Financial Literacy for Teens and Young Adults

Arguably the most important and formative years of developing good financial practice is in one’s teens and early adulthood. High school years introduce the first job, pressure to choose a career path, and it’s the sad, sad time when parents start to pare back on doling out money for all those ‘wants’. University is a challenging environment to learn financial independence, as it is a time in one’s life where expenses are high (beer and pizza) relative to the income one is generating (zero). And that first job and newfound sense of freedom can lead to temptations with potentially disastrous outcomes.

One of the most important things parents can do is talk to their kids about money, set expectations and help them figure out a path to independence. When they’re still relatively young and the stakes are low, they can afford to make a mistake or two.  Parents do a disservice to children when they treat financial discussions as taboo, or send mixed signals if mom and dad are not on the same page of the money management textbook.

Children set to inherit significant wealth are no exception to these lessons. Life happens. Money can go more easily than it comes, as can health and a whole host of other unexpected real-world challenges. Developing strong financial literacy skills and learning how to manage money help children grow up responsibly and face some of life’s biggest challenges head-on. Children of affluence will need lots of practice before they inherit the trust, and arming them with these skills will help them make better decisions as they look after the family legacy.

“Prepare your child for the path, not the path for your child.”

This is the second part of a two-part series about the importance of instilling values and developing financial literacy in children before they find out the hard way that they don’t have a solid grasp on either one. This second part focuses on teens and young adults.

Still learning – ages 13 to 18

Receive an income

There are many advantages to having a job as a teenager. Not only does it teach important life skills such as independence, time management and responsibility, but having a source of income is a big first step to becoming an adult. With some basic rules established (and a watchful eye on grades), an opportunity to earn money should be encouraged. Introduce different ways to earn a living, i.e. salary, commissions, bonuses, etc., as well as the idea of getting paid what you are worth – especially as it relates to choosing a career path.  For parents who would rather their teen not work, an allowance can be just as important a tool for teaching good financial habits and discipline.

How to save

At this age, when now always feels better than later, and saving for retirement is something ‘old’ people do, goal-setting can be a great way to teach teens how to save. Making choices with the future in mind takes on a different meaning when your child’s interests have graduated from Barbies and Lego to iPhones and cars. Whether paid income or allowance, help teens set a goal and then sit down together to make a savings plan for how to achieve it.

How to track money and live on a budget

Now that teens have control over the money in their pocket, it’s time to create a budget. In order to make and manage a budget they need to know the comings and goings of their funds. Reconciling accounts is way of not just catching errors, but developing the discipline of monitoring cash flows and financial assets. Once they determine their regular cash flows, they can create a proper budget with income and expense projections, and develop a plan for the future.

Consider an economics and/or finance course

Teenagers are ready for a little more ‘meat’ in the subjects of economics and finance. so if this discussion takes parents out of their comfort zone, high school economics and finance courses are a good tool. If your child does not have access at school, there are private organizations that offer courses – and even summer camps – specifically tailored to teaching money management to teenagers.

Put into practice – young adults

Continue investment education

• Because investing is a long-term commitment, an important and age-appropriate concept to begin to teach at this stage is risk. Risk – as defined by investment industry standards – is the uncertainty of returns. Though individuals can have subjective definitions of risk, there are basic investment concepts related to risk that are fundamental and hard to dispute. One of the most basic relationships is the risk / reward ratio: the more risk you assume, the more return you should expect. Diversification, asset allocation, time horizon, returns, indices and benchmarks are all terms associated with the risk/reward concept that can serve as the fundamental building blocks for a young person’s investment philosophy and strategy. Chatting about types of investments can’t hurt at this stage either (i.e. an ETF is a diversified basket of stocks that mimics the returns of an index).
• If your child has an existing investment trust or a substantial amount of money, now is the time to set up an introductory visit with your financial planner and/or investment manager. Discuss with your advisor ahead of time what you want your child to learn in this session so that they are prepared. This is an important step as your child gets older and their finances become more complex, as they will look to their planner and investment manager as trusted resources.

Understand tax

Kids will get a basic understanding of income tax with their first job, and they should be encouraged to do their own tax returns. That being said, there are other implications of tax that they should at least be aware of. How does capital gains tax differ from tax on interest income or dividends? As you ponder investment choices with them, teach them to give consideration to after-tax returns.

Learn how to handle credit

University is probably the first opportunity for a young adult to get into real financial trouble. The banks are ready to pounce on students with irresistible credit card offers. At this stage, it makes sense to start with a discussion on why a credit card is actually a good thing – it builds your credit history which will gives a score and dictates how likely a lender will loan you money for that first big purchase. Reaffirm, however, that the credit card should be paid off every month to avoid high interest charges. Another option is for the parents to provide a loan to their children and charge interest. Even a nominal rate will act as a reminder that borrowing has a cost.

Start actively saving for the future / Cash flow management

Saving for the far-off future is hard for any nineteen year old to get their head around compared with saving for an iPad. So there are a few straightforward things that young adults can do that a) are easy to manage if you set it up right from the start and b) let their long-term time horizon do the work for them. They don’t have to save a lot. A regular, automatic deposit is an easy way to save that will help the young person get accustomed to the “net” paycheque.

• Open a TFSA account. This should be the first thing they do on their 18th birthday, and it can be explained that this is the only ‘free lunch’ they’ll ever get from the government. Time is on their side. The importance of this account is magnified the earlier it is opened, as the power of compounding can have a colossal effect on future net worth, especially because tax is not eroding its capital value.
• Once they start earning income and are maxing out their TFSA contributions, they should open an RRSP. Your 23 year-old will look at you like you have three heads. Save for retirement? Now? The answer is “yes, now.” This is the time to put into practice the investment concepts that they have learned thus far. Also, take advantage of employer matching programs. Encourage your young worker to participate, and inform them that they don’t necessarily need to take that RRSP deduction right away. They can always carry it forward to a future year when they are in a higher tax bracket in order to get the best ‘bang for their buck’.

Learn how to live within their means

Though tempting (particularly when they find out how much the bank is willing to lend them for a mortgage), young adults must learn to not overspend on houses and other large capital items, especially those susceptible to depreciation. The ‘Keeping up with the Jonses’ force can be very strong at this age, with so many public and peer influences in the mix. Young adults need to keep a rational head on their shoulders. A visit with your financial advisor ahead of these milestone decisions should be encouraged.

Nip debt problems in the bud

If debt has already been racked-up, whether as a student loan, a credit card gone wild or to buy their first car, help them make – and stick to – a plan to pay that debt down methodically but quickly. Explain that non-deductible debt is a negative investment which eats away at capital, and the faster they can pay it down, the faster their capital can start working for them.

Act philanthropically

The best way to teach your children about charity is to let them see you give and serve. Children who are exposed to philanthropy early on are more likely to turn into adults who value charitable giving. Help your young adult make a connection between giving and their own interests – whether it be sports, a family tradition, or their community. Kids who align themselves with a cause close to their heart will have a more meaningful philanthropic experience.

“From a small seed, a mighty trunk may grow.” – Aeschylus

Now, some homework for the parents

We’ve spoken a lot about parents instilling values in their children to help them forge a path to self-sufficiency. The aforementioned lessons involve a transition not only for the child but also for the parents.  For mom and dad, it means evolving from a world of parent “subsidy” to a position of fostering independence, which includes that crucial step of letting go.  While parents help kids as a show of love and support, they often make the mistake of providing a subsidy without guidelines, and it makes it difficult for young adults to develop self-reliance.  This can be a substantial hurdle to jump and parents should not assume it will happen quickly.  Take time, get advice from your trusted financial advisors, start early, and proceed gradually so the transition is as smooth as it can be for both sides.