The financially illiterate — whether they’re children or young adults — should know some basic personal finance lessons before they go out into the world.
And avoiding bad habits shouldn’t just apply to the young. Adults of any age can learn bad financial habits that are passed down from generation to generation, creating a cycle of poor financial decisions that they keep repeating while remaining financially illiterate.
Teaching the financially illiterate
“Many young people look to their parents for guidance on money issues,” says John Vento, a certified financial planner and author of a book on financial independence. “Unfortunately, many parents lack a strong understanding of financial matters, and as a result, they miss opportunities for saving, lending, and basic financial services.
“We need to break this cycle — and one way to do so is to make financial literacy an educational focus in high schools, colleges, and universities,” Vento says.
To help end the problems of the financially illiterate, Vento has a lesson plan that he says should be taught in the nation’s high schools and colleges. Here are 10 of his lessons for the financially illiterate:
1. Live within your means
This requires living on less than your take-home salary and any other resources you receive, such as income from an annuity or a trust, he says. Living within your means does not mean existing from paycheck to paycheck.
Living within your means does not mean living on credit or on loans, or turning to parents or friends to pay the tab when you cannot quite meet the rent or need to buy a new computer. It means not only figuring out how to pay for your needs and wants, but budgeting your income so that you still have a little money left over.
“The single most important step any individual must take to become financially independent is to commit to living within his or her means,” says Vento. “In addition to living within your means, if you are ever going to get to Point X, you must also save money,” which he recommends be 10% or more of your gross pay.
2. Understand taxes
The average American family pays more than one-third of its income in federal, state, and local income taxes — and even more in property taxes, excise taxes, sales taxes, and other hidden taxes, such as taxes on cigarettes, liquor, and certain luxuries.
You don’t have to know the U.S. Tax Code by heart as a financially illiterate person, Vento says. But you should have enough basic knowledge about taxes and the tax system to ask the right questions and find the appropriate help to suit your own unique financial and tax needs, he says.
3. Determine your financial position
This doesn’t mean simply knowing your annual salary or identifying how much you take home in every paycheck — although that is definitely part of it and a key understanding for the financially illiterate.
Know what your financial assets, liabilities and net worth are, and regularly track where all your personal funds are coming from and going to. Determine your financial goals for various timelines, such as five and 10 years, and throughout your retirement.
4. Manage debt
There’s good debt and bad debt, a fact that the financially illiterate may not know. Basically, good debt is money that people borrow for purchases and situations that, in the long term, will help them amass wealth and ultimately reach Point X, Vento says. Some examples of good debt include student loans, business loans, certain investment asset loans, and some personal-use asset loans (such as an affordable home mortgage).
[pull_quote align=”left”]”When you do not use debt properly, that can lead to significant hardship and can prevent you from ever becoming financially independent,” says John Vento, a certified financial planner.[/pull_quote]Bad debt is money that people borrow (usually on a credit card) for the purchase of nonessential expenditures as well as many personal-use assets.
“When you do not use debt properly, that can lead to significant financial hardship and can prevent you from ever becoming financially independent,” he says. “However, when you use debt to leverage yourself in the pursuit of accumulating wealth, it can be a very powerful tool.”
5. Insure your health and life
Even a sound, carefully planned investment strategy can fall apart if you haven’t prepared properly for unforeseen problems concerning health and life, whether you’re financially illiterate or not.
If you or a member of your family is hit with a prolonged illness, a severe injury, a disability, or death (especially of the primary wage earner), the planning and investing you have so carefully developed can quickly disintegrate, Vento says.
6. Protect your property with insurance
The type and extent of insurance you need will change throughout your lifetime, as will the types of assets and the extent of wealth you have accumulated. The three major personal property risk management issues include homeowner’s insurance, automobile insurance, and umbrella liability insurance.
“You should consult with your property liability insurance agent or broker to fully evaluate your needs so that you can determine proper coverage to meet those needs,” Vento says. “It is critically important to remember you should always secure your new insurance coverage before you drop your old policy. You never want to leave yourself unprotected without proper coverage in between policies.”
7. Pay for college
Many people, parents especially, worry about covering the ever-growing expense of getting a college education. Of course, it’s possible to get academic or athletic scholarships or grants. But most young people will need additional funds either from their parents’ savings or through student loans if they don’t want to remain financially illiterate.
“With the skyrocketing cost of college, it’s important that you start planning early,” Vento says. “Parents and rising college students should take advantage of college savings programs such as Internal Revenue Code Section 529 plans, Coverdell Education Savings Accounts, savings bonds, financial aid, as well as education tax deductions and credits.”
8. Plan for retirement
Everyone should be planning financially for retirement, regardless of how old or young they are. Especially given that people coming into retirement are facing concerns that retirees did not face 20 or 30 years ago, including living longer and supporting themselves throughout turbulent financial times.
[pull_quote align=”left”]”The longer you wait to start saving for retirement, the harder it will be to accumulate the amount you need to be financially independent,” says John Vento, a certified financial planner.[/pull_quote]“The longer you wait to start saving for retirement, the harder it will be to accumulate the amount you need to be financially independent,” Vento says. “Remember, one of the most valuable investment assets you have is time; the more years you save the greater your chance of financial success.”
Contribute to your employer’s retirement plan, or if that is not available, to an individual retirement account (IRA). Implement a retirement saving strategy that allocates a specific dollar amount or percentage of your salary every pay period. Vento recommends saving at least 10% of your pay.
9. Manage your investments
Select an investment model you can stay with, even in the worst of markets, he says. Your investment plan should provide you with the highest potential rate of return in the long run while being within your risk tolerance, Vento says. For the financially illiterate, this can be one of the toughest things to understand.
10. Preserve your estate
Without preserving your estate, unintended beneficiaries — even if they are financially illiterate — may take a significant amount of your estate instead. These unintended beneficiaries include the federal and state governments, the state administrator, attorneys, and perhaps even relatives you have not spoken to in decades.
The money you may spend today on a qualified estate attorney may save your estate significant dollars in both estate taxes and administrative costs down the road.
Learning all of these lessons might not stop the financially illiterate from experiencing another financial crisis, but they’re a good start.
