You may have heard about the concept of financial literacy — the idea that having an understanding of various personal finance topics will lead to better personal financial outcomes. A search of the web returns definitions such as “the possession of skills and knowledge that allows people to make smart decisions with money.” A query to ChatGPT returns a response about budgeting, saving, investing, and debt, among other such concepts.
As a Certified Financial Planner professional, I certainly believe in the merits of financial literacy. However, there are conflicting opinions about whether financial literacy should be taught in the classroom as part of a standard curriculum. Some suggest that it’s important that teens and pre-teens have a basic understanding of personal finance. Others argue that unless these concepts are being used on a regular basis, they will quickly be forgotten. This group proposes these concepts should be introduced “just in time,” or as somebody is contemplating a financial decision.
Having tried different ways to introduce my teen and pre-teen to various financial concepts over the years, I have moved into this latter camp. I have witnessed, and with some frustrations, how these ideas just didn’t take hold. I now believe that a better approach is to introduce concepts just as a young person is presented with a financial decision.
With the Class of 2023 heading off to college or joining the workforce, I began to think of my own experiences and mistakes as I left high school. My parents attempted to instill some sense of financial literacy in me, but as with most advice at that time, it went unheard. It took a number of years to come to the realization that an understanding of personal finance topics can have positive impacts and help individuals make more informed decisions. However, in these early years of adult life, some concepts may be more important than others, and having an understanding could prevent substantial mistakes. Three that come to mind are: budgeting, use of credit, and credit scores.
Looking back, I wish I had more appreciation for the freedom and independence that come with graduating high school and moving into adulthood. This newly acquired independence brings with it many responsibilities and few guardrails. I found at times it became very easy to overspend. I had no idea of my expenses and what my personal cash flow looked like. What I didn’t fully appreciate was the concept of budgeting. I really dislike the word “budget” as it tends to imply some sort of restriction. I tend to prefer the idea of a spending plan.
In my early years of college, the bulk of my available funds came from student loans. Those loans were dispersed quarterly in a lump sum. After paying for some immediate expenses such as tuition, books, lab fees, etc., there was still a rather large pot of money remaining. If I simply had the wherewithal to make a spending plan and budget that lump sum over the coming months, I could have avoided dangerously low bank balances. A spending plan doesn’t have to be any more detailed than simply forecasting income and expenses and then making sure they are balanced. There are many apps that will help with this, but I happen to be a fan of old-fashioned spreadsheets.
Another memory I have is how easy it was to obtain a credit card in college. I remember the credit card companies posting up in the quad and raking in applications from unsuspecting students. As I look back on it, it amazes me that any credit was issued to a person with no income, no assets, and no credit history. What I didn’t fully appreciate is how quickly spending can accelerate when all you have to do is swipe or tap. Sometimes that available credit can be mistaken for available cash, but it definitely is not available cash. In fact, it’s the exact opposite. Without understanding this difference, I found myself with debt I certainly should not have had at that point in my life. Fortunately, I was able to manage it, but it was uncomfortable at times.
It was bad enough to dig myself into a hole of debt. What made it worse was my lack of understanding of the cost of that debt. At that time, in the early ’90s, average interest rates on credit cards were about 19%. Since then, interest rates have risen dramatically and the average rate on credit cards today is almost 25%. And for many types of credit, it is not only the interest that needs to be paid, but there could also be annual fees or origination fees. These fees, in addition to the interest rate, make up what’s known as the annual percentage rate (APR). Comparing the APR, not just the advertised interest rate, is the best way to compare the overall cost of credit.
The three concepts of budgeting, use of credit, and credit scores tend to relate to one another. If someone has a spending plan in place, he or she will be less likely to rely on a credit card. This in turn can lead to a higher credit score as debt is used responsibly. Not only for recent grads heading out into the world, but for each and every one of us, having an understanding of these concepts can lead to better personal financial outcomes.
~ John Manocchio is a Certified Financial Planner™ Professional with Pacific Crest Wealth Planning serving the Truckee/North Lake Tahoe region. He and his wife Sarah have called Truckee home since 2005. They are raising two active boys and a rescue dog named Lucy. Together they enjoy skiing, mountain biking, camping, and all our region has to offer.