You may have heard about the concept of financial literacy. The idea that having an understanding of various personal finance topics will lead to better personal financial outcomes. A search of the web will return a definition such as “the possession of skills and knowledge that allows people to make smart decisions with money”. A query to ChatGPT will return a response about budgeting, saving, investing and debt among other personal financial concepts.
As a CERTIFIED FINANCIAL PLANNER professional, I certainly believe in the merits of financial literacy. However, there are conflicting opinions over whether financial literacy should be taught in the classroom as part of a standard curriculum. Some will suggest that it is important that teens and pre-teens have a basic understanding of personal finance. Others will argue that unless these concepts are being used on a regular basis they will quickly be forgotten. This latter group suggests these concepts should be introduced “just in time”, or as somebody is contemplating a financial decision.
Having tried different ways to introduce my teen and pre-teen to various financial concepts over the years, I have moved into this latter camp. I have witnessed, and with some frustrations, how these ideas just didn’t take hold. I now believe that a better approach is to introduce concepts just as a young person is presented with a financial decision.
With the Class of 2023 heading off to college or joining the workforce I began to think of my own experiences, and mistakes, as I left high school. My parents attempted to instill some sense of financial literacy in me, but as with most advice at that time, it went unheard. It took a number of years to come to the realization that an understanding of personal finance topics can have positive impacts and help individuals make more informed decisions. However, in these early years of adult life, some concepts may be more important and having an understanding could prevent substantial mistakes. Three of these concepts come to mind, budgeting, use of credit and credit scores.
Looking back, I wish I had more appreciation for the freedom and independence that comes with graduating high school and moving into adulthood. This newly acquired independence comes with many responsibilities and few guardrails. I found at times it became very easy to overspend. I had no idea of my expenses and what my personal cashflow looked like. What I didn’t fully appreciate was the concept of budgeting. I really dislike the word “budget”, it tends to imply some sort of restriction. I tend to prefer the idea of a “spending plan”. In my early years of college, the bulk of my income came from student loans. Those loans were dispersed quarterly in a lump sum. After paying for some immediate expenses, tuition, books, lab fees, etc., there was still rather large pot of money remaining. If I simply had the wherewithal to make a spending plan and budget that lump sum over the coming months, I could have avoided dangerously low bank balances. A spending plan doesn’t have to be any more detailed than simply forecasting income and expenses and then making sure they are balanced. There are many apps that will help with this, I happen to be a fan of old-fashioned spreadsheets.
Another fond memory I have is how easy it was to get a credit card in college. I remember the credit cards companies posting up in the quad raking in applications from unsuspecting students. As I look back on it, it amazes me that credit was issued to a person with no income, no assets and no credit history. What I didn’t fully appreciate is how quickly spending can accelerate when all you have to do is swipe or tap. Sometimes, that available credit can be mistaken for available cash. It definitely is not available cash, it is the exact opposite. Without understanding this difference, I found myself with debt I certainly should not have had at that point in my life. Fortunately, I was able to manage it, but it was uncomfortable at times.
It was bad enough to dig myself into a hole of debt. What made it worse was not understanding the cost of that debt. At that time, in the early ‘90s, average interest rates on credit cards were about 19%. Today, interest rates have risen rapidly and the average rate on credit cards is almost 25%. And for many types of credit, it is not only the advertised interest rate that gets paid. There could be annual fees or origination fees. These fees in addition to the advertised interest make up what’s known as the APR or annual percentage rate. Comparing the APR, not just the advertised interest rate, is the best way to compare the overall cost of credit.
The 3 concepts, budgeting, use of credit and credit scores, tend to relate to one another. If there is a spending plan in place, it will be less likely that a credit card is used. This in turn can lead to a higher credit score as debt is used responsibly. Not only for recent grads heading out into the world, but for all of us, having an understanding of these concepts can lead to better personal financial outcomes.
This article is meant to be general in nature and should not be construed as investment or financial advice related to your personal situation. Please consult your financial advisor prior to making financial decisions.
The financial professionals of Pacific Crest Wealth Planning are Investment Adviser Representatives with/and offer advisory services through Commonwealth Financial Network®, a Registered Investment Adviser. This communication is strictly intended for individuals residing in the United States.
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