Financial literacy is a big problem in the United States. In a recent study, only 9.4% of American students performed at the top level in a financial literacy test that included such tasks as calculating the balance on a bank statement and interpreting income tax brackets.
In a perfect system, our children would learn everything they need to know about personal finance in school, but that unfortunately isn't the case. With that in mind, here are six of the most important financial lessons young people should learn before entering their adult lives.
Matt Frankel: As a former high school math teacher, I could ramble off a list of 100 financial lessons that we should be teaching in school. However, I think that more lessons about compound interest could be beneficial -- but unfortunately no significant time is typically spent on the topic until college-level mathematics.
Specifically, I think every high school student should graduate with the knowledge that compound interest could be your best friend or worst enemy. If you're borrowing money -- especially on a credit card – most young adults (or even the older ones) don't realize just how much it really costs.
A few years ago in one of my Algebra II classes I did an experiment. I asked my students how long it would take to pay back $2,000 worth of credit card debt at 23% interest if they paid $40 per month. The guesses ranged from four to seven years. Many were shocked to learn that it would take nearly 13 years and cost about $6,200 -- more than triple the amount of the debt.
On the other hand, to show how compound interest can work in your favor, I also asked the following: "If you deposit $5,000 into an account every year, and your investments grow by 8% each year, how much will you have after 40 years?" Not a single person in the class had a guess of more than $200,000 -- not even close to the actual answer of $1.3 million.
Compound interest can become a financial trap, or could be the road to financial freedom -- and we should be making this abundantly clear to the young adults of the U.S.
Jordan Wathen: It amazes me that we allow people to graduate high school without the slightest understanding of how loans work, and how much they cost. I can't help but think that if the average American had a better understanding of how loans worked the housing crisis might have been much less damaging, and the amount of student loans outstanding wouldn't be anything close to $1 trillion.
Even some basic rules of thumb would put students on the right track. For every $1,000 you borrow, a typical 5-year car loan will cost about $20 per month, a 10-year student loan will cost about $11 per month, and a 30-year mortgage will cost about $5 per month. These are inherently imperfect, as all rules of thumb are, but they can go a long way in helping to shape better decisions.
If nothing else, students should know that typing "amortization calculator" into their favorite search engine will give them everything they need to calculate how much their college choices will ultimately cost, how much a luxury car really strains a budget, or why buying a McMansion straight out of college probably isn't the best idea. These represent the three biggest purchases most people will ever make, yet the average high school graduate is unprepared to face them head on.
Selena Maranjian: One thing I wish I learned long, long before I did was how you can make a lot of money with money. In my teens and 20s, I just let any extra money I had languish in my savings account at the bank, and I only thought of it as there for when I wanted to buy something, such as a new stereo or car. I knew I was earning interest on my savings, but it rarely seemed like much, and I paid little attention to that.
I wish I'd appreciated how effectively I could have put much of that money to work. For example, if I'd just parked a single $10,000 lump in an inexpensive index fund tracking the overall market, and if I'd earned an annual average return of 10%, close to what the stock market averages over long periods, it could have grown to more than $280,000 over the 35 years from age 30 to 65. A single $5,000 investment made at age 25 could have grown to more than $225,000 over 40 years. And just imagine what I might have amassed if I'd kept plunking money into the stock market over the years.
One way that such wealth building happens can be via dividends. If you sock money away in shares of healthy, growing dividend-paying companies, you can collect regular dividends over the years and reinvest them in additional shares of stock. The dollars you sock away for decades can work very powerfully for you, generating more dollars that can earn more dollars, and so on. Early retirement can be within reach of young people if they start investing early.
Adam Galas: My father introduced me to investing at the age of 13, when I was in Middle School. Throughout high school, college, and into medical school I noticed that my peers misunderstood the stock market and how to best use it.
Many of them viewed the stock market as incomprehensible, something that could only be understood by those with advanced degrees in that field and thus most young people I met didn't bother to try to invest at all, even those who had discretionary income.
Those that did attempt to invest would say things such as "Stock X is a lot better than Y because its only $3 instead of $100, thus it is more likely to double" or "Stock X is down 20% this year so I should sell and buy Y which is up 50%."
Over my 16-year investing career I've studied pretty much every kind of investing method you can imagine, from short-term speculating into penny stocks, leveraged options, currency trading, day-trading, and commodities. From very painful personal experience I've come to the conclusion that consistent long-term buy-and-hold investing in quality companies with dividend reinvestment is the absolute best way to build wealth and achieve one's financial dreams.
That simple truth is backed up by numerous studies spanning 145 years of US market data – since 1871, the S&P 500 has returned an inflation adjusted 6.9% -- that covers every conceivable kind of world and economic event, from bank panics, depressions, world wars, oil shortages, and killer flu pandemics that killed up to 5% of the global population.
Brian Stoffel: Home economics classes that my classmates and I were required to take in middle and high school were great -- they focused on cooking, how to run a "mock" restaurant, and everyday home activities. They helped us realize what it meant to be frugal.
There was only one problem: no one wanted to be frugal. We wanted all the latest bells and whistles. We didn't see the point in having money and not spending it. Other than "staying out of debt," we never covered the "why" of frugality.
Fellow Fool Morgan Housel once wrote that freedom of time is the only reasonable financial goal that anyone should ever have. I think he's right: if you can focus on what you want to focus on -- when you want to focus on it -- your life is great.
And you only get that type of freedom when you live frugally, and build up a safety net around you to insulate you from tough economic times. I can only imagine how motivated the next generation of students would be to live frugally if they all had this guy visit their classrooms during their senior year of high school.
As my colleagues point out, there's quite a bit that schools fail to teach. But, I can find no more egregious error than not being taught how to properly market ourselves to prospective employers.
At no time during high school or college can I recall being taught the basics of self-marketing, which includes how to properly create a resume; how to fine tune it to demonstrate your skills and how they would be pertinent to an employer; how to use social media and other channels to find appropriate jobs commensurate with your skill level; how to interview for a job; or how to network once you've landed a job to ensure you have some potential for upward mobility.
Adding salt to the wound, not being taught how to market ourselves also means we don't know how to ask the right questions during and after an interview. This translates into workers often being underpaid for their skill level. Worse yet, a recent PayScale survey suggests that 57% of respondents haven't asked for a raise. If you don't understand the basics of marketing yourself or your skills, it'll be difficult to prove to your employer that you're worth more and deserving of a pay raise. If you can net higher wages it could mean the difference between simply retiring and retiring comfortably, and on your own terms.
Obviously I'd like to see schools step in and begin emphasizing these points, but I'd also encourage parents reading this to share your real-world job experiences with your children to help give them an edge when they enter the workforce.
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