David J. Perrotto
How should you prepare your child when they turn 18
18 is a huge year for many children. It means for most; they are now adults. The stores finally will sell them cigarettes in most states. They are allowed to apply for their first credit cards.
They can even go out and get thousands of dollars in student loans. Every child is getting ready to either continue their education path, or start to work full time. But for most, the concepts of budgeting, credit scores, and financial independence, isn’t something that many have been taught, or grasped. Many children don’t understand concepts as compounding interest, or the consequences of taking on too much debt at such a young age.
One of the first things your child should learn is about how interest works, especially compound interest. Whenever you take out debt, let it be credit cards, student loans, auto loans, or even when you buy a home, the way the bank/company makes money is through compounding interest. The term “compound interest” means that any interest charges are added to the principal (which is the amount you originally borrowed) so that your debt grows exponentially. If you have a $1000 debt and it accrues 10% interest every month, then the first month you will be charged ten dollars (1000 x 0.10). With compound interest, that ten dollars is added to your original debt, so now you have $1100 of debt. The second month you are again charged 10% interest, which this time comes out to eleven dollars (1100 x 0.10), so now you have $1210 of debt. This is critical to know when your child is getting student loans, especially with the average debt in the tens of thousands of dollars.
Next thing your child should know, is how bank accounts work, and what fees are associated with them. Most importantly what an overdraft fee is. When you have less money in your account for something that you bought, the bank will allow you to buy it, but they will charge a hefty amount. The average overdraft fee charge is 34 dollars. American’s paid over 15 billion dollars last year in overdraft fees. The second fee you will see a lot on your statement is an ATM fee. Most banks will charge you if you do not use their bank to pull cash out. What that means is that the bank will charge you a fee, usually two dollars, and the ATM will charge you a fee, usually 2-3 dollars. So that means if you pull 20 dollars or 200 dollars, you would be paying almost 5 dollars to have access to your own money! Now imagine your child took out money every weekend, and over drafted once during the month, are looking at an extra 50 dollars a month in unneeded expenses.
Now let’s move on budgeting. Before their graduation, your child should know how to create a budget. They should understand the differences between income, expenses, and savings, and the concept that expenses should not exceed income – otherwise, they will accumulate debt and incur costly interest and fees. They should know how their income flows into their bank account, and how bills are paid, and how they should work towards saving money for retirement/large purchases. Two important things that should also be drilled into your child before he or she leaves for college, if they work a part time job, try to save for retirement right away, what they do now, can have huge benefits over the course of their lives. Having an emergency fund instead of using a credit card to pay off some rainy day issue, and having money in an IRA account at such an early age allows compound interest to work in their favor.
The last thing for your child to understand is taxes. It's important to understand how income taxes work even before they get their first paycheck. When a company offers them a starting salary, they are going to need to know how to calculate whether that salary will give them enough money after taxes to meet their financial goals and obligations. It will be critically important for your child to learn how to maneuver through taxes as it will be a huge part of their lives.
All in all, this is a great start, and a useful start to help your child out and get them on the path to financial independence and stability. Your child is growing up, and you are that guiding light, and the lessons you teach today, will reverberate for years.