Can your kids manage money?
By Luma Wealth on April 14, 2020
Helping Kids Develop Healthy Financial Habits: A Lesson on Spending and Debt
Your kids see you tap, swipe and type your credit card information to make purchases, but do they understand the thought behind your spending decisions? Do they know how you differentiate between necessities and discretionary items, and why it’s important to set aside funds for emergencies and investing in the future?
Help your children develop healthy spending habits by providing them with context around where your family’s money goes and showing them how to be mindful about spending.
Share how you apportion your money
You don’t have to disclose your family’s income statement or balance sheet to show your kids how you allocate resources. A simple pie chart, like the one below, demonstrates the concept of bucketed funds. In this example, 25% of income is allotted toward investing (such as retirement and college savings), 8% is set aside for short-term savings (money in the bank including funds aside for emergencies), 50% is used to pay living expenses and 17% is earmarked for discretionary purchases.
How income is allocated
Explain how you distinguish between needs versus wants
Help your children differentiate between money required to finance living expenses, such as the mortgage, heating and grocery bills versus discretionary purchases, like travel soccer and a family vacation, through a family activity that can help your children become strategic spenders.
Have each family member jot down items they’d like to purchase, each on its own index card. Then ask them to categorize the items as ‘Needs,’ something they must have to survive, ‘Wants,’ something they can do without, or ‘A little of both.’
Take turns discussing why you feel each item falls into the assigned category and where you would suggest making adjustments. Some items may fall into a grey area, arguably both a want and need. For example, computers and cell phones may be considered luxuries, however you may feel you need them for conducting business, completing schoolwork or staying safe.
Brainstorm budgeting for the things that make you happy
Many of the discretionary items in our ‘Wants’ column enrich our lives. You may get enjoyment from going to the theater, joining in a Zumba class, dining out with friends or renting a beach house to spend time quality with the family. Your children need a plan for spending money on the things that make them happy, too.
Help them prioritize the items on their lists and brainstorm age-appropriates ways to save up to pay for them, such as accumulating their allowance, doing extra chores around the house, or getting a part-time job. Discuss the danger of making impulse purchases, which may end up being things they don’t actually need or truly want, and as a habit can lead to large credit card bills and an accumulation of debt.
In addition, talk to your children about the joys of giving and encourage them to allocate a portion of their income toward philanthropic causes.
Talk about when it may make sense to borrow
Teach your children about the circumstances for which borrowing may make sense, by explaining the difference between ‘Good Debt’ and ‘Bad Debt’:
Good debt is an investment in the future. For example, a mortgage is money borrowed from the bank to finance the purchase of a home to live in; and it’s an asset that may increase in value over time. Other examples include a student loan, for an education that can increase potential earnings and a business loan, which provides capital for growth.
Bad debt is money borrowed for unnecessary purchases that do not enhance your future. It’s a message especially important to share with teens and young adults, who may be ready to apply for their first credit cards. Help them understand the true cost of revolving credit and that when credit cards are used responsibly, they can help them begin building their credit rating.1
Warn about the true cost of revolving credit
Here is a hypothetical example for older children to demonstrate the perils of credit card debt:
Situation: You want to go on spring break with your friends, but you do not have the money to pay for it.
Action: You recently applied for and received a shiny new credit card, so you charge your share of the hotel bill, restaurants and flight. After you return to school, you receive a credit card bill totaling $3,000.
Consequence: You only have enough income to make the minimum payments due each month. Although you had fun on the trip, at an annual percentage rate (APR) of 15.09% (the average in 2019)2 it takes you nearly nine years to pay the balance. With interest, your total cost is $4,281.57.3
| Amount spent on credit card | $3,000 |
| Interest rate (APR) | 15.09% |
| Minimum monthly payments | $120 |
| Balance payoff | 104 months (8 years, 8 months) |
| Total Paid | $4,281.57 |
At Luma Wealth, our goal is to empower your efforts to raise financially responsible children. Follow us on LinkedIn, Facebook, and Twitter to access our thought leadership, and please reach out to your Luma Wealth advisor for additional guidance.
