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What To Teach Your Teens About Money

May 6th, 2007 at 11:30 pm

There's an old saying that 'the apple doesn't fall far from the tree'. For those of you too young to have heard that phrase before, it means that children will be a lot like their parents. I was reminded of that the other day when I found my twelve year old reading "The Millionaire Next Door".

Lest you think that I'm some kind of fanatic, I don't give my children homework assignments on money management. The book was just sitting next to my easy chair. But, in fairness, my kids have heard me talk about the value of money on a regular basis. And I do hope that some of the lessons stay with them.

You have the same opportunity to help shape your teen's money perspective. Lessons learned now could save them a lot of grief later. So let's spend a little time talking about what to teach your teens about money.

A cornerstone of building a sound financial future for your teenager is to teach them how to save money. Sounds easy, but even many adults don't know how to do it. And that might be because no one ever taught them.

You can use three strategies to teach a teen to save. First, you can encourage them to reach a goal. Suppose that they want a $100 pair of shoes. Let them save $5 or $10 a week until they have the purchase price. Have them put a reminder of their goal in strategic places. They'll learn patience and persistence. And by the time they save the money, they might also learn that they really don't want the shoes any more.

Another way to encourage savings is to match any money they put into a savings account. Set a minimum length that the money must stay in the account before being withdrawn. Don't want them to put it in with your match and withdraw it a few days later. This won't work for everyone, but some teens will love to watch their savings grow.

The teen years are also a good time to teach your young adult to 'pay themselves first'. That means that they set aside part of their income for savings before spending anything.

It's a perfect time to learn this lesson. Most teens don't have any real financial responsibilities. They don't have items that they're forced to buy each month (like rent, electricity, food). They generally just spend what they have available.

Of course, many adults do the same thing. They spend until they're out of money. Learning to set part of any income aside for savings is a great habit that will pay dividends for their entire lives.

Next a question for you. Do you remember who taught you to balance your checkbook? Most of us don't. And that's a shame. You'd be surprised how many people reach adulthood without knowing how to perform this simple task. And it's important that your teens learn it.

First, they need to know where they stand financially. Even a teenager should know how much money they have. The reason is simple. It's essential to understand that you can run out of money. Balancing a checkbook is a wonderful way of teaching them that there are penalties if you spend money that you don't have.

The alternative is to let them learn to keep spending until they've reached their credit limit. And that lesson will create heartaches later in their life.

PC software makes balancing a checkbook easy. But make sure that they don't just enter numbers and let the software do all the work. They need to understand the basics. You put money in. You write checks to take money out. What's left is the balance.

They also need to learn basic investment information. It's really essential for modern life. Teach them that stocks represent ownership in a company. And bonds are like an IOU. Introduce them to CD's, money market and mutual funds. Perhaps you'll want to subscribe to Money magazine and discuss the articles with them.

Don't forget to teach them how risks and rewards work. They need to know that a big return will include a big risk. It's surprising how many people think that they can get huge returns without taking any risk. That's a good way to lose money.

Also teach your teen about the beauty of compound interest. Let them know that money will double every 7 years if it earns 10%. That means that $1 that they don't spend on a soda today would be worth $128 when they're in their 60's. Compound interest is the secret ingredient of building wealth.

Conversely, they need to learn the risk of compounding debt. They'll learn this lesson before they die. Help them to learn it without pain. Teach them that borrowing money obligates them to pay the loan back with interest. And that credit cards are set up so that they keep making payments each month without ever paying off the debt. In fact, if they pay the minimum due on a charge card each month, it's just like doubling the price of everything they buy. That's a lesson that's less painful if you learn it before the bills come due.

Teach them what things cost. Some families share budget information with their teens. Others prefer to keep that private. If so, send your teen on a pretend 'first apartment' hunt. Have them walk through all the costs of setting up an apartment including rent, utilities and food. It will be a real eye opener for them.

Finally, help them to learn the difference between creative thinking and creative financing. Creative thinking is the ability to have a need and find a way to fill it without spending money. People who don't have money are forced to consider alternative answers. And some of those answers are quite creative.

The flip side is the person who only thinks of creative financing. He can't think of a way to solve his problem without making a purchase. His creative energies are spent trying to figure out who will loan him the money to make the purchase. Not only will he spend a bunch of energy trying to figure that out, but he'll make making payments for quite awhile, too.

Many of these lessons will pay dividends for the rest of their lives. Who knows, if your teen learns them well perhaps the apples will fall close to their tree, too.

How Much To Spend On An Apartment

March 25th, 2007 at 05:03 am

I just found an article you wrote on budgeting. You said to spend no more than 33% of your after-taxed salary on housing. I have to find an apartment and live on my own. I never had to do that before. I am struggling with a budget and not knowing what I can really afford for an apartment. -- Michael

Michael is right to make sure that his apartment expenses don't cripple his efforts to get off to a good financial start. And, he'll find that his choice of an apartment will make a huge difference on whether his budget (and his finances) work.

Before we look at Michael's housing question, let's spend a moment on constructing a budget. They're not nearly as scary as you might think. The purpose isn't to lock your money up where you can't get at it. A good budget simply provides information about your expenses and how they relate to your income. The goal is to help give you data to make good decisions.

Michael asked about after-tax income. There are two ways to do a budget. One includes your taxes and uses your "gross" (before tax) income. The other uses your "net income" (after tax). Generally, it's easier to use the after-tax method. It tends to be a little less complicated.

In an after-tax budget, Michael's take home pay would be his income. And he would not budget for any payroll deductions (i.e. insurance, retirement plans, taxes, etc.).

OK, now let's get back to Michael's main question. How much can he afford to spend on an apartment? It's generally accepted that 30 to 35% is about right for housing expenses. That would include rent, plus utilities, any maintenance and decorating.

Some would argue that Michael could spend up to 40% for housing. The trouble with that is Michael has a limited amount of money. His paycheck needs to cover housing, automobile (or transportation), food, insurance, entertainment, clothing, medical/dental, miscellaneous and debt repayment. So an increase in housing expense means a decrease somewhere else.

Michael didn't share what his income is. So we'll have to keep this somewhat general. But, we'll still be able to illustrate the point.

The three biggest expenses he'll face are housing, transportation and food. Along with 30% for housing, he'll probably need another 15% each for transportation and food. So he's already spent 60% of his money, leaving just 40% for everything else.

The quickest way for a budget to fail is to overspend these "big three" categories. If Michael spends 65 or 70%, it becomes almost impossible to make up the difference in the smaller categories. Even if he cuts back drastically in areas like entertainment and clothing, he just won't find enough savings to offset the additional expense.

Overspending in these big areas is also a problem because we often make commitments for months or even years in advance. It's not like your electric bill. If it was too high last month, you can start turning down the A/C today. But, if you agreed to make forty-eight auto payments, there's not much you can do about it for awhile. Or, if you do make a change, it will significantly disrupt your lifestyle.

Let's suppose that Michael's take home pay was $2,000 per month. He really wanted an apartment that cost $800 (40% of his income). Add his car payment ($225), gasoline ($75), groceries ($150) and restaurant/meals ($150). That totals $1,400 and only leaves him $600 to cover debt repayment, clothing, entertainment, medical, miscellaneous, savings and any unexpected bills. Chances are that he'll quickly be putting some of those expenses on his credit card and adding to the unpaid balance. At some future point, that will come back to haunt him.

If Michael were making a lot more, he'd have more flexibility. If his monthly income were $10,000, it wouldn't make as much difference if he spent 35 or even 40% of his income on housing. He'd have more in other categories to make up the difference.

Most of us live with limited income. It's important for us to get our housing, auto and food expenses under 60% of our take home pay if we're going to keep from getting into financial trouble.

So Michael is smart to pay attention to his housing costs. He's identified the cornerstone to a sound financial future. Let's hope he finds the perfect, affordable apartment!

Kitchen Remodel & Budgeting

March 19th, 2007 at 05:13 pm

We have kitchen doors from the 70s or earlier. We would like to change the color but don't know whether we should stop there or go as far as changing cabinets. - John

John's got a lot of company. Kitchen & Bath Business Magazine forecasts that there will be 6 million kitchens remodeled this year at a total cost of $79 billion!

It isn't surprising. Kitchen remodeling projects generally recover nearly all of their costs when you sell your home. MSN House & Home released a report showing that projects costing up to $25,000 returned 90% or so when the home was sold.

So that's a good reason for redoing your kitchen. Another is that it's one of the most used rooms of your home. And, if you listen to the people who study such things, the more time your family spends in the kitchen the healthier and happier your family will be.

OK, so you're thinking about doing something. But, like John, you wonder how much to do. The best place to start is to figure out what you can afford. Kitchen projects can quickly get out of hand. Once started, it's easy to upgrade to a more expensive drawer pull or cabinet door. There's a lot of pressure to go just one step further. And then one more after that. But those decisions can be very expensive. Have a dollar limit in your mind based on what you can afford. Hold on to that boundary. Just about everyone, including your own ego, will want you go spend more.

And, expect some unanticipated expenses. It's prudent to only plan to spend 90% of the money you'll have available. Save the 10% for mid-project surprises.

Next you'll need to decide how extensive your remodel will be. It may be as simple as repainting wood cabinet doors and walls. Perhaps you'll want new countertops and faucets. Or it might be a matter of gutting the entire kitchen and starting from scratch.

Naturally, more extensive means more expensive. This is the stage to get some rough pricing for different aspects of the job. Bounce the costs against your budget. You should have enough information to decide how much you want to take on.

Some people will argue that it's ok to borrow for a kitchen remodel. After all, you're making your home more valuable. That's true. But you'll still end up repaying the loan when you sell. And that means less money in your pocket. If you do borrow, consider repaying the loan while you still live in your home.

If you're going to be making major changes, be sure to consider the three major functions of a kitchen: storage, preparation and clean-up. Think about how your family uses the current kitchen.

Make major decisions before you start construction. Remember making adjustments once work has started will be expensive.

New cabinets are generally the most-pricey part of a fully new kitchen. Choose them carefully. Their style and color will have a major impact on the room and your budget.

In fact, choose all your materials carefully. You'll find that quality varies considerably. The fact that there are a lot of choices means more work for you, but does provide a greater opportunity for savings.

Don't assume that the big home center store is the cheapest or best. Check with specialty kitchen and cabinet shops. Ask if they have any cabinets that they were unable to deliver. You may be able to benefit from another's mistake.

If the job is beyond do-it-yourselfing, ask around for a handyman or contractor. Unless the job is fairly simple (read inexpensive), you'll want to get three bids.

Check out contractors thoroughly. Ask for references and contact them. Ask the contractor about licenses, insurance and bonding. You don't want to make a mistake here. Under normal circumstances a full kitchen remodel will take about two months after planning and materials have been ordered. The wrong contractor could drag that out indefinitely.

Talk with the contractor before starting. Ask a lot of questions. The way they answer will tell you a lot about how they'll perform. For instance, some will encourage you to skip getting required permits. Better you should skip that contractor. Yes, the permits will cost you, but they'll also guarantee that the job is planned and done correctly. The building inspector can be your best insurance against shoddy work.

Finally, expect disruption. Eating all your meals out for two months can get expensive. So some families load up the freezer with meals that can be reheated in the microwave. It's easy to prepare extra portions of the meals that you're already making during the weeks before your kitchen is off limits.

Updating a kitchen can make a big difference in your home. Whether it's just painting cabinet doors or a full blown new kitchen, it takes time, consideration and money. Hopefully, whatever John decides will bring his family together and make many fine memories.

Envelope Budget in a Cashless Society

March 19th, 2007 at 07:45 am

My family has been trying to work with a budget for the past several months, but the "envelope" system is just not practical with our primarily cashless lifestyle. How can I track our cashless expenditures for gas, groceries, personal items, etc. and still know how much is left in each category as the month goes on?

Lisa's right. Some of the old budget tools don't work so well today. Fewer of our purchases are made with cash. So merely controlling cash isn't an effective budget tool.

Before we look specifically at Lisa's question, let's spend a moment to talk about how budgets can be used. A budget is a wonderful way of collecting information about your finances and presenting it in a way that's useful to you. A simple monthly budget can tell you at a glance where your money is going. When compared to previous months, it can tell you what's changing in your spending patterns. That's important. Just knowing that your electric bill is higher could help you identify an air conditioner that needs servicing before it breaks down completely. It's also a good way to find potential savings. If you need to reduce spending by $250 a month, don't look in a category where you only spend $300.

Lisa is attempting to use her budget for its second purpose. A budget can provide discipline and control over-spending.

There are variations, but in the basic envelope system, Lisa would cash her paycheck. She would have a number of envelopes for the different categories of spending, such as rent, food, transportation and so on. Cash from her paycheck would be divided into the various envelopes based on how much she felt she needed in that category.

For instance, if she got paid weekly and expected to spend $40 per week on groceries, $40 would go into the "grocery" envelope. When she went to the store, she'd take the "grocery" envelope with her and pay for her purchases with the money in the envelope. If she got to the checkout and had more than $40 worth of groceries in her cart, she could return some groceries or take some cash from another envelope. Of course, that meant that she'd have less to spend on that category until the next payday.

The envelope system worked well when we used cash for all of our purchases. You immediately knew if you could afford a purchase. Moving money from one envelope to another was a warning sign that you could be getting into trouble.

Unfortunately, very few of us use much cash anymore. We're much more likely to pull out a credit/debit card or write a check. And an envelope system doesn't handle credit cards very well.

One way to modify the envelope system is to add an additional envelope for your checking account. When you charge something, move cash to the "checking account" envelope. If you charge $20 worth of groceries, move $20 from the "grocery" to "checking account" envelope. Then when the credit card bill comes, you'll have the money available to pay the bill.

Or Lisa could use a "pretend envelope" system. She would set it up just as if she were going to use an envelope system. But she wouldn't actually put cash into the envelopes. Instead, on the front of the envelope, she'll list how much money is assigned to it. As she writes checks or makes charges, she'd subtract that money from the balance listed on the front of the envelope. When the running balance on the front of the envelope got to zero, she'd have to quit spending in that category or "move" money from another envelope.

Another way would be to use one or more sheets to keep a running balance for each category. She could have one sheet represent each envelope. Or she could have one sheet per month that contained the balances for all of the envelopes. The sheets, or perhaps a small spiral notebook, could be kept in her pocket or purse.

The danger in any virtual envelope plan is that you'll forget to make the entry and your balance will appear bigger than it is. One way to avoid that is to put any receipt into your pocket or purse. When you get home you can deduct the expense from the proper envelope and place the receipt inside.

There are also products that Lisa can buy that will help. One is available at budgetmap.com. They offer a specialized check register that allows you to keep track of different budget categories. Another is mvelopes.com. They feature an online approach.

Lisa is wise to recognize the limitations of any tool that she uses. But, she's also smart to look for a system to help her keep her finances in line.