"American history and practical math ... you study ’em hard and hopin' to pass." — "School Days" as performed by Chuck Berry
An increasing number of states are now requiring students to pass a course in financial literacy before graduation. Let's take a moment and design a basic curriculum.
We’ll start with the importance of saving. Then we’ll discuss the concept of compound interest. Say a student saves $1,000 babysitting or lawn mowing over the summer and invests it. Imagine it earns 5 percent annually; then he or she will have $1,050. That $50 profit, and the $1,000 principal, gets compounded each and every year thereafter. We’ll emphasize that initiating the investment process at age 18 versus age 28 makes an incredible difference over the long run.
On the flip side, we'll undertake an honest discussion on all kinds of debt, from student loan debt to credit cards. We'll devise a typical budget for young adults, and show how much, say, a $500 monthly student loan or credit card payment can impact one's ability to become financially solvent. There is such a thing as productive debt, and we’ll consider when assuming such debt might be appropriate. Taking on debt to get through medical school or to start a business may be money well borrowed. We'll cover entrepreneurship and explain various types of entities (LLC's, S corp's, etc.) as well as the basics of running a business (like making payroll).
We'll overview finances in the workplace. We’ll explain how to read a paycheck and how to calculate one's income tax liability. We’ll explain the nuances of contributing to Social Security and the benefits and downsides of taking benefits at various ages at retirement. We'll cover various types of work-sponsored retirement plans, and emphasize the importance of participation in 401(k)’s and other tax-favorable accounts.
Then we'll talk living arrangements, and compare the financial efficacy of home ownership versus renting. For those inclined to buy, we'll explain mortgages, down payments, and closing costs. We'll determine when 30- and 15-year fixed mortgages make sense versus variable rate mortgages. We'll calculate how much is saved by sending $100 extra each month applied to mortgage principal, and show how, in so doing, the student can cut substantial time off the life of the loan. We'll also detail the hidden costs of home ownership: taxes, insurance and maintenance.
Finally, we'll cover investing, the last step in financial freedom, defining stocks, bonds, and other types of securities. We'll caution about costs associated with certain types of mutual funds and annuities. We'll provide an overview of markets and establish realistic investment return expectations.
Then we'll take recess and say a silent prayer for these future graduates. Their world is much more complicated than ours was at their age, and financial preparation is vital.
Margaret R. McDowell, ChFC, AIF, author of the syndicated economic column "Arbor Outlook," is the founder of Arbor Wealth Management, LLC, (850-608-6121 — www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin. This column should not be considered personalized investment advice and provides no assurance that any specific strategy or investment will be suitable or profitable for an investor.