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What I’d like my kids to know about budgeting, debt and wealth

By on October 18, 2017

Budgeting means living within your means

As an adult, you’ll have expenses and bills. They never end.
There are different ways to set up a budget. First, you have to estimate what your monthly expenses are. Next, you have to remember by what medium you’ll pay the expense: electronic payment, check, cash, or credit card. The toughest thing about a budget is limiting unexpected expenses. These can range from vehicle repairs to just having to go out to eat more often than expected. It is up to you to have a savings account with a cash reserve as well as how you deal with monthly unexpected expenses. A successful month is one in which you spend close to or less than what you expected to have to spend. Keeping your spending for personal items and food under control is one of the hardest things to do as a young adult.

Avoiding Credit Card or other Non-Fixed Rate Debt

Young people are just beginning their careers and many times do not have a high salary. Further, some are going to college and do not have a job at all. Many times, they believe they have to take out college loans in order to make it through school. There’s no way around this for some young people if they attend a high cost university and their studies require 100% focus. School loans are usually fixed rate percentage and if individuals get a good job after they graduate school, they can pay those back over time. Credit cards however are different. Their interest rates can increase over time. It is also just never a good idea to put living expenses on a credit card at a young age. It is better to get a part time job and stick to a budget. Doing that will set you up for success later on in life. If you cannot work due to school, budget shrewdly to keep your living expenses low. The goal for you should be to graduate with as little as debt as possible. If others at your college seem to have it all such as a nice car and money to go out all the time, be happy for them. They may have come from wealth. If not, they are likely spending on credit, something you do not want to get into the habit of doing. Learning to have fun without spending lots of money is a lifetime skill in and of itself. Develop that skill early. Throughout life, credit cards will likely still be needed as they are the only safe venues right now for ordering things or tickets on the internet. Check (Debit) cards can be used as well; but, for large purchases, they can be dangerous to use as your checking account information is exposed. When using credit cards, you can still budget in purchases into your monthly budget then pay the credit card bill as soon as possible to avoid interest fees.

Developing Wealth by saving for Retirement or Owning Appreciating Assets

Building wealth involves saving in a long term savings or retirement account as well as purchasing appreciating assets such as homes. Retirement accounts such as 401K’s, Roth IRA’s, or IRS’s are the easiest forms of investment because over time they will increase with value and take very little of your time managing. There is a yearly limit on how much you can put in to each of them. You can put in up to a certain amount into a 401K from your job wages as well as put into a personal Roth or regular IRA. I recommend putting money into the Roth IRA instead of regular Roth as you avoid taxes when you pull out your money upon retirement. It is not always possible to put up to the limit for both a 401K and Roth IRA every year possible through life especially when you’re young. But, a good rule-of-thumb is:
Try and save 10% of your monthly income throughout life for retirement and do not touch it. Save more if you can but at least 10% will give you a good retirement if you start young.

Purchased homes or other real estate can appreciate over time but takes some of your time to manage. For example, if you get a bad renter in you may have to file paperwork to get them evicted. The paperwork to handle all of this is relatively simple and if you follow a process you are usually ok. Working with your renters first is usually a good idea. I’ve sold three properties without a realtor and managed two properties as well. It did pay off for me each time. However, selling homes like this requires you to do a lot of the paperwork and physical work of maintenance yourself in order to make money as realtor or property management fees are very high.

For most people like myself, purchasing a home involves getting a mortgage from a bank. A mortgage is debt; but, if it is a fixed-rate mortgage that is a at good interest rate, the debt is not considered to be the same type of debt as a credit card. While you pay down the mortgage monthly with some of the money going to the bank for interest and some toward the principal you owe, the home’s value can appreciate as well over time helping create more equity when you sell it. With that being said:never purchase or refinance a home with the use of an adjustable-rate-mortgage.

In my mind, these loans should be illegal. There is no sense in purchasing a home where the bank can raise the mortgage payments on you over time to the point you cannot afford to stay in your home and have to sell. If you cannot sell soon enough, you will lose your home to the bank. It does not make sense. Adjustable-rate-home loans are in the red category because of this. They are used to acquire more money by the banks and usually offered to those who have trouble obtaining a fixed-rate mortgage due to lower credit scores. In general, they also create more selling in the housing industry which the banks like. It is almost always a bad idea to get one of these type of home loans.

Credit card debt as well as vehicle loan debt, does not give you that benefit as credit card debt has no equity at all and vehicles depreciate rapidly leaving you with little equity relative to what you owe on the vehicle. I would try and think that any debt that does not aid you in purchasing an appreciating asset like a home is “bad debt.” That includes credit cards and vehicle loans. They fit into a red category. Student loans are also “bad debt” but they can contribute to getting you through to a good paying job.

A good rule-of-thumb throughout life is that your total non-mortgage debt should not be higher than 50% of your total yearly household net income.

Net income is how much you take home in your paycheck, not your Gross income which is your official salary. Taxes, health insurance costs, savings, and Social Security contributions are taken out of your salary before you receive it.

Throughout life, keeping this ratio can be tough but can be done. After leaving college, most individuals do not pass this test. But, after a few years of saving and maintaining their budgets properly as well as paying off debt, for most individuals, this is an achievable goal. Once you are at this level, maintain it by watching how you spend keeping the rule for non-mortgage debt in mind. Purchasing an expensive car or running up credit card debt to eat out or buy clothes are the largest culprits in preventing young people from getting financially fit.

On average, a good rule-of-thumb for deciding whether to get a mortgage to buy a home is: Is it cheaper than what it would cost you to rent and do you plan to live in it for at least four years?

If not, you might want to reconsider buying a home especially as a young adult. Our opportunities often come unexpectedly and require moves in order to advance our careers. Moving is exhausting and a lot of times we would fair better to just rent and focus on our studies or careers and save into our retirement accounts. Owning your own home also requires some home maintenance effort on your part that also takes time.

About Billy Jackson

Billy R. Jackson is a dad and author of "Preparing Them For The Big Bad World," a book he specifically wrote for young adults when making life decisions. He has a BA in Political Science from Norwich University (2001) and a Masters in Business Administration from University of Wisconsin-Consortium.(2013)