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Finances for Freshman: How to Prepare Your Kids for Financial Responsibility When Entering College

Emotions often run high the day any parent drops their child off at college for the first time. It’s an important moment for families and one that symbolizes the start of a child’s independence. Granted, we’re uncertain whether campuses will even be open come August, but the day will be coming soon when your youngster will pack their bags and strike it out on their own. 

As a parent, grandparent or guardian, you want your child to set their newfound independence off on the right foot emotionally, physically and financially. Working with your child to understand the financial responsibilities independence brings is a crucial step in preparing your kid for college. Below are a few ways in which you can work with your child to help them understand the impact healthy financial decisions can make on their time in college and their future. Being that we’re all sheltering in place, now is the perfect time to start the conversation.

Preparation #1: Be Selective in Your Financial Support

How much money a parent chooses to give their child over the course of a semester varies vastly. Some may be inclined to cover all expenses, others may want their child to be responsible for everything on their own. If you do choose to provide some financial support to your college student, it may be beneficial to be selective with how much you decide to give. Doing so can help create an important lesson for your child on the value of money, without leaving them completely cut off.

Depending on what you’re able to do, it may make sense for you to help cover your child’s room and board, meal plan, insurances, medical expenses, etc. But once the necessities are taken care of, you may want to consider leaving the rest up to your child. Without a steady or reliable source of income from you, it can quickly become apparent what are needs (food, school supplies, etc.) and what are wants (going out to eat, weekend trips, movies, etc.)

Whatever approach you decide to take, sit down and make the expectations clear before they head off to school.

Preparation #2: Warn Them About Credit Card Offers

In 2009, the Credit Card Accountability & Responsibility and Disclosure Act was passed. One of the main purposes of the act is to help protect college students from falling prey to credit card offers they couldn’t resist. Before the act was passed, credit card companies were allowed to approach students right on campus and entice them with impressive giveaways that masked the true commitment and cost of signing up for their credit card. Now credit card companies are no longer allowed to offer giveaways to students on campus, near campus or at any university-sponsored events off-campus.1

While companies likely won’t try to buy your child’s business by giving away freebies, college students are still a targeted demographic for many credit card companies. Whether it’s through the mail, email, social media or over the phone, credit card companies are still finding ways to entice young adults (even underage students) into signing up for their card services. Before your child heads off to school, make it a priority to explain the real commitment signing up for a credit card comes with such as high-interest rates, payment due dates, late fees, yearly fees and more. Empower them with the knowledge they need to either ignore the offers altogether or do some digging to find a credit card that may best fit their needs.

Preparation #3: Discuss the Importance of Budgeting

While some college students choose to work on campus to help supplement the cost of their living expenses, many may not. And for those that do choose to work, their hours may be limited to what they can fit into a schedule packed with classes and extra activities.

For many students entering college, it’s likely that they held a summer job or internship during the months leading up to college, or they have a bit of savings socked away for the semester. You may have even chosen to give your child a lump sum at the beginning of the semester to cover extra expenses. Whatever the case may be, you’ll want to help your child understand the importance of making the money they have last through budgeting and saving.

Give them a realistic idea of what expenses they may need to account for. Help them understand how to utilize whatever income stream they will have during the semester to spend and save wisely. Sit down and create a sample budget with your child. 

We like the zero-based budgeting approach, which assigns every dollar a place to go each period (one month, quarter, or semester, whichever makes the most sense). Sum up all the cash inflow they will receive, both through your support and the income they bring in through working, and assign each dollar to a category. Even if your support will cover the same expenses each period, it may be a good idea to include them in there so the child understands and appreciates your aid! Here’s a sample budget:

Let’s dive a little deeper into this. You'll notice that the total money coming in equals the total money going out. This is the nature of a zero-based budget. BUT, assigning every dollar a place to go does NOT mean they have to spend every dollar! If all the regular expenses are accounted for and there is money left over, it can be allocated to savings and investment accounts (‘Emergency Fund,’ ‘New Bike Fund’ and ‘To Invest’ shown above). What we hope to see is, over time, your child will look for ways to tighten up their budget so they can assign more and more dollars to their savings and investment accounts. 

Now let’s get into the importance of saving.

Preparation #4: Stress the Importance of Saving

It shouldn’t be difficult to explain to your child the importance of having money set aside for emergencies. Look at our situation now - lots of Americans and people around the world are having to fall back on their emergency funds to cover basic expenses. You may support your kid in the case a major event occurs, but if they have a small emergency and are able to handle it on their own, it will be a fulfilling experience for them.

As far as emergencies funds go, we suggest starting them out with a goal of saving $500-$1,000. Emphasize that this money is for emergency situations only! Concert tickets and new video games do not qualify as emergencies - these are things they should save up and pay for with cash. Or, if they’re building credit, then it’s a good idea to have them save the full amount of the expense in cash before purchasing anything on credit. This way, they aren’t buying things they cannot afford.

Preparation #5: Show Them the Extraordinary Power of Compound Interest

We suggest your child has a fully funded emergency fund prior to allocating part of the budget to investing. If you prefer, you could encourage them to assign, say, 75% of leftover dollars in the budget to the emergency fund, and 25% toward investments. Whatever you decide, it’s crucial they understand how powerful compound interest is. Here’s a chart we put together to demonstrate the enormous benefit of starting to invest early.

Now bare with us, there are a lot of numbers here, but if you dig in you can see how impactful this chart may be on your child. 

Here’s the story: Billy and Bobby both started their investing careers with the same schedule of yearly contributions. $500 in year 1, $1,000 in years 2, 3 and 4, and then $5,000 each year thereafter until reaching the age of 60. The catch is that Billy started at age 18, and Bobby started at age 25. By the time they are both 60, assuming an average rate of return of 7%, Billy’s investment account dwarfs Bobby’s by almost $400,000. Amazing! You can use this chart to help explain the importance of starting early. If they are just in awe, and are ready to get excited about investing diligently, they can play around with some different numbers on a compound interest calculator like moneychimp. These can be fun and motivating tools that encourage your kid to tighten up their budget and save and invest on a consistent basis. 

Those are the most important lessons we believe should be covered with your college bound children before they head out on their new journey. As you work on buying bedding and gathering textbooks, make sure to set some time aside to help your kid understand the financial implications their first step into freedom and independence will likely have. Seeing your child head off to college for the first time is a feeling like no other. Having these discussions now can help them (and you) feel comfortable and confident in the financial decisions they’re making and habits they’re developing during their time in school.

  1. https://www.ftc.gov/sites/default/files/documents/statutes/credit-card-accountability-responsibility-and-disclosure-act-2009-credit-card-act/credit-card-pub-l-111-24_0.pdf

Sonoma Wealth Advisors is a registered investment adviser and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements.  The information presented is for educational purposes and believed to be factual, but we do not guarantee its accuracy and it should not be regarded as a complete analysis. All expressions of opinion reflect the judgment of the author/presenter as of the date of publication and are subject to change and do not constitute personalized investment advice. An investment adviser representative should be consulted directly before implementing any investment strategy. Investments are subject to market risks and the potential loss of the entire principal amount invested. Past performance is no guarantee of future results.

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