Financial Literacy- A primer

I used to teach financial literacy in high school.  

It was bad.  

Financial literacy is only taught to students who are barely scraping by.  These students struggled with math fundamentals and weren’t interested even when we were talking about how to get a car loan.  They didn’t care.  When asked, they would assert that their parents would take care of their financial lives forever.

Yeah, right!

As an adult, you will be responsible for your financial life.  If you are reading this, you probably weren’t one of the lucky few who got to take a financial class in high school.  So let’s go over some of the basics right now.  

Be advised, this is just a starting point.  You will need to learn more about finances than are in this post.  This should be enough to get your bearings and get started.

Good Debt vs. Bad Debt

There are two kinds of debt: good and bad.  Good debt is debt taken on as an investment.  

Buying a house is generally considered good debt.  The house is purchased with a mortgage and then the house will ideally be worth more than the mortgage when sold.  The proceeds from the sale will pay off the original loan leaving a nice profit.

Student loans used to be considered good debt, but that is changing.  They are only good debt if the amount of money you will be making in the job the degree qualifies you for will pay enough money to pay the loans off and live well at the same time.  Increased costs of higher education have made this equation precarious at best.

Just about everything else is bad debt, also called consumer debt.  Bad debt occurs when you borrow money to buy something you can’t afford that depreciates in value.  

New cars are bad debt.  A boat is bad debt.  Buying $400 of books you can’t afford and not paying off the credit card balance is bad debt.

Ideally, no one would take on any debt.  The less debt you incur, the more options you have.

Credit Cards

Let’s be clear, virtually nothing charged to a credit card is good debt.  

When living paycheck to paycheck, people use credit cards to charge food and other necessities.  It sucks, but from a financial standpoint food isn’t good debt. 

If the universe were made in a way that makes sense, I would be able to steer you away from credit cards and then tell you how to use them in an emergency, but doing that would hurt your credit score.

For you to take on debt of any kind, you need a credit score.  Credit scores are calculated based on how old lines of credit are, and how they are used on a monthly basis.  So you need a line of credit, and a credit card is the best place to start.

Credit cards are relatively easy to get.  It is not bad to start with a “baby” credit card and then work up to something more main stream.  

The lowest tier of credit cards (“baby cards”) work kind of like a visa gift card.  Preload them with cash and then use the card up to that limit.  This is a great way to get in the habit of only spending what you have available and beginning to budget.

Even if you qualify for a regular credit card, treat your card just like a preloaded debit.  By not carrying a balance you avoid interest and build your credit at the same time.  Having this line of credit available and built up will help during emergencies or when getting a loan for a house or car.

Credit cards also come with loads of protections that are useful for shopping online.  Never use a debit card to shop online.  If someone steals your card they could wipe out your bank account and the bank would be unable to recover the lost funds.

Student Loans

It used to be that student loans were considered good debt.  You would graduate with your art degree and go on to make a decent salary.

Getting a degree is no longer a guarantee of higher earnings.

Do not take out student loans if you can avoid it.  Before choosing a school, look up the expected earnings for your chosen major.  See how many people from your major are actually in the industry you are targeting.

It may not make sense to pursue a degree if you will be making around minimum wage, or if that degree only has a very few number of people in the industry you want.

Consider going to a cheaper school, going to community college for the first two years, or pursuing a certificate program before considering student loans.  Apply for scholarships and grants and get a job.

Student loans are particularly insidious because of how they are structured.  They only disappear when paid off.  

Drop out of school, you are still on the hook.  Die in a car crash?  Your parents may be responsible for paying off your loan even if they didn’t co-sign it.  Not making enough money to pay it?  Too bad, they will garnish your wages.  Bankruptcy isn’t going to clear the loan either.

Once you take the loan, interest starts accruing immediately.  You aren’t responsible for paying it down until you graduate, but until then it will grow silently behind the scenes.  That $10k loan could easily be $15k a few years later when you are ready to start paying it off.

Honestly, I would take a personal loan before I considered taking a student loan.  Yes you need to start paying it off immediately, but you can at least get rid of it through bankruptcy if you need to.

Building Credit

The credit score is probably one of the most influential pieces of metadata about you.  

Your credit score determines if you can rent an apartment, or a car loan.  It affects your interest rates and credit limits.  A poor credit score can even disqualify you from certain jobs.

It is important to start building your credit score as soon as you possibly can.  If your parents are supportive, they could help you get a debit and then a credit card through your bank before you turn 18.  If they aren’t, you need to get a bank account and a credit card as soon as you are 18.

To build credit, use a credit card every month and pay it off every month.  Your history of ontime payments is one of the biggest factors in determining your credit score. Pay every bill ontime and keep your balance low and you will have a good credit score when you need it.

Understanding Compounding Interest

Compound interest is as much your friend as it is your enemy.  

Applied to your savings accounts, compound interest will help it grow; but applied to fees and debt, and you could soon find yourself with a bill you can’t ever pay off.

Remember this commercial?

Compound interest really works like that, now imagine that same domino effect happening to your student loan balance.  

That really happens.  Your student loans start increasing the fees and interest the second you sign on the dotted line, but you don’t start paying them off until after you graduate.  So that could be 4 years of compounding interest on your loan amount before you even start repayment. 

Bank accounts- types and benefits

You need a bank account.  

I don’t care if you have never had one before, or if your parents function just fine without one, every adult needs a bank account.  Not only do bank accounts keep money safe, but they reduce fees so you can keep more of your money.  

Start with a checking account and a savings account.  As you make and save more money, you will open up more accounts of various types. 

Checking account

If you only have one bank account, it needs to be this one.  A checking account allows for an unlimited number of deposits and withdrawals.  You can access it with a debit card and write checks (which are still important in the housing industry).

A checking account lets you get direct deposit from work and makes it easier and cheaper to pay bills.

Get a checking account before the first paycheck from your first job needs to be deposited.  

Many checking accounts have fees, atm fees, and a minimum balance requirement, but not all do.  Shop around and see what you can find that works best for you. 

Savings account

Shortly after opening a checking account, it is time to open a savings account.  This is easy to do with the same bank and they will link the checking account with the savings account to make moving money easy.

Unlike checking accounts, they only allow a maximum of 5 withdrawals a month and unlimited number of deposits.

Savings accounts are where you should save up for that new game or vacation, but they are also a good place to start building an emergency fund.

Many people have multiple savings accounts to save up for different things.  I used to have two: one for my college tuition and costs, and the other as a cushion in case something happened.  I would move any spare money I had at the end of each month into the college fund until it reached $10,000 (the approximate bill for a single semester of tuition and fees) and then start funneling that extra cash into the emergency savings account.

By the end of my 4 years of college, I had a cleaned out college savings account and around $4,000 saved up so I could get an apartment and take my time finding a job.  I now use the old “college” account to save up for big purchases like a car or new dishwasher.

Money market account

These are savings accounts tied to the stock market.  Some have fixed rates of interest and others go up and down with the market.

My account makes a fixed 2.5% interest, which is much better than a traditional savings account.  If you are planning on holding an emergency fund in your bank, this is the place to do it. 

Like a savings account, you do not have an unlimited number of withdrawals.  

While this is generally a great place to store emergency money you might need to access quickly, don’t hold too much money in a money market account at a time.  Once there is over $10,000 in an account, start thinking about investing in stocks or CDs.

Are you looking for a way to start saving? Check out Share to Inspire’s 14 Money Saving Tips to get started.

Retirement Accounts

Open a retirement account after you get your very first paycheck.  Deposit something from each paycheck into your retirement account.

Remember that compound interest thing?  The longer your money works in a retirement account, the more it grows and the faster you can retire.  Even $5 a paycheck will grow your money faster than waiting a couple of years to start.

There are a few kinds of retirement accounts, so what should you choose?  If you are just starting out you should open a ROTH account.  

ROTH accounts tax the money going in, and then don’t tax the money coming out when you retire.  When you are just starting out, your income will be smaller than when you retire, so the taxes on the money going in will be less.  

This equation changes as you get older, and at some point you will be making more than you will be able to pull in retirement.  At that point, open a 401k or a regular retirement account. 

Car Loans

It is nearly impossible to live life today and not take out a loan of any kind.  Modern life requires us to have certain things that are expensive and may be beyond your ability to pay right now.  Cars are one of those things.

Do not take out a car loan if you can avoid it and buy used.  Cars are not an investment.  They depreciate quickly and require ongoing maintenance, insurance, and gas to keep running.

But it is also almost impossible to live in america without one.  So chances are you will be getting a car loan.

If you do, do not get a loan for longer than 5 years (60 months).  Cars are no longer made to last and you don’t want to be paying for a car after it has broken down and been replaced.  

Try to avoid dealer loans.  They are higher interest and often require you to pay the interest first so you can’t save money by paying the loan off early.  If you get stuck with a dealer loan, you can often refinance the car in the first 2 months to another loan with lower interest rates.  

A Note on Buying a House

The time will come when it is time to buy a house, and chances are you will need a loan to do it.  To get a great deal on a home loan, be sure to shop around and have a great credit score.  

How do you know it is time to buy a house?  Here are some of the main indicators:

• You plan to stay in a single location for 10 plus years
• It is more expensive (or the same amount) to rent
• You want to care for and maintain a house

I am 32 and I have owned 2 houses.  Why?  Because it was more expensive to rent a 1 bedroom apartment than to own a house in the locations I’ve been living in.  

We knew we wouldn’t be in the same location for 10+ years, so we bought a fixer upper both times.  These houses had great bones and didn’t need us to move walls, but were clearly not taken care of.  

By the time we sold the first house, we had removed the popcorn ceiling, painted the whole house, redid the garden, zero-scaped the front lawn, replaced most of the electrical, and replaced the door handles and other hardware.  All that work earned us $30k which became the down payment on our second house.  

I won’t advise anyone to buy a fixer.  They are a lot of work and you need to be handy for a house like that to make sense.  But you should buy the house with the most work you can handle at that moment.  The more work you need to do, the cheaper the house will be.  

We bought our current house for $280,000; an identical house down the street that was in better condition but needed new paint was $320,000.  There was a 3rd house with the same floorplan that was on-trend and move-in ready.  It was $345,000.  See how the prices increase?  

I know buying a house seems like an unattainable privilege.  But the way I see it is you need someplace to live.  So buy something dirt cheap to start out.  Live in it while you fix it up, and then upgrade to something better.  That is why it is called the property ladder.  Our first house was crap in a crappy town.  Our current house is nice enough to have children in.  

It is a process. 

Stocks, bonds

When you have a nice emergency cushion built up, it is time to start thinking about stocks and bonds.  

Your money will grow much better in stocks than in a traditional savings account, but it is riskier.  I like to think of money we have in the stock market as fun money.  Don’t put anything in there you can’t afford to lose, and keep investing what is in the stock market to help it grow.  

I read somewhere that $100,000 is the tipping point.  Once you have $100,000 invested in the stock market, things just seem to keep growing and it takes off.  I don’t have $100,000 in the stock market yet.  I have $20,000 we are trying to grow, and it is rough.  

We started in the stock market 2 years ago with a couple thousand dollars.  Every once in a while we throw another $100 in the stock account and invest it.  To grow money in the stock market, stay on top of it and use an account that doesn’t have high fees.  

The truth is, if you aren’t in the stock market, you are losing money.  Inflation is increasing faster than your money is growing so your buying power is less.  Investing is a skill you need to know.  There are books and entire blogs dedicated to the topic.  Find your favorite resource and use their advice.  

Wrapping it all up

Our world runs on money.  To be successful, you have to understand money.  Take some time and think about your financial future.  

Can you afford college?  Should you go somewhere cheaper?  Should you live at home or move out?

These questions have financial components to them you should not ignore.  Before you make any decisions, run the numbers.

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