Financial Literacy & Independence for Teens - Step 2 -Saving and Budgeting
KEY POINTS
Parents are uniquely positioned to guide their teenagers through the critical process of establishing short-term and long-term financial goals.
Goals derived from the SMART-ER approach can unlock your teenager’s financial potential.
Budgets are not one-size-fits-all. Teenagers need to find a budget approach that works for them. We highlight 5 approaches that may align with your teenager’s perspective.
Financial Literacy
Financial Literacy is an essential life skill for teenagers to develop. They should think of it like a muscle that needs to be exercised for life. A dedicated exercise regime can lead to financial independence and success.
We highlight the following key principles to teach teenagers regarding saving and budgeting:
Financial Goals
Teenagers should be encouraged to develop short-term and long-term goals. Such may include a trip, automobile, emergency fund, or post-secondary education. Goals can be inspirational, motivational, and transformational: if they are SMART-ER goals.
What are SMART-ER goals?
Specific
The goal must be specific, significant, clearly defined, and well communicated.
Measurable
There must be a quantitative basis for measurement. Overall achievement of the goal may be broken down into increments measured over specific time periods.
Achievable
Goals may seem lofty and unrealistic to some and completely attainable by others. Individuals need to find their sweet spot between stretching themselves and setting themselves up for failure from creating unrealistic goals.
Relevant
Teenagers will likely have some vision of their future that may include post-secondary education, purchase a house, or the launch of a new business. Each of these visions requires goals that integrate and are well aligned with the vision.
Time
Goals need to be time bound and tracked toward such end point(s). The likelihood of achieving a goal drops dramatically if it is not time bound.
Evaluated
Progress toward achievement of each goal must be consistently evaluated. Similarly, if a goal is dependent upon a team, each team member must be consistently evaluated.
Reviewed
It is important to clearly communicate the results of the evaluation with the appropriate team members. This creates a synergistic loop of goal setting, tracking, evaluating, reviewing, assessing, and realigning the goals if necessary.
Budgeting
Teenagers need to understand the purpose of budgeting its underlying concepts, and how to budget.
Purpose
A budget provides a roadmap to assist in the reaching of financial goals. A realistic budget can provide financial freedom while reducing stress. Financial freedom is the state of being able to afford your lifestyle while achieving your short-term and long-term goals.
Tracking Income and Expenses
It is key to understand that income and expenses will vary over time.
Salaried employees typically experience a more consistent income than hourly and seasonal employees. Similarly, some expenses are recurring (e.g., rent, groceries, gasoline) and some are infrequent (e.g., purchase or repair an automobile, gifts).
The concept of discretionary / non-discretionary expenses is just as important as the concept of consistent / irregular expenses.
Non-discretionary expenses can be categorized as long-term (e.g., housing, furniture, appliances) and short-term (e.g., taxes, food, medicine).
Similarly, discretionary expenses can be categorized as long-term (e.g., boat, jewelry) and short-term (e.g., travel, dining out, alcohol).
Be careful not to let non-discretionary expenses (i.e., needs, necessities) become discretionary. For example, the purchase of a new $5,000 television may be considered a primarily discretionary expenditure if a $1,000 television would have sufficed and been more aligned with the overall financial plan.
There are many budgeting apps to choose from that can help create a comprehensive budget. Alternatively, a simple spreadsheet can accomplish many of the key budgeting goals.
Excel has several template budgets available for download. Simply go to the File tab, select New, and then click on Budgets. You will have instant access to budgets tailored for comprehensive personal budgeting, college / university, weddings, food, travel, business, and more.
Take the time to prepare monthly budget to actual comparisons. The variances will provide valuable insights into your earning and spending patterns. Potential opportunities to tweak the budget should become apparent as the underlying causes of the variances become fully understood.
Emergency Fund
With practice, it becomes relatively easy to budget for recurring expenses and even infrequent expenses can be anticipated and incorporated into a budget with ease.
Unexpected expenses or a loss of income are a different story.
How do you suddenly pay to fix or replace a transmission, washing machine, lost phone, or dropped laptop?
Emergency Funds are Essential
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Emergency Funds are Essential 〰️
The loss of income or unexpected expenses can be devastating to a budget and its related cash flows. Many families find themselves living paycheck to paycheck without sufficient credit facilities to absorb negative cash flow events.
An emergency fund is typically created to cover 3-6 months of expenses. Ideally, revolving debt (e.g., credit card, line of credit) is paid in full; however, such is not always possible.
Disciplined individuals may consider paying down revolving debt with funds initially designated for the emergency fund. Such can generate significant interest cost savings while building a good credit rating.
TIP
Discretionary expenses (e.g., entertainment, alcohol) should never be paid for with revolving credit if the emergency fund is underfunded.
Budgeting Approaches
Everyone has their own approach to integrating the above budgeting concepts into a live budget. What works for one person may not work for you. We recommend you try one or more of the following approaches and see which one works best.
Pay Yourself First Budget
This concept should become a cornerstone planning tool for everyone. It prioritizes savings and adjusts spending, to the extent possible, to ensure savings goals are met.
Typically, the individual has a set amount automatically transferred from their checking account on pay day to a designated savings account or investment account. This eliminates the temptation to defer the savings and accessing the funds for other purposes. Individuals are less likely to access the funds once they have been set aside.
This concept can extend to charitable endeavors. It provides the individual and charitable organization with consistent cash flows. The individual receives the annual bonus of a tax refund or reduced taxes payable at tax time.
Zero Based Budget System
This approach is based on allocating every dollar earned to savings, non-discretionary expenses, and discretionary expenses. This budgeting system does not leave any cushion as every dollar is accounted for.
If you implement this system, be sure to create an emergency savings account to reduce the risk of incurring unforeseen debt.
Envelope Budget System
This system is great for those lacking financial discipline and need to eliminate credit card usage. Follow these simple steps to implement the approach.
On payday, go to the bank and withdraw the exact amount of funds required to cover your expenses that will occur between now and your next payday.
Next, label your envelopes for each expense category (e.g., rent, groceries, entertainment, alcohol, tobacco) and fill them with the cash equal to the budgeted amount. Be sure to securely store your envelopes.
Until next payday, you can only spend what is in each envelope. So, if you empty the entertainment envelope before the next payday, you either go without any additional entertainment or you need to find an envelope to borrow from.
You cannot use your credit card.
70/20/10 Budget System
This system is easy to understand and allocates your funds as follows:
70% Living expenses
20% Savings and debt repayment
10% Discretionary expenses
These percentages are very broad and may not align with your unique financial situation. As you become more aware of your spending patterns, tweak the percentages to better align with your short-term and long-term goals.
The key is to tailor the model in a way that works for you.
Intervention Budget System
Sometimes financial hardship may necessitate a self-imposed intervention. The key objective is to eliminate ALL discretionary spending. No more coffee on the go, dinners out, movies, streaming services, a stick of gum, it is 100% eliminated.
This model is likely unsustainable over the long-term. That is fine. The goal is getting spending under control while simultaneously paying down debt and reducing interest costs.
Hopefully you emerge less stressed, more financially secure, and with newly engrained spending patterns that are conducive to your overall long-term financial plan.
BOTTOM LINE
Teenagers are at an ideal time in their lives to start thinking long-term. Parents can provide invaluable guidance with goal setting and establishing healthy financial habits. Budgets are great tools for ensuring financial goals are progressing as planned. The key is to find a budget approach that works for the individual.
