Helping A Teenager Take The First Steps Towards Financial Freedom

Yesterday, I had a very long IM conversation with a young cousin of mine who is in high school and has a pretty lucrative lawn care business going on right now. Most of my younger cadre of cousins and nieces and nephews look to me for advice on a lot of things that they would never ask their parents – I’m somehow identified as the oldest member of their generation in their eyes, and thus I “get it.”

Anyway, he wanted to know how he should handle the money since it was more than he had ever had before by far. He had also overheard me talking to others about investing – and he knew he should be making more than the 1% interest that he would make at the local bank.

Here’s all the advice I gave him – and knowing him, he’ll probably follow almost all of it to the letter. Feel free to chip in with any additional advice; I’ll send it along to him and also give this URL to similar-aged people who ask such questions.

Ask yourself “What do you want to do with this money?” It’s fine to have a lot of answers. Perhaps you want to save for a car or save for college. Maybe you want to go out and buy a Nintendo Wii. Possibly you’re thinking long-term already and are looking at a house down payment after your schooling is done. One other possibility that is probably way out of your consideration right now is retirement, but if you put even a little bit away for that right now, it will be an enormous amount by the time you retire (fifty years of compound interest, even on a little bit of money, can be enormous). It’s fine if you don’t want some of these things, or any of them.

Pick at least one relatively short term goal (two years or less) and at least one relatively long term goal (more than two years) In my cousin’s case, he wanted a car in the short term (he’s fourteen) and to save for a house down payment in the long term (he’s going to go to trade school and become an electrician). Those both seemed like incredibly sensible choices to me given his age, and I told him so.

Split your money into five piles. The first pile should be the taxes pile. I told him to call his parents’ tax preparer, tell the preparer how much he would make from mowing, and ask whether he would pay any taxes on that amount. I don’t believe he’ll owe any at all, but it’s a good value to instill in someone who doesn’t know anything at all about taxes yet.

The other four piles should divide up what remains. I would make a “pocket money” pile, so you can go out to the movies and other stuff with friends. I’d make a “business” pile, which would be used to repay any money you borrowed to buy equipment or gas – and also to buy more equipment or gas as needed. I’d also make a “short term goals” pile and a “long term goals” pile.

How should these piles be divided? It depends heavily on the business (some businesses will gobble more money than others) – make sure you have plenty of money to cover business expenses. Pay that first, then take the majority of what’s left and split that evenly between the long term and short term goals. The remainder is your pocket money. I used an example of $100 in income over a week for him: you might have to put $5 of that into taxes, leaving $95. You might also need $10 worth of gas and might need some more equipment in the future, so I’d put $20 in the equipment pile, leaving $75. I’d put the majority of that ($40) into savings, with $20 each into long term and short term savings, and then the other $15 I would spend as pocket money. I told him that if he does this all summer and again the following summer, he’ll be in excellent shape to get a used car after he turns sixteen and he’ll be in excellent shape for buying his own house when that comes around, too.

Where should the money be saved? I encouraged him to get a couple of online savings accounts linked to his account at his local bank (offering to help him if he had any questions). One should be for the short term savings and one for the long term savings. That way, he can’t be tempted to just stroll down to the bank branch, take out a bunch of money, and go buy something ridiculous, plus the interest benefits on many online savings accounts (I recommended ING Direct and HSBC Direct) are as high as 5%. If he puts in $20 a week each week this summer (for 13 weeks), he’d earn about $10 more just by having it sit in the online account for a year rather than at the local bank, and that’s not even including sign-up bonuses and the interest on the fairly nice balance he already has at that bank.

What about investing in stocks or real estate? Investing can wait. It’s quite possible that he may decide to use that down payment money to help buy a car in two years, and that’s the only chunk of money that I would even consider having him use for investments.

What about a Roth IRA or something? Again, that can wait. If his parents were doing investing for him, I might recommend it, but this young man is building up a solid income at the age of fourteen – the fact that he’s doing any financial planning now at all puts him way ahead of the game. Let him learn his lessons about the challenge of saving and investing this way so that his choices don’t have serious tax consequences.

In short, the real lessons that you can give to a teenager are the idea that you should put some of your money away for the long term and that some places are better than others to put your money. Drowning them in options and other issues will only tell them the same thing that their parents might have learned, that personal finance is scary when it really isn’t. If they’re interested, keep going with more suggestions, but focus on the core ideas of putting away some of your money for the long term. If they really get that piece, they’re already light years ahead of their peers.

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