Financial Pointers for a Teenager

As a followup to my previous post, parents have been asking for pointers for their kids who will soon want to become more financially independent. Here is what I would tell these youngsters:

Thanks to Funny Everyday for the image.

Eight Steps to Financial Maturity

Step One

If you haven’t done so already, find a way to get your first experiences with being employed and receiving a paycheck, even if it’s part time or short term. There’s nothing like getting paid for work to give you some profound financial understanding. You'll also need to open a checking account, and why not also a savings account at the same time. We'll talk about those shortly.

When you do get your first paycheck, take a look at your salary and how the final amount is calculated. You will see that your employer pays out quite a bit more money than you receive. This is because he is paying the federal and state taxes that apply to your situation.

If someone tries to tell you that it is the employer who is paying those taxes, you should know that he would very likely pay you more if those taxes were not obligatory. More about this someday if you have questions about it.

Step Two

Once you have opened your bank accounts, be sure you have learned how to balance your checkbook, and keep your savings account up to date. This means that every time you use your debit card or a check to pay for something, you must write the amount in your checkbook so that you know exactly how much money you have left in the account. Overdrawing on your account will be very expensive. And don’t forget any regular bank expenses such as small maintenance fees, unless your bank offers you an account without any. Be sure to ask the banker about this when you open the accounts.

Step Three

Try to understand a little about the history of money. You may have already seen my little introduction to this. If so, you’re ahead of the game. If not, I would suggest you take a few minutes to understand some basic notions.

Step Four

Do a little reality exercise as follows: Get out some paper and make a list of your expenses during each day. Do this every day, and I mean every single day, and every single penny. Don’t worry, it doesn’t take more than 30 seconds.

The justification is this:  I don’t think there’s a human alive who doesn’t arrive at the end of the month wondering where the money went. Some even get paranoid and think somebody must have stolen it! And that’s probably not the case. We simply spend way more than we think, because small expenditures add up over time.

Step Five

Once you have gotten into the habit of doing this for about a month, prepare a neat page with columns and rows. Then take a look at your listed items. What are the major categories of your expenses? Examples might be Starbucks (it's amazing how much kids spend at Starbucks), clothing, drugstore items, gifts, rent, food, school-related, transportation, eventually vacation, insurance, taxes, things of this sort. Then add a column for miscellaneous, and another for savings.

Now: Every evening, put your daily expenses under one of the columns. By doing this little chore on a daily basis you will begin to see how to set up what’s called a budget. It will help you become conscious of how much you are spending and where you might be able to change your spending habits. 

Later in life, this little discipline will come in handy when you have a family to organize, or other plans. It will put you solidly in control of your finances. (Here's a nice little nonprofit that sells a neat budget booklet that will facilitate this for you.)

Step Six

You will be tempted soon, if not already, to sign up for a credit card. Keep in mind that savings are your friend, and credit (actually debt) is your enemy. As a youngster, you start out with no credit at all, but at some point you will find it important to have a good credit record. The best way to get a card is through a store like Walmart. Later you will be able to apply for other types of cards.

BUT … BEWARE!

Credit cards are devilish. They encourage you to spend more than you can earn, or receive as allowance. You will be allowed to go into debt if you promise to pay the card company back over time, assuming the card company believes you. But the hitch is that they will try to take a huge amount of money for this service, sometimes up to 14-26% annual interest. And they’re sneaky, because they’ll only ask for a small sum every month. You should understand that they do that because they get much more of your money this way. You are the obvious loser in this arrangement.

Let’s just try the experiment on our calculator: Enter an amount representing a purchase, say $200. Your credit card will charge you something like 18% annual interest. When the first bill is due, you pay the minimum, for example, $10. You now owe $190 plus $2.85 for the interest. The next month you pay $10, and you now owe $182.85 plus $2.74. Keep doing that until the whole debt is paid off. Two years later, you will have paid the $200, plus another $70.64. That’s 35% more than the original price!

And the worst part is that while you’re paying the minimum amount every month, you think you still have lots more credit to spend, and if you're not smart you probably will spend it. But obviously that just makes it much worse, since what you owe will increase alongside the interest amount.

Is it really worth it? You could instead have waited a couple of months and saved up enough money to buy whatever it is for the $200. Then you could start saving right away for your next purchase, instead of paying interest to the bank.

Believe it or not, many Americans have several credit cards that they are paying off all the time. This means they are constantly indebted to some bank, and many have no savings at all. Sometimes they are late in paying even the minimum, and the bank charges them horrendous late fees. I doubt these people have ever taken the time to calculate how much money they are paying for the privilege of getting themselves into debt. A few get into so much debt that they can’t get out of it without some kind of intervention.

If you're going to have credit cards, my recommendation is that you pay off all charges every single month, in total, period. Use the card as a convenient payment device, and not as a magic source of extra money. Do this, and your credit rating will be good. And you will be smarter than 95 percent of humanity.

Be sure to ask your bank to sign you up for smartphone notifications of every expenditure, even small ones. It happens frequently that our credit card or bank card numbers are stolen, and if you catch any improper expenses immediately, you can call the bank and get the charges reversed. But you have to act fast.

Sometimes – very rarely for most of us – credit can be helpful. For example, you may unexpectedly need a car to drive to work or school. If you have a credit card, you might be able to buy a cheap car with it, and then pay off the amount over time. This may actually be something you'd want to do in spite of the extra interest expense. But be sure to calculate all the amounts you will pay, including the interest, to find out the total cost of the car. And of course you want to be certain that you will be able to pay off the debt with whatever income you will be receiving and still have enough money for your other expenses.

Step Seven

Start thinking about saving a little money every month for future need. You will be surprised how often you’ll find something that you’d like to buy but can’t afford. And small savings every month add up surprisingly quickly. I just heard from a friend that her mother started a small savings account in her early 20s with about $25 a month, and by the time she was retiring, it had over $200,000 in the account!

Step Eight

I know it seems too early, but think about eventually preparing for your retirement. You will not be happy in your old age if you don’t have any savings. We tend to be a little nonchalant about this, but when you do get there, you will be very happy to have saved up a good sum of money. You don’t want to count on whatever small benefits the government might have for you some 50 years from now.

When you get to that point where you are saving a good bit of money, perhaps we can discuss how best to invest and protect it over time.

What Is Money? The Basics Your Teenager Needs to Know

Recently someone asked me to write an explanation of "money" for a teenager. Perhaps you have a youngster who could use such an explanation, so I am publishing it here.

* * * * * * * * *

The Evolution of Money

Once upon a time, people didn’t use money as we know it today. Instead, they exchanged favors for favors, work for work, or items for items, or some other combination.

For example, in the early settlement days of this country, pioneer traders would exchange jewelry, knives, and guns for beaver skins offered by American Indians. Or a baker could exchange ten loaves of bread for a case of apples. Or a friend could help you build your house, and you could help him sow his crops.

But this immediate type of barter exchange is not always convenient, since you may not want to acquire something right this minute. Sometimes you want to buy an item in a different town. Sometimes you may want to get a haircut next week, but not today. So people came up with the notion of “money” as a way to hold on to the compensation for your work, or for the items you sold, so that you could use it later.

Way back in history, this money could take the form of a valuable sea shell, or a cow. In later times it might be a silver coin or two, or a bar of gold. These objects had what's commonly called "intrinsic value," meaning that they were appreciated not just for their value in exchanges, but also for their own beauty and/or utility.

Eventually, the idea of writing a promise of value on a piece of paper became popular, especially in market situations. Because towns evolved to the point where most people didn't necessarily know each other, intermediaries became involved. For example, if you had a lot of coins, this intermediary was someone you could trust who could hold your coins and give you his paper in exchange. Everyone knew this person, so his paper promises were considered valid.

This transaction permitted you to go about your purchases without lugging your coins around or risking them being stolen. This kind of paper money was a kind of claim ticket, a kind of promise of future purchasing power, and the intermediary was actually the first banker.

Today, at some point in your life, what and how many dollars you have will probably depend upon how much your work is valued by the person who hires you. With the paper dollars you receive (or the digital dollars that arrive in your bank account), you can buy things and services. Or if you don’t want to buy anything right away, you can save the dollars so that you will have them for later use.

Three Facets of Money

So we have now described three basic facets of money:

1. Unit of account
2. Means of exchange
3. Store of value

You can easily understand that units of money are a handy way of comparing the prices of things, and that since money is expressed in terms of numbers of currency units (dollars in our case), it can therefore be counted. (No. 1) It can also be spent (No. 2), or it can be saved and invested (No. 3).

How Much of Our Money is Real?

The question arises whether or not paper or digital dollars are a good “store of value” over time. This question would lead us into a discussion of monetary inflating, about which I wrote a few months ago. It's rather complicated, but to make a long story short, the unfortunate truth is that paper or digital money is not always what it appears to be.

Just to give you an idea of what I mean, take a look at this chart of the diminishing value of a U.S. dollar since the beginning of the last century:

I have also prepared another chart and some photos that illustrate this phenomenon here.

It is very important that you realize that what I will call real money can only be those paper and digital claims that truly represent work done and that haven't yet been exchanged for other things or services. (This is an oversimplification, but I think it gets the important message across.) Anything above and beyond that should be called credit.

It used to be that banks were in control of the amount of real paper money and credit that were created. This worked pretty well since they were closer to the actual production of things. Bankers usually knew their clients well.

Unfortunately today, the amount of paper or digital money created in the US is now handled by a government-appointed bureaucracy (the Federal Reserve, or the Fed) that has no idea how much money should be printed to represent work done. In reality, for the past 100 years or so the amount of dollars printed or digitally created is way more than it should be.

Without going into too much detail right now, you do need to understand that any creating of money beyond the total value of work done by everyone represents credit, which is very different from our current definition of money, even though most people use the same name for it. Credit is really debt, and it must be repaid in dollars from future earnings. And credit involves risk. In fact the more credit, the more risk. We could say that credit represents tomorrow's work.

So far, all the real dollars and the credit/debt dollars created by the Fed have been absorbed by our economy and that of other nations. In fact, so much credit/debt exists today above and beyond real dollars that no one really knows how much our Nation has created, nor how much we can increase our debt load. The situation is precarious.

Throughout history this has happened in a number of societies, and it does not end well. Most recently, perhaps you lived through 2009-2010 and remember the hardships some people had to endure when things turned sour. That episode was the beginning of a tremendous crisis caused indirectly by excess credit. It was rescued in extremis by the Fed, at least temporarily, until the next episode.

You can also learn about what happens when things go badly by reading some of the stories of 1929, or of the Roman empire's decline.

If you have questions please don't hesitate to comment below. It will inspire more explanations. Another article is coming soon about handling your finances.

PS: My Dad (Edward C. Harwood, founder of the American Institute for Economic Research) stopped using the word "money" because its meaning has become very slippery, even among academics. He began using the phrase “purchasing media” instead of money, but that is a bit cumbersome for a teenager, so we’ll keep using “money” for now.