Most people learn about finance the hard way through mistakes made from practical experience. People usually aren’t taught about personal finance in school. Moreover, parents don’t teach their children the basics either because they don’t understand it themselves, or they don’t take the time to it. So, most of us learn about money as we go through life. We make purchases, go into debt, and end up with a meager retirement account. CNN Money reports that 43% of workers surveyed in 2010 said that they have less than $10,000 saved for retirement. Even with full Social Security benefits, these people will be hard pressed to maintain their pre-retirement lifestyle. What if they had made better financial decisions earlier in their life? Perhaps if they were told about some basic financial principles they would be in a better position? Here are ten basic financial principles that your kids should know to avoid making simple mistakes:
Don’t spend beyond your means. This is such a basic principle that it would not seem to be worth mentioning; however, it is the key principle to financial success. Most financial advisors will tell you to pay yourself first by saving 6-10% of your income. You can only do that if you spend less than you make. So the first and perhaps most important rule of financial success is not to spend beyond your means.
Save for a rainy day. As soon as you start working, open a savings account as an emergency fund, a rainy day fund. A rule of thumb is to have a reserve equivalent to six month’s salary in case you are out of work. If you have an emergency like a major car repair or medical bill, you will need to replenish the fund if you pay your bills using your emergency savings account.
Pay off credit cards monthly. It is good to have one or two credit cards so that you can establish a credit history; however, make sure to pay off the balance on or before the due date. Credit card companies charge excessively high interest rates and fees. If you pay your balance in full, you get to use their money without interest; however, if you are late or make a partial payment you will pay finance charges that are easily avoided. Also, don’t take a cash advance unless it is for an emergency. Again, they will charge you cash advance fees and if you don’t pay it off within their promotional period, they will also charge higher finance charges which makes this very expensive.
Open an IRA when you are young and make the maximum annual contribution. The time value of money works wonders when you invest over a long time horizon, bur you must start when you are young. People who start investing in their early twenties will far outpace those who begin in their thirties or forties. Those who start late will never catch up because they don’t benefit from the compounding effect on their investment which is also leveraged inside of a tax-deferred account like an IRA.
Fully participate in your company 401k. If you work for a company that offers a 401k plan, make sure to participate fully, or a least to the level of the company match. If the company has a matching grant, that is like free money. It will quickly add to your nest egg, but you must invest or they won’t match it. Also, just like an IRA, a 401k account is tax advantaged, so the compounding effect will be multiplied as a tax-deferred investment – meaning that you won’t pay any taxes until you withdraw the money in retirement. Also, only borrow against your 401k plan or withdraw funds if it is an extreme emergency. You must protect your 401k plan as a retirement plan. If you leave your employer then roll it over into a self-directed retirement plan, but do not take the money out early to avoid penalties. Keep your 401k for your retirement.
Buy some universal life insurance in your 20’s. Universal life insurance is a combination policy that offers both a term life insurance plan and the benefit of a tax deferred savings account inside of the policy. Everyone will need some life insurance, especially if they are married and have children. Buying life insurance when you are young, can reduce the cost of the premium investment and allow the cash value to build up in the account. If you die unexpectedly, the proceeds will protect your family or pay for your children’s education. If you live into retirement, you can convert the policy to an annuity to supplement your income.
Buy a house when you can afford one. Real estate is one of the best investments over a long time horizon, even though the value of real estate has declined during the recession of 2008. Over thirty years, you will likely have an excellent return on your investment in your home, and if you have a mortgage, the interest is tax deductible from your income taxes. When you buy a home, make sure you work with an experienced Realtor to help with the details and to advise you on making an offer. If you don’t overpay or borrow more than you can easily afford, then a home in a nice neighborhood is a great investment in addition to a nice place to live and raise a family.
Always make sure you have health insurance. One of the primary reasons that people go into bankruptcy is because of excessive medical expenses. The best way to safeguard yourself is to make sure that you have health insurance for you and your family. Hopefully, your employer will offer a good policy; however, if you are self-employed or working for an employer who doesn’t offer insurance, be sure to obtain an individual policy. You can not risk being uninsured because the consequences are too great.
Buy good used cars. Cars are not a good investment, but are necessary for transportation. If you buy a late-model used car with low mileage, you will have reliable transportation, and avoid the lion’s share of the depreciation loss of a new car which happens right after you drive away from the dealer. While many people will want the luxury of a new car, you will be far ahead in retirement if you buy good quality used cars and invest the savings in your IRA or 401k.
Get a high-deductible collision policy for your car ($500). A $500 deductible policy is a good way for most people to balance the cost of insurance and the risk of a collision. If you are a good driver, you will save enough on lower premiums to self-insure the higher deductible amount. Save the difference between the cost of a high and low-deductible policy in your rainy day account so it will be there in the event of an accident.