By: Dusty Rollins, Oxford Wealth Strategies
A few weeks ago, I met with a couple of clients of mine that I have worked with for a number of years now. I will call them Bob and June. As we were finishing up the meeting, I asked them if there were any other questions they had for me before they left. Bob’s eyes perked up. He told me that they read our article a few weeks ago, about kids not getting the best financial education and it made them think of their oldest son, Nolan. Nolan has been out of college for about three years. Bob explained that Nolan is making some pretty good money as a project manager for an engineering firm, but he and June are not sure he is making the best financial decisions. They asked if I could talk to him.
I agreed and one week later the 25-year-old was sitting across from me in my office.
We started off with getting to know each other; where he lives, what he does for fun and how he likes his job. Nolan told me that the favorite part of his job, as is the case with most kids right out of college, is the paycheck. And I learned that Nolan has all sorts of ideas about what he should be doing with that paycheck, none of which included saving for retirement.
Nolan has earned about $48,000 per year for the last three years. He has saved $10,000, which equals 6 percent of his total earnings ($154,000), or 2 percent per year.
Hmm. You see, Nolan is more interested in paying for his Sam Adams and paying to look good for the ladies than he is planning for his financial future.
I explained to Nolan that down the road, if he wants to impress one of those “ladies”, he is going to need to save more than 2 percent per year.
I could tell that Nolan wasn’t going to stay with me for a long discussion about investment vehicles, compounding interest, the time value of money, responsible financial practices, budgeting and all of the other factors necessary for a sound financial plan.
Instead, I approached the conversation from a different angle. I gave him three basic mistakes to avoid, starting with one I feared he might have already made, based on the fancy new Audi I saw him driving as he pulled into the parking lot. I advised Nolan not to use a significant portion of his income or assets on an expensive car. You see, vehicles are depreciating assets; they lose value with each passing day. We all are aware of the instant loss in value of a new car as soon as it is driven off the lot, but even used cars become worth less over time. But according to a recent CNN Money article, in 2016, the average monthly payment on a car loan was $503. It was $406 to lease a car. Either way, that’s a lot of money!
I asked Nolan if he ever wants to be a millionaire. Nolan’s head immediately bobbed up and down. I showed him some simple math, and Nolan could see that discipline can make him a millionaire. If he were to invest about 500 bucks a month from now until retirement (rather than spend it on a car), earning 8 percent on that money would yield approximately $1.5 million dollars by age 60. We talked a bit about how to be smart with financial resources and the importance of saving consistently, which might mean driving a five-year-old Chevy rather than buying or leasing that fancy new car. I explained that there are basically two emotions when dealing with money: pain and pleasure. Having a bit of pain now can lead to a life of pleasure. Nolan started to get it.
The next mistake I cautioned Nolan to avoid relates to housing. We talked about how many young folks are “house poor.” Nolan is still living with his parents, “temporarily,” but he wants a place of his own eventually.
I explained how the lending process works. Home buyers are expected to put a 20 percent down payment on the purchase price of a home, otherwise they are forced to pay a monthly mortgage insurance fee in addition to the regular payments that cover principal, interest, taxes and home insurance. I also explained that lending institutions determine their maximum loan amount based on a debt-to-income ratio. While the maximum current ratio is 43 percent of current debt (including any mortgage) to income, I recommended to Nolan that he keep that ratio to 25 to 30 percent. Although, yes, the bank will often approve home buyers for much more, using such a large chunk of income on a mortgage payment often prevents those same home buyers from saving for other needed expenses in the future. And instead of using mortgage instruments with variable rates or ballooning mortgages, both of which make a house seem much more affordable, I suggested Nolan save more for a bigger down payment or even to consider whether it makes sense to buy a two-family to collect rental income to help offset the mortgage payment.
I ended our conversation by cautioning Nolan to use credit wisely. Many young adults make the mistake of opening credit cards and taking out loans with limits and terms that they realistically can’t afford. And unfortunately, a small mistake when you are young can have a debilitating effect on your credit score for the rest of your life. I told Nolan that it is critical that he pay his credit cards on time and, ideally, in full. The same goes for his car lease and his future mortgage payments. If a borrower misses just one month’s payment, it can take years of timely payments to repair the damage to his or her credit score.
Young people have a world of exciting opportunities available when they get that first job. But with all opportunities come less-than-exciting responsibilities. Let’s prepare for a bright financial future!