April 4, 2023 – When things go wrong with money, the consequences can be big. Debt can prevent people from reaching life goals, and it can take years to pay off credit cards or repair damaged credit.
These issues are made even more critical when people are struggling to pay for daily needs because of high inflation, the potential for recession, and the tightening of household budgets as employers cut jobs.
With money impacting people’s lives so strongly, why do so few people get financial literacy training? Some people assume that’s a parent’s job, but money can be a dicey topic in households. A lot of parents simply aren’t comfortable talking about money or their personal finances with their children, according to Gail Colbert, personal finance coordinator with the University of Delaware’s Center for Economic Education and Entrepreneurship in the Alfred Lerner College of Business and Economics. It’s a bit like the old squeamishness about broaching the “birds and the bees” talk, she said.
But teaching personal finance skills can help build responsible, financially secure and independent citizens, she said, who can navigate financial challenges like those many people are experiencing today.
With an assist from Scott Bacon, her colleague in the Center for Economic Education and Entrepreneurship, Colbert suggests five financial skills she thinks everyone needs to learn about and use.
This one is really the most basic. At its root, budgeting is as simple as not spending more than you earn, so that you can have the money when you need it, both to pay bills and to pursue goals like education or hobbies.
“What many people fail to do is account for their expenses, at least with any kind of fine detail,” said Bacon, assistant director at CEEE.
Not all of us are wired to enjoy keeping track of numbers and making entries in spreadsheets, and we don’t all have the same financial goals, but failing to properly account for the money numbers in our lives can strain relationships and add loads of unnecessary stress.
Colbert mentioned the “50/30/20” rule of thumb, which divides after-tax income into three categories: Half for essentials like housing, groceries and transportation; 30% for discretionary spending like movies, shopping and eating out; and 20% for long term financial goals, such as retirement.
There are lots of methods for different personalities, ranging from sorting monthly cash in envelopes marked for different spending categories, to using software like Mint, Wally, PocketGuard or Quickbooks. The details of the system, according to Colbert, are less important than the habit of building a personal method that works for your situation. The key is to learn to do it and to keep going.
When making spending decisions, people should try to be flexible and consider the economic environment, Bacon said. They may decide that since inflation is high, they want to spend more and save less this year, but next year, if inflation goes back down, do the opposite.
As inflation pinches budgets, it’s wise to examine ways to cut back, Forbes Advisor notes. That could include steps like cutting streaming services or other subscriptions, making sure your home is as energy-efficient as possible, and consolidating debt at the most favorable rates possible.
Saving and investing for retirement
Being introduced to the power of compound interest — earning interest on both the deposit and the interest over time — is often amazing to young savers, Colbert notes. They might not always be able to take advantage of it, however. (Perhaps they haven’t budgeted enough to be able to save.)
Saving can be difficult, but helps people afford vacations, cars, education and other purchases that are out of reach of your monthly income, Colbert said.
“Everybody’s goals are different,” Bacon said. Some people might prioritize saving for retirement more than others. The important thing is that people “understand the consequences of their choices. For example, if you go on that vacation today, first consider the future consequences of not investing that money before making that decision.”
Savings accounts at credit unions or FDIC-insured banks are safe, but pay lower interest. To save the amount you need for retirement, you will need to commit over many years and may want to try options with higher rates of return, like stocks or real estate, Colbert said, although those come with more risk.
The main thing, Colbert said, is to start as early as possible. That can be tough to do while also feeding a family and paying the bills, but it will pay off. Even setting aside a small amount regularly over a period of decades will add up. Just don’t count on Social Security; although it supplements income after retirement, it may not be enough for most people to keep up their standard of living, Colbert said.
A 401(k) is a great option, especially if an employer will match it. That match is essentially 100% interest up front, Colbert said, and also mentioned an Individual Retirement Account, or IRA, that can offer tax breaks for reaching savings levels.
One thing people often don’t think enough about when they are applying for jobs is the benefits, Bacon said. They focus on the salary, but not additional benefits such as pensions, saving options, health insurance, education assistance, employee discounts and more.
Smart use of debt
We all end up in circumstances when we need to spend money we don’t have. Colbert points to situations like a broken down car or other emergencies, or buying a new home. Many people can’t afford to pay for a house with cash, she said. To meet those expenses, loans may be necessary.
But not all debt is the same. Payday loans — think short-term, high cost loans typically due on your next payday — promise quick cash but deliver crippling interest rates. Credit card debt that is not paid off each month can also result in punishing interest at an average of 19.07 percent for existing accounts, according to WalletHub.
“We’ve just reached a new record credit card debt as a nation,” Bacon said, citing February 2023 numbers from the Federal Reserve putting the tally at almost $1 trillion, making the average credit card owner’s balance about $6,000.
“That’s scary data which indicates many borrowers are maxed out,” Bacon said. “That means the next time they need tires for their car after a blowout, they might not be able to make that purchase … because it’s beyond their credit limit.”
Also, student loans can be very difficult to get forgiven, Colbert noted. Students should carefully consider the earning potential of a future career. If you get a degree in medicine, you’re likely to take on more debt than, say, if you get a degree in journalism. But at the same time, different college degrees yield different lifetime earnings, so debt may be worth it in the long run.
Two common ways to pay off debt are the “snowball method” and the “high-rate method,” according to Colbert. With the snowball method, you focus on the smallest debts first and work your way up, knocking them out one at a time. With the high-rate method, you tackle debts with the highest interest rates to knock them out first.
The latter might make the most sense mathematically, Colbert acknowledged, but the snowball method can help people who struggle with motivation, as they achieve small victories by wiping out loans.
You can’t escape risk altogether even with safer investments, Colbert said. It’s also no use saving up your money and then losing it to fraud, scams or unwise investments. So it’s important to learn to understand and minimize risks.
Be wise to the different schemes designed to pilfer your bank account, like incredible “investment opportunities” or threatening phone calls demanding payment. Make sure you have strong passwords – never “password123” or birthdays or other words or phrases that a thief could easily guess, and set up your bank accounts and credit card accounts with multiple factor identification codes that can be sent to your phone or other devices.
“If it seems too good to be true, it generally is,” Bacon said. “Everyone should consider this every time they open up an email, or read a story in the news or answer the phone.”
People need to stay up to date on the latest scams if they can. Bacon recommends the Consumer Financial Protection Bureau’s fraud and scam page as a good place to start that education.
“A successful fraudulent scheme is based in psychology. The people pushing these scams understand and take advantage of this,” Bacon said. “They’re very skilled at their craft.”
When it comes to stocks, “some people might be willing to settle on those that yield a lower return on their investment if they believe their principal investment will remain safer,” Bacon said.
Those kinds of investments can include 401(k)s and IRAs, bonds, exchange-traded funds, index funds and mutual funds.
Everyone has different tolerances for risk, Bacon said. “I’m the guy that carries Band-aids in his pocket when I go places.”
Others may be fine with more risky investments, but they should be aware of what they’re getting into. Research has shown that people tend to pay more attention to potential future benefits than potential future costs, Bacon said.
“Cryptocurrency — I might make a fortune. I could also lose my shirt and end up with nothing,” Bacon said. “Many tend to ignore that part.”
It’s important to do the research, and he recommends talking to a trained financial advisor.
Understanding housing options
Although there are advantages to homeownership, don’t get the idea that it’s always better than renting.
The conventional wisdom used to be that everyone should buy a home if they could, Bacon said. But that is changing. People might end up with a home worth a lot of money, but be “house poor.” That is, their whole lives they pay the mortgage instead of going on vacation or dealing with the stress of paying for a new stove or replacing the roof — what Bacon calls the “headaches of homeownership.”
Colbert said it really depends on your situation. A student wrapping up a degree might not have a job lined up, and will need flexibility and the ability to move quickly, making renting a better option. For Colbert, renting was the best option for her when she first got out of college. “We didn’t know where we were going to go. I had a teaching job, but my husband was still in law school, and we had no idea … what our monthly income would be,”Colbert said.
While it’s true that renters generally have no property maintenance costs, Bacon said they do need to understand that “when they’re 60 and they want to move somewhere, they won’t have built up the equity or property appreciation that a homeowner might have. They’re not going to be able to sell that home and bring those proceeds into retirement with them.”
But buying a home has its benefits. That includes the obvious: As you make payments, you own more and more of the property, one way of building up wealth. Mortgage payments can also lower your tax bill each year, Colbert noted.