The United States may be one of the richest nations in the world, but only a little over half of U.S. adults are considered financially literate. Few states have mandatory classes in personal finances for high school students, which means it’s often up to parents to teach their teens about money and to give them a good foundation for financial literacy. Here are some pointers about financial education for teens to help prepare for financial independence.
Understand how bank accounts work
If your teenager doesn’t have a bank account yet, it's time to open one and begin using it as a tool for discussing personal finances with your teen. Teens should understand that a bank account is more than just a place to store money. There are often fees for using the account and, in the case of a savings account, interest paid to the account holder. A bank account can also lead towards getting a secured credit card once there’s a sufficient account balance.
Understand compound interest
Having a good grasp of compound interest is fundamental to financial literacy, yet one third of adults in the United States have a poor understanding of it. Simply put, whether you’re talking about a savings account or a credit card, when interest is applied to money, that interest will also have interest applied to it. Over time, the value of the money can grow exponentially. A savings account that accrues interest is the easiest way to demonstrate this concept.
Understand the cost of debt
Compound interest also applies to debt. If you owe money on a credit card, for example, the compound interest applied to what you owe can quickly exceed the amount you originally borrowed. Using credit to purchase things can be dangerous and many Americans accrue too much debt causing big problems that can lead to default or bankruptcy.
Understand credit scores
Any high school student who has taken an exam or brought a report card home realizes that our society uses scores to measure merit. So even if they don’t benefit from having a good credit score today, they should understand it will be important in the future when they want to buy a house or a car that likely requires the use of a loan.
Every time you borrow money, the lender records how well you have paid it back, which counts toward your credit score. When you want to borrow more money, the lender will look at your credit score to help decide whether you’re a risk worth taking. The lender can also use your score to determine how much interest to charge you.
Understand a spending plan
Sooner or later, everyone learns to live within their means. As a teen, learning to live within a limited budget now can avoid the transition that often accompanies going out into the world. A good way to do this is to create a budget from an allowance or summer job. If they don’t have a source of income yet, consider giving an allowance for specific work around the house and have them pay for things that you might already be buying like clothing and cell phone bills. Using a budget will teach them that any purchase, such as a new phone, will most likely require a sacrifice in other spending to make up for it.
Understand why it's important to save
The importance of saving money for the future is a lesson that will pay off for decades to come. If your teen has an allowance or a part-time job, they should have a savings account specifically for saving towards a long-term goal, like going to college, buying a first car and even retirement. Then, at each payday, put a percentage of that money into the account. You might consider illustrating that saving money makes money by matching any contributions you make to that savings account.
Regardless of how you approach the topic of improving the financial education for your teen, discuss any decisions or issues openly and together with your teen to develop a dialogue about the importance of financial literacy.