Preparing Young Adults for their Financial Future

With back-to-school right around the corner, we wanted to use this blog to address preparing young adults for their financial future. particularly those between the ages of 15-24. While some of these topics are especially important for young people, many are relevant for all ages.

Budgeting

There is a common misconception that “budgeting” is restrictive – that one must eliminate life’s pleasures – trading a night out with friends for a single serving of Cup Noodles ramen at home. Not so.

Rather, having a budget simply means that you’re thinking about money decisions before making them. The idea is to become more intentional with your spending so that you’re not forced to stay home, alone, eating Cup Noodles simply due to short-sighted planning.

So, in the same way that a recent college entrant has to learn about balancing their classes, homework, study hours, extracurriculars, and social life, they also need to learn how to prioritize their financial wants vs. needs.

Not having experience managing month-to-month living expenses is no excuse for unconsciously blowing through funds – whether their own funds, loaned funds, or the supplemental money provided by the bank of mom & dad.

Budget Practice for Young People

One way for our children to manage their wants vs. needs as it relates to finances is to give them a sense of agency and personal responsibility in how funds are spent.

High Schoolers

When it comes to back-to-school shopping, consider giving your high schooler a budget to spend on new clothes, shoes, backpacks, and other discretionary items they may need. If you’re feeling generous you can even let them know that whatever they don’t spend, they can keep.

“Want those new Jordan’s? Have at it! But don’t complain when you’re remaining funds only afford you a pair of shorts and a t-shirt!”

Those $60 Vans almost immediately begin looking more appealing.

College-aged Kids

For parents providing their college-aged kids with supplemental funds, consider setting parameters around monthly living expenses.

Always re-funding their checking account and/or paying off the credit card bill in full each month is unlikely to instill personal responsibility as it relates to finances.

Instead, consider setting a monthly amount that you’ll contribute to their debit account. If you’re child exceeds that and there’s still five days left in the month they’ll either learn to love those Cup Noodles or they’ll adapt… or they’ll get frustrated and tell you you’re a bad parent.

In any case – they’re learning through living.

Big Ticket Expenses

Inevitably, there will be cases when your child asks for your support for bigger ticket expenses.

Examples: a spring break trip, studying abroad, or purchasing a car.

Does your child need to fund any one of these fully through their summer job, work-study, or internship? As parents, that’s your call. It’s likely that many parents reading this either self-funded these things or skipped out on them because both parental support and personal funds were lacking.

However, for parents that are lending financial support to children, getting your child to contribute towards the larger goal – perhaps a defined percentage or an agreed upon amount – is a great way for them to have skin in the game.

Developing a Good Credit History

Building good credit history is an important task. In an increasingly cashless society, creating a track record that shows you are a reliable borrower is a major step in the right direction towards financial independence. The sooner one begins, the better.

Secured Credit Cards

Getting a credit card can be a challenge for those without a credit history. This is where secured credit cards come in. Children over the age of 18 can qualify, regardless of income.

REASON: A secured credit card requires putting down a security deposit (think: collateral) that acts as the card’s credit limit. It’s kind of like your little one riding with training wheels again… but it builds their credit history.

We found Bankrate’s list of secured credit cards helpful to sort through the variety of options.

Do note that secured credit cards are not the only way for a young person to get access to a card that builds their credit history – they can also be added as an authorized user on a family member’s credit card.

Establishing good credit at a young age can open up opportunities down the road and credit scores can impact all of the following:

  •  Leasing an apartment
  • Setting up utilities
  • Applying for a job
  • Buying or leasing a car
  • Purchasing a cell phone plan
  • Interest rates for credit cards and various loans

Additionally – there are some basic rules of thumb to ensure that credit is being used appropriately and improving a new borrower’s credit score:

  • Set up automatic payments (to ensure no missed payments)
  • Keep credit utilization below 30% credit utilization (i.e. staying below 30% of total credit limit)
  • Pay off your balances in full when due (i.e. not paying off immediately after each transaction)
  • Make student loan payments on time

DID YOU KNOW: Your three free credit reports can be accessed directly from annualcreditreport.com – the only source for free credit reports as authorized by Federal law.

Other important financial know-hows for young adults:

Knowing How a Bank Account Works

Do they understand:

  • minimum balance requirements?
  • overdraft and service fees and how to avoid them?
  • how long it can take to transfer funds between different accounts and institutions?

Being Smart About Cybersecurity

Many students use shared Wi-Fi networks that are not secure – are they aware of this?
Consider investing in a Virtual Private Network (VPN) to establish a secure, encrypted connection between your child’s computer and the internet.

Renting Textbooks

No need to buy new if you can rent or buy used.

Student Loans & Delayed Gratification

For those that take out student loans, it’s not uncommon to have some extra funds available after tuition/room/board fees are paid.

No – these funds are not fun money. Student loan borrowers should be reminded that the longer these surplus loan funds can be stretched, the less they’ll need to fork over for monthly repayment when they begin working.

Long-term Investing

Children with on-the-books earned income are also likely to be in a low (or zero %) tax bracket. This presents a great opportunity to open and fund the golden egg of their future financial plan: a Roth IRA.

Final Thoughts:

Discussing household finances is, unfortunately, a taboo subject in many families. However, the more proactive we can be in preparing young adults for their financial future the better we can equip them with information to help them avoid common pitfalls and succeed.

So – please – think about those young adults (or soon-to-be young adults) in your life and share what you can. Each of us stands on the shoulders of those before us. Even if you don’t feel that your lived experience is worth sharing, it’s highly likely that a young person could glean gems of wisdom from both your financial successes and your defeats.

Parents: Also be aware of recent FAFSA updates and the pros and cons of cosigning a student loan.

CLIENTS: We are offering an on-demand financial literacy course that your children have access to for FREE. This is not only a great educational opportunity for them, but also something they can leverage on their resume or school application.

Please be in touch if this might be of interest.

The Dreaded “R” Word

The Dreaded "R" Word

Probably like you, we’re hearing the dreaded “R” word – recession – being referenced quite a bit lately.

In fact, in the month of June, Google Trends – which analyzes the popularity of Google Search across various regions and languages – indicated that searches for “recession” have officially surpassed those for “inflation.”

What’s causing the dim outlook?

In simplest terms: Uncertainty.

Most of that uncertainty lands squarely around the recently overtaken Google Search favorite: inflation.

At the European Central Bank Forum in Sintra, Portugal last week, Fed Chair Jerome Powell – the man with quite possibly the most unenviable job in America right now – said:

“I think we now understand better how little we understand about inflation” and that there is “no guarantee the central bank can tame runaway inflation without hurting the job market.

Not the most reassuring words.

Inflation Blame

A succinct summary of inflation contributors (credit to Barry Ritholtz):

  1. Covid-19
  2. Congress
  3. President Biden CARES Act 3
  4. President Trump CARES Act 2
  5. Consumers (who overspent without regard to cost)
  6. Consumers (shift to goods)
  7. Russian invasion of Ukraine
  8. Just In Time Delivery (supply chain)
  9. Fed/Monetary Policy
  10. Wages/Unemployment Insurance
  11. Home Shortages
  12. Semiconductors/Automobiles
  13. Corporate Profit Seeking
  14. Tax Cuts (2017) / Infrastructure (2022)
  15. Crypto

Inflation: The Path Forward

Between a rock and a hard place, the Fed has made clear that it will prioritize reining in inflation.

To do this, the Fed will continue tightening monetary policy. Quantitative easing (QE discussed more in previous contribution) has been discontinued and additional interest rate increases are planned.

The question then becomes – as Powell alluded to in Sintra – whether the Fed can achieve this without further upending the broader economy.

So, does all this point towards the inevitability of a recession?

Let’s start with the basics.

What is a Recession?

Recessions are an unavoidable contraction in a nation’s economy, a natural part of the business cycle.

While many consider two consecutive quarters of declining GDP to be a recession, the non-partisan National Bureau of Economic Research (NBER) – the official arbiter of recessions – defines it slightly different.

According to NBER, “a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months” that manifests itself in the data tied to “industrial production, employment, real income, and wholesale-retail sales.”

Essentially three criteria that must be met to officially qualify as a recession: depth, diffusion, and duration.

What causes a recession?

Recessions can be set off in a variety of ways. Some causes include:

  • Sudden economic shocks (1973 OPEC energy crisis)
  • Bursting of asset/debt bubbles (‘01 dot-com bubble, ’08 subprime mortgage crisis)
  • Too much inflation/deflation (US inflation in ‘70s, Japan deflation in ‘90s)

Is another recession inevitable?

It’s pretty much guaranteed, yes.

Since 1854 (the first year we have official economic data), the United States has experienced 35 recessions which have occurred, on average, nearly every 4-5 years.

A chart outlining some of these recessions (and their respective GDP contractions and durations) was featured in a blog post of ours from 2019 (also a timely read considering Le Tour just started!):

The Next Recession and What We Can Learn from the Tour de France.

Why do we care about recessions?

Recessions have real world consequences:

  • Unemployment can rise: Recessions can lead to less spending/consumption which can result in layoffs, pay/benefit cuts, and heightened job insecurity. For job seekers, recessions can be a challenging time because there is less hiring and employees will typically have less leverage in pay negotiations.
  • Businesses can fail: The same reduction in spending/consumption that leads to unemployment can also directly lead to businesses being forced into bankruptcy.
  • Retirement plans can be upset: The retirement landscape is already full of landmines for the average American. Sprinkle in a recession + inflation and you have an environment that will be unforgiving to overspending/mistakes. Those that retain jobs may decide to stick around longer to weather the storm.
  • Borrowing can get more difficult: As the broader economy slows down, or backtracks into recession territory, it’s not uncommon for lenders to tighten their standards for mortgages, vehicle financing, and other types of loans.

Is the United States heading for a recession?

It’s all opinion and speculation until it’s here. Poll various economists, strategists, and bankers and you will get inconsistent answers.

Even better yet – and perhaps just as reliable – ask your neighbor what they think. Consumer sentiment alone speaks volumes.

While recessions are hard to predict, leading indicators are pointing to the U.S. inching closer to one:

Room for optimism?

The consumer makes up 70% of the economy and there is an argument that, based on US household holdings of cash and cash equivalents, that the US consumer has never been more prepared for a slowdown:

US Household Holdings of Cash & Cash Equivalents

And no, the cash is not necessarily being hoarded by just the wealthiest households. Those in the bottom half are holding 45% more cash than from two years earlier.

Growth in total household wealth also provides a glimmer of hope.

Between Q4 2019 and the end of Q1 2022, total household wealth increased from $109.9T to $141.1 T – an increase of nearly 30%. All this while the ratio of household debt to disposable income dropped to the lowest levels of anytime seen between 1980-2020.

Air flight – another indicator of consumer sentiment measured by TSA checkpoints – is also seeing it’s highest levels of passengers since the start of the pandemic. This is a great sign when considering that business travel is still down 30%.

Will this continue? Anyone’s guess. But at the moment the average US consumer has more cash, less debt, and more overall wealth than they’ve ever experienced.

Closing Thoughts:

The next time you hear the dreaded “R” word referenced, consider taking a page out of the Stoics’ playbook: prioritize the things within our control, and ignore the rest.

We have no way of knowing, or control over, when the economy will rebound, when inflation will subside, or when the market will be primed to recover it’s losses.

However, the things we can control include:

Financial:

  • Spending habits (and potentially adjusting in light of inflation)
  • Making strategic tax-planning decisions
  • Paying down high interest debts
  • Continuing to invest in the market.

Life:

  • What we consume (food, media)
  • Our mental and physical fitness
  • Who we choose to spend time with
  • The amount of sleep we get
  • Our body language and breath
  • Our opinions, attitudes, aspirations, dreams, desires, and goals.
  • The number of times we smile, say “thank you,” or express gratitude for all we do have today
  • Our level of honesty with self and others

In the words of Epictetus, “He is a wise man who does not grieve for the things which he has not, but rejoices for those which he has.”

Cosigning a Student Loan: Pros & Cons

Student Loan Cosigner

Cosigning a Student Loan: Pros & Cons

The process of taking SAT/ACT exams, sending out handfuls of college applications, and eventually deciding on your school of choice is an emotional rollercoaster ride for even the most prepared and least anxious of students. At the very end of this arduous process, students (and parents!) find themselves at the very beginning of the next undertaking: financing a college education.

For lucky students, their parents or extended relatives are there to help. For many others, student loans are oftentimes the only viable option. As an immediate family member, extended relative, or family friend of someone pursuing a university-level education, you may be approached to cosign a student loan.

Much attention is given to student loans, however little attention is given to the impact of cosigning a student loan. For anyone that is considering a role as a cosigner, besides acknowledging the obvious benefit to the student borrower (i.e. they’ll be able to qualify for the loan!), it’s also necessary to know what’s at stake for you.

Who can cosign a student loan:
More often than not, a cosigner can be anyone with a strong credit history who has a willingness to help the student in question.

All lenders have their own cosigner requirements, however many institutions require cosigners to have a credit score of 670 or better and sufficient income to pay back the loan in the event the primary borrower defaults and is unable to repay. There are cases when lenders will go a step further to get a better sense of the cosigner’s overall stability – this can include reviewing the cosigner’s job history, how long they’ve lived in their home, and whether they’ve been in their job for at least a year.

Additionally, one of the least discussed (yet most important!) topics for deciding who should cosign a loan is the cosigner’s health. Many private lenders include language in the lending agreements that allow them to demand that the loan be paid in full upon the death of the cosigner. This is a point that deserves more attention considering that it’s not uncommon for grandparents (many who are older and may not be in their best health) to serve as cosigners.

What does it mean to cosign a student loan:
Personally, I’ve never encountered a student fresh out of high school who met the requirements to take out a student loan without a cosigner. This is likely due to their limited income and minimal (often non-existent) credit history. As the cosigner of a student loan, you are guaranteeing repayment of the debt. As cosigner, you hold a legal obligation to take over debt repayment in the event the borrower cannot keep up.

When banks lend money to borrowers for real estate in the form of a mortgage, the property itself serves as collateral. If the borrower is unable to keep up with their payments, the lender has peace of mind knowing it can cut its losses by seizing the property and selling it to a new buyer.

Considering that student loans are not backed by any physical collateral that can be seized and resold, a cosigner is a bank’s best option to recover an owed student debt.

Naturally, many students look towards their financially-stable family members to cosign student loans.

When parents or family friends of the borrower ask me for my thoughts on cosigning a student’s debt, I ask two questions:

  • Are you prepared for the responsibility to pay off this debt if the borrower cannot keep up with payments?
    • If no, DON’T cosign!
    • If yes, next question…
  • Do you, personally, have any large upcoming purchases/investments that will require borrowing a large sum of money (such as a new home purchase/mortgage or business loan)?
    • If yes, maybe don’t cosign. REASON: The cosigned loans will show up on your credit report and may complicate/restrict your ability to borrow.
    • If no, consider the borrower, your relationship with that person, and your confidence that they will be responsible in repaying the debt. If you accept the risks of being a cosigner and trust the borrower’s explicit commitment to repay the debt – go for it.

Benefits of cosigning a student loan:
For starters, the student borrowers are the primary beneficiaries of a cosigned loan. Cosigners allow students who would otherwise not qualify for a student loan to qualify and secure the funding needed to pursue their education. Additionally, if the cosigner is someone with stellar credit and strong income, the lender may take these facts into account and offer loans with lower, more competitive interest rates.

Many borrowers need cosigners for student loans due to not having much (if any) credit history. By having a student loan in their name and staying consistent on their monthly repayment, student borrowers are making significant (albeit unintentional) strides in establishing a personal credit history.

For cosigners, there’s little personal benefit to cosigning a loan (besides seeing a potential loved one pursue their dreams).

Drawbacks of cosigning a student loan:
A cosigner’s credit score will be impacted if the primary borrower misses a payment. Despite effectively serving as co-borrowers, cosigners rarely ever receive any formal notice that the primary borrower (i.e. the student) has missed payments. Unfortunately, missed payments are a common occurrence that frequently occur when borrowers are not setup for autopay or when a new loan servicer assumes the loan.

Another drawback to cosigning a loan is its impact on the cosigner’s debt-to-income ratio. As discussed before, the cosigned loan will show up on a cosigner’s credit report and may therefore reduce the cosigner’s ability to qualify for a personal loan or mortgage. Even if able to qualify for the loan, the increased debt-to-income ratio may result in the cosigner ending up with a less competitive interest rate.

In the event that the borrower is unable to repay the loan, collection agencies will look to the cosigner for payment. For most cosigners, this is the most significant drawback to cosigning a student loan and the one that must be most seriously considered when deciding to serve as a cosigner.

Even in the best of circumstances, a borrower and cosigner’s financial entanglement leaves the door wide open for relational stress.

How to decide whether to cosign a loan:
Making the final decision whether or not to cosign is personal. At a minimum, cosigners should have a sincere conversation with the prospective borrower to ensure the borrower understands the implications, and risk, to a) themselves and b) the cosigner.

It’s recommended that prospective cosigners also take an inventory of their own finances during this process. Be sure to consider your credit and to factor in whether or not any upcoming expenses will require a loan.

How to get a cosigner release:
Unfortunately, loan servicing companies never voluntarily let borrowers or cosigners know when they qualify for a cosigner release. Getting a cosigner release for a student loan typically requires that the borrower has graduated from school, has made at least 12 on-time payments, and has a sufficient credit score (credit score > 600) and income to repay the debt on their own. Additionally, it’s also typical that loan servicers will request the borrower (not the cosigner) to initiate the release process.

As a financial planning firm, we have clients who are the borrowers and others who are the cosigners. Regardless of borrower/cosigner status, we always work to have cosigners released as soon as possible.

  • Benefit of cosigner release to borrowers: Many private student loan promissory notes have provisions that allow the servicer to place the borrower in default (even if payments have been made on time) if the cosigner dies or files for bankruptcy. Releasing the cosigner as early as possible can prevent borrowers from experiencing surprise defaults and student loan balances automatically being due in full that are no fault of their own.
  • Benefit of cosigner release to cosigners: A parent or family member opts to cosign a student loan so that the borrower can pursue an advanced education. From the very beginning, it should be understood that releasing the cosigner should be a priority following the borrower’s graduation. Getting released as a cosigner means the former cosigner’s credit will no longer be impacted by missed payments and that the original borrower will be fully accountable for the debt.

The Consumer Federal Protection Bureau (CFPB) offers sample letter templates that borrowers/cosigners can send to servicers to request a consigner release.

For additional reading, our co-founder, Dennis McNamara, was featured in Forbes on this topic: https://www.forbes.com/advisor/student-loans/pros-and-cons-of-co-signing-a-student-loan/