Arguably, nothing derails financial success like mounting high-interest debt.
While in college, students have the time and ideal place to practice budgeting and credit management skills. This means when they graduate, they can hopefully transition to full financial independence.
As Robert Frost said, “college is a refuge from hasty judgment.” Hasty judgment almost always doesn’t end well with personal financial management. This is particularly true with critical personal financial management tools and concepts that can be learned during college that can be used throughout adulthood. Fortunately, your child has you to help model and teach these pragmatic lessons.