In this excerpt from The Money Class, Suze Orman explains how to nurture a financially savvy family.
Our families are the heart of our lives. We want our children to have endless opportunity, to be able to achieve and create and flourish. We want our parents to reap the benefits of a lifetime of hard work and live out their golden years free of worry. But too often these hopes lead us astray. We fall prey to our good intentions. We sacrifice the wrong things for the right reasons, putting our financial security at risk to make someone we love happy.
When your credit card bill is full of purchases you made because your kids asked for something, you're lying to yourself and your kids about what your family can afford. When you deplete your emergency fund to help your sister cover her chronic financial shortfalls, you're lying to yourself and your sister about whether you can afford to help her—or that you even are helping her, rather than merely enabling her irresponsible behavior. When you tell your kids to focus on getting into the best college regardless of the cost even though you'll have to spend your retirement savings to cover the bills, you're being dishonest about the severity of that sacrifice. In each of these situations, your rationale seems irrefutable: You give out of love, because that's what family is all about, right? But the truth is, there's no way to build sustainable dreams on a foundation of financial dishonesty.
In this day and age, even families who are financially responsible are being hit by punishing economic headwinds. A layoff or a position that hasn't produced a raise in recent years can make you feel like it's becoming harder and harder just to get by. You may also find that your grown children and elderly parents need financial assistance. Combine these factors with poor returns on your retirement portfolio and a decrease in your home value, and you have real cause for worry.
Which is why the way your family spends and saves money, and how money flows through the generations of your family, may need to be revisited. For many of you, the challenge will be to rein in your family's spending. For others, the task will be to reassess your very way of life. No matter your situation, the first thing you must do is start talking. We're always more successful in reaching our goals when we have the support of those we love.
You may think having truthful conversations about your financial situation is embarrassing or painful. You may feel defeated by having to tell your son you can't afford to send him to sleepaway camp this summer, or to ask your siblings if your holiday gift giving can be pared down this year. But when you live your life with honesty, you're at your most powerful. Here is how to maintain your financial integrity as a daughter or son, a parent—of a young child, a teenager, or an adult—and a grandparent.
Recent surveys report that in the wake of the financial crisis, parents worry that their children's future will be limited. That's what we're addressing head-on, so that instead of living in a state of anxiety about your kids, you can act to secure their future right here, right now. Raise a child in a home where money is valued, and that child is likely to be an adult who values money. It really is that simple. Here's how to instill that trait:
1. Ask Your Children What They Love You can begin this conversation when they're as young as 4 or 5. When you ask, do they talk about you, their grandparents, a sibling? Or is their list about possessions? It's natural for us to desire material possessions. But you know my motto: People first, then money, then things. If your child has moved things to the front of the line, you have some work to do. If you're clear that you care most about your family rather than what you own, you're telegraphing an important lesson.
2. Establish the Work-Pay-Purchase Connection When they're between 3 and 6, your children need to learn why you work, and the purpose money serves. Explain that the groceries in the refrigerator were bought with the money you earned. Once your child is old enough, have him join you on errands and pay the cashier. Physically connecting to money helps us focus on what we spend. That's a lesson children should learn early.
3. Introduce Work-Pay Into Your Family When they're between 6 and 10, tell your children you'll pay them for doing chores. Set a weekly time when you'll make the payment. Once your children become teenagers, stretch out payments to every two weeks. It's an introduction to budgeting.
4. Take on the Great Utility Challenge Pull out your utility bills and make your older kids an offer: If they're able to reduce monthly costs by 15 percent, you'll split the savings with them. You'll be amazed by how quickly the lights are turned off in rooms they're leaving, and how everyone is happy to put on a sweater and turn the thermostat down. This challenge teaches your child that it takes money to live.
5. Don't Apologize for Being Financially Responsible There may be times when you must say no to spending that you previously said yes to. Be compassionate. Be patient. But please don't apologize. There shouldn't be any regret.
College is among the best investments anyone can make—the lifetime earnings advantage for a college graduate is about $1 million. But there's a truth every family must accept: Cost matters. It's incumbent on you to develop a strategy that allows you, as a family, to send your children to college without compromising your other financial goals. Here's how:
1. Put First Things First Before you save for a child's future college costs, you need to meet certain financial criteria: You must not have credit card debt. You must have an eight-month emergency savings fund. You must have a term life insurance policy. You must be saving for retirement, aiming to set aside 15 percent of your gross salary. Until all of that's in place, you're not to think about saving for college. There's financial aid for school. There are loans for school. But there's no aid or loans to help you in retirement, or when you run into a rough patch.
2. Choose the Best Savings Plan If you do have the ability to save for college, I recommend doing so with a 529 college savings plan. A 529 plan allows anyone, regardless of income, to contribute money to a special savings account. The two big advantages of a 529 plan are valuable tax breaks and the fact that just a small percentage of the assets (less than 6 percent) of what you've saved will be factored in by colleges evaluating your request for financial aid.
3. Involve Your Child Start talking about college finances no later than freshman year of high school. Your child deserves to understand exactly what, if anything, you'll be able to pay toward her education. Waiting until senior year to spring the news that you have little or nothing to offer is unfair.
4. Put a Financial Safety School on Your List Guidance counselors advise applying to at least one school where you're likely to be accepted. Take this strategy a step further and apply to a public in-state school you know will be affordable. A public four-year school can cost one-half to one-third what it costs to attend a private four-year college.
5. Make the Most of High School Explaining your financial situation to high school students gives them even more incentive to do well academically. Every A they receive now can help them qualify for financial aid. Advanced Placement classes can also help all of you save: Many colleges will waive some courses for students who score well on the corresponding AP test.
6. Know Your Loans Here's the strategy: The student should take out federal Stafford loans first; then, if more money is needed, the parent should consider a federal PLUS loan; neither should take out a private loan from a bank. Ever. Federal loans charge reasonable fixed interest rates and allow borrowers to choose from various repayment plans. Private loans, however, typically charge a variable interest rate, which is often higher than the fixed rate on federal loans. If you run into financial trouble once you're in repayment, private lenders have no obligation to help you out with a different payment schedule. And most galling, in the event a private loan borrower dies, the creditor can still demand payment. (With federal loans, the debt is forgiven if the borrower dies or becomes permanently disabled.) If avoiding private loans means your child must consider a less expensive school, then that's the truth your family needs to accept.
If your grown children ask you for financial assistance, you must suspend your parental instinct to help without hesitation. Sometimes you'll find that your children have a bigger financial issue that a loan isn't going to fix. Here's how to tell good help from bad:
1. Beware the Mortgage Loan If, after months of trying, your daughter and son-in-law still can't afford their mortgage, resist the urge to float them a payment. You're only delaying the moment when they accept that they probably need to walk away from their home. If your child's family is coping with a layoff, you—and they—need to understand that a new job may not pay as well as a prior position. That may mean it's time to find ways to reduce their living costs.
2. Think Carefully About Cosigning If a lender doesn't think your child is qualified to handle a loan, you should be leery, too. If she were to lower the price tag of the car she has her eye on, would she be able to qualify on her own? If so, that's a far better move. Is the lender hesitant because she has a low credit score? That says she hasn't yet learned financial responsibility. By cosigning the loan, you're enabling your child to continue her irresponsible behavior.
For Daughters and Sons: Help Your Parents Plan Ahead
There are some important topics to raise with your parents while they're in their 50s and 60s, to help ensure their financial security in their 70s, 80s, and beyond. Too often, families avoid discussing the inevitable road ahead. Then, when aging parents find themselves in bad financial shape, there's less time and opportunity to deal with things effectively—which is why I advise having this conversation sooner rather than later:
1. Will They Be Able to Retire Mortgage-Free? Your parents' goal should be to have no mortgage costs in retirement. If this isn't feasible, then your next conversation should perhaps be about combining households. Even before the recession took hold, a Pew Research Center survey found that 16 percent of households—accounting for 49 million Americans—included parents and their grown children.
2. Have They Considered Long-Term-Care Insurance? If your parents can't afford a policy on their own, you and your siblings should consider helping with the cost. Spending a hundred dollars or so a month now to help with LTC premium payments could save you tens of thousands of dollars decades from now, if your parents eventually require nursing care.
3. Have They Run the Numbers on Their Retirement Income? If your parents are considering retiring before age 66 or so, do they feel confident that they will have enough retirement income to support themselves for 20-plus years? If not, they may need to put off retirement.
4. Are Their Essential Legal Documents Updated? It's not enough that they drew up a will or revocable living trust ten or 20 years ago. They—and you—need to make sure that those documents are current, particularly if there's been a death, divorce, or remarriage in recent years.
According to a recent poll by MetLife, grandparents bestowed $370 billion on their grandchildren from 2003 through 2008. Here are strategies to help you make the most of your generosity:
1. Set Up a Roth IRA For a Working Grandchild If your grandchild has earned income, you can fund a Roth IRA for her. Say you add $2,000 to her Roth IRA each year from the age of 15 to 25 (a total of $20,000). Assuming that money grows at an annualized 6 percent until she turns 70, your $20,000 in gifts could be worth nearly $385,000.
2. Help Them Save for a Car or Home Ask your grandchild what she hopes to save up for, and offer to become her cosaver. Think of this like a 401(k) match: For every dollar she saves, you'll match 25 cents or a dollar.
3. Give Experiences, Not Things Studies show that happiness comes more from pleasurable experiences than from objects. Give gifts you can enjoy together—tickets to a ball game, a jaunt to the city to hit a museum or the theater, or a getaway at your home to spend the weekend together. Time, after all, is the most precious gift you can ever give to those you love.
Suze Orman's new book is The Money Class: Learn to Create Your New American Dream (Spiegel & Grau).