Read Karen Ramsey’s Column in U.S. News

If you enjoy the content on the RamseyInvesting.com blog and you’re looking for additional insights into personal finance, check out Karen Ramsey’s new column in U.S. News! Every month, Karen will provide advice and tips on investing, retirement, and more. This month, Karen discusses the benefits of creating a Personal Spending Plan in order to ensure a more secure retirement. Read more now! 

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Helping Your Children become Financially Responsible Adults (part 2)

In this week’s blog post, Karen Ramsey continues with her tips on how to help your children become financially responsible adults.

4. Give your kids an allowance and cash gifts on special occasions to help them discover the power of saving. If you choose to give your children money, you can use it as a way to help them become more conscious about money and allow them to discover the power of saving.

I suggest splitting the cash gift allocation into four buckets; 1) Tithing; 2) Immediate Gratification; 3) Delayed Gratification; and 4) Long term goals:

  • Tell them that 10% of their money has to be given to someone in need. This is the “tithe” allocation. My younger daughter Annie told me, “I want to send money to an orphanage in China.”
  • Thirty percent of their allowance can be spent on anything they want right now. This is the “immediate gratification” allocation. If they want to spend this 30% portion on movies or candy or whatever, that’s their choice.
  • They need to save 30% for things that cost more. This is the “delayed gratification” portion. They may want a camera, a cell phone, an archery set, or in-line skates. They have to save until they can buy them.
  • The last 30% is for long-term goals, like college, or a trip to South America when they are sixteen.

Each portion of the cash gift has its own purpose. Each portion has a lesson that the child can learn from it. Incidentally, the above method of allocation is a valid practice for adults, as well.

For younger kids, give them jars for each portion of their allowance. You won’t believe how focused they will become, how fascinated and proud they will be, seeing the longer-term jars fill up. Visitors to your home will be escorted to the kids’ rooms to see their jars of money. In later years, you can set up a savings account instead of jars for the kids’ longer-term goals, and they will learn about the power of compounding interest.

I started Lydia, my oldest daughter, on a 25-cent allowance. When her Long-term jar got full, we set up her savings account at the bank. When her first statement arrived, showing she had earned 21 cents interest, her eyes lit up.

“How did that happen?” she wanted to know.

“Isn’t it amazing?” I asked. “All this time while you have been sleeping and eating and playing, your money has been just sitting there growing. And they gave you almost a whole quarter for it.”

She couldn’t believe it. Now every month, she can’t wait until the bank statement comes. She wants to see how much she earned while she was sleeping, eating, and playing.

5. Let them know what it costs to run a household. Allow children to participate in the choices about how to spend money and the reasons behind them. In junior high or high school, let them in on how the family finances work. Let them sit with you while you pay the monthly bills. Let them observe you writing the checks. Or let them write the checks and record them in the register. You can show them how much will go for groceries, etc. and how much is left at the end of the month. This is not intended as a guilt trip, but as an education. It allows them to feel that they are included in the overall picture. And they will have a better understanding of why you sometimes have to say no. As a result of this involvement, they will develop an understanding of good money management that will be invaluable to them later in life.

By not giving your children everything they desire, setting clear financial boundaries, helping them learn how and why to save, as well as what it costs to run a household, you are likely to help your children develop a better relationship with money. They will be more apt to solve their own problems, earn their own rewards, and mature normally. When the inevitable day comes that they get in trouble, they will not need to turn to you for financial assistance because you’ve helped them to learn how to make good money decisions on their own.

Going through this process will teach your children important lessons they would not learn if everything were just given to them. We don’t include our children in financial discussions because we don’t want them to worry about money, but including them makes them feel more valued and respected. Don’t you sometimes harp on your kids to be more responsible? Involve them in family financial planning, and observe the result!

Helping Your Children become Financially Responsible Adults

One of the complaints of many people today is that the world is full of people who feel entitled, particularly Millennials. As parents, we often ask ourselves, in a world that seems to reward entitlement, how do we raise children who have a healthy relationship to money and teach them to be financially responsible? Most people first learn about money from their parents—not by talking about it in any meaningful way, but by observing. But our parents may not have been the best role models for managing and spending money. After all, they probably learned about money by observing their parents. But what if we broke the cycle and actually talked to our kids about money?

We don’t usually include our children in financial discussions because we don’t want them to worry about money, but including them makes them feel more valued and respected in addition to beginning to teach them valuable money lessons. You certainly don’t need to talk to them about mortgage ratesand retirement plans. But you can include them in discussions about the financial ramifications of some of the decisions you make. Kids can understand and handle a lot more than we give them credit for.

At what age can you start teaching your kids about money and choices? I suggest somewhere around age six or seven. This is when they start comparing what they have to what their friends have. At this stage, the habit of asking for everything to “keep up with the Joneses” sets in. Here are five tips that can increase the chances that you will raise financially savvy children who grow into financially independent adults.

1. Don’t give them everything they desire. We all want to be good parents. One way to be good parents is to say no to our children when it’s appropriate. We don’t have to give in to pressure. The fact that we live in a consumer culture is a surprise to no one.  Our children are constantly bombarded with product marketing messages, whether online via Facebook and other social media or television programming, which has shifted significantly since we were children.  In the 1950s, a half hour television program occupied about 27 minutes of narrative space, leaving three minutes for commercials.  Today, half hour programming is about 21.5 minutes, with 8.5 minutes of commercials. We live in an era where brand name logos are the “in” things to wear. This influence comes right into our living rooms.

Resist this influence. Saying “no” at times will set your children on a responsible course for the future, and it will make an extraordinary difference to your pocketbook.  Saying “no” does not mean you love your children any less, that you are depriving them, or that you have failed somehow. It means that you are establishing clear boundaries.

2. Set financial boundaries for your children. Kids need and love boundaries. When kids are given everything they ask for during their developmental years, it makes a strong imprint. They grow up believing they should have everything. It creates and reinforces a mindset that says the way to get something is to demand it—or always expect that it will be given to you. It eliminates the cause-and-effect relationship between productive effort and reward. It sets in motion a materialistic pattern that will cost both you and your children tens of thousands of dollars over the years. Make the boundaries clear. Tell them, “I can afford to get you this pair of roller blades. If you want that other more expensive pair, then you’ll have to help make it happen.”

3. Help your children set reachable financial goals. Have your kids create a list of their goals: getting a new soccer ball, taking rock climbing lessons, or traveling to Mexico. Then have them prioritize which of these are most important, and help them develop a savings plan to achieve some of their goals. As parent, you decide the goals to which you want to contribute. Tell them, “Okay, you want an iPhone. You want a guitar. You want every new X-Box game under the stars. You want a clubhouse in the back yard. Here’s how much money is available. You decide which of these things you want most. Or maybe you want to save this money and go to Disneyland next spring. You decide. It’s your choice. But you can’t have it all—unless you want to earn the money to pay for it.” This strategy also de-emphasizes a reliance on credit.  This teaches children not to go out and charge whatever they want, but to create attainable goals, and then save the money to buy the things they want.

If you involve your kids in financial decisions, you might even be surprised at what they come up with. A friend’s daughter thought of starting a silver polishing business. Around the holidays she distributes fliers in the neighborhood and always has plenty of customers.

Tune in next week for the final two tips on how to help your children become financially responsible adults!

Three Universal Misconceptions About Money

We hold three misconceptions about money that are almost universal.

The first misconception is: If I had more money, I would be happier. I could move to a bigger house. I could get that new car. My investment portfolio could get to the level it needs to be. I could finally get ahead and not struggle so much. I would have more peace of mind. I would have more free time. I could do what I really want to do—and be happy at last.

The reality is that more money will not give you peace of mind. No doubt you make a lot more than you did on your first job. Is your life more fulfilled because of your additional income? Do you feel freer, more content, more secure, and more alive? Do you have fewer problems now? Do you at last have money figured out? Does more money really bring you happiness? You hope that it does.

The second misconception is: People who make more than I do don’t have money problems. We assume that we are alone in not understanding money. When we see another person who earns more money than we do, we automatically assume that they must have money figured out.

Just because people make more money than you doesn’t mean they are free of the financial problems with which you wrestle on a daily basis. Most people spend up to the level of their income, and their problems follow right along with them. Assuming that your basic needs are well-covered, it makes little difference how much money you make—unless you have a plan.

We are often “insane” about money—we keep doing the same thing over and over again and expecting a different result. Until you have a plan, life is not going to change. It has little to do with how much you make. It has everything to do with your goals and whether your spending is consistent with those goals. Think about it. What is your life all about? Are you heading in the direction of your true purpose? Is your financial plan leading you toward or away from that purpose?

The last great misconception about money is: Someday, one day, it is all going to turn out okay. When people say this to me, I ask them, “Just what is going to happen to make it all turn out? Your next raise? An inheritance? Or maybe winning the lottery?”

I need to tell you this, my friends: Someday it’s not going to turn out—unless you do your part. You’re probably not going to marry the prince or the princess who will bestow instant wealth upon you. You’re unlikely to win the lottery. Your next raise won’t fix all your problems. It’s not going to just work out unless you have a plan that includes your goals and you implement that plan.

What would life be like if you decided to be more satisfied now? What would it be like to have a conscious understanding of money and its role in your life? How would you feel about money if its sole purpose was to provide an avenue to your goals and deeper passions?

We need to better understand the real purpose and potential of money, and how we use or misuse it. Money is simply a medium of exchange. By clarifying our goals, we can put money to work for us instead of the other way around.

The course to success begins by reflecting on why we react and spend as we do, while leaving behind our old beliefs about money. We can then head in a new direction based on knowledge—knowledge founded on where we are and where we want to go. Getting there then becomes a simple matter of steering and adjustment.

If you wish to change your relationship with money, there are three things you must do.

First, gain a clear understanding of how you spend your money and on what you spend it. Second, incorporate your deeper goals into a financial plan and commit to that plan. And third, allow yourself to be satisfied now.

If you are not satisfied with your life, don’t look to money. It will not solve your troubles. Look elsewhere. But where?

Perhaps the ancient Chinese sage Lao-Tzu is a place to start:

Fame or integrity: which is more important?
Money or happiness: which is more valuable?
Success or failure: which is more destructive?

If you look to others for fulfillment,
You will never be fulfilled.
If your happiness depends on money,
You will never truly be happy with yourself.

Be content with what you have;
Rejoice in the way things are.
When you realize there is nothing lacking,
The whole world belongs to you.

Putting It All Together (part 2)

The final area where I can help you in your Personal Spending Plan is the determination of where to make the changes—where to reduce your spending?

When you review your monthly expenses, classify them into three categories: Committed, Somewhat Discretionary, and Very Discretionary.

Committed items are things on which you are obligated to spend money—house payment or rent, utilities, car payment, car insurance. These expenses are not likely to go away, no matter what your goals are.

The Somewhat Discretionary category includes things on which you must spend money, but which allow you some discretion on the amount. You have to buy food, for instance, but perhaps you could do so more economically.

The third category is the Very Discretionary items, like gifts, eating out in restaurants, clothing, hobbies, snacks, and entertainment. These are the things on which you could really spend a lot less if you chose to, and you want to look here first for money to be reapplied toward your goals.

In this part of the process, you want to reduce the amount you spend on the Very Discretionary and Somewhat Discretionary expenses. First, reduce these amounts so you are at least not spending more than you make. Then, continue to cut back until you free up money to accomplish your goals in the time frame you desire.

Don’t be discouraged if you can’t fund all your goals the first time you try this process. This round is only the beginning, and as you accomplish one goal, that money can be reallocated to the next goal on your list.

Before you reallocate anything, ask yourself, “How much satisfaction does this bring me?” If you have an item for which you spend money that is very discretionary, but truly brings you a lot of satisfaction, then don’t cut that one first. For me, dining out once a week with my family gives me a great deal of satisfaction. If I were to cut that from my spending plan, it would constitute deprivation.

However, I use a great deal of self-restraint when spending money on movies. I don’t buy lattés, and I rarely go out for lunch. I pass up a lot of indulgences to save the money necessary to dine out once a week with my family. Though discretionary, some items on your list may need to be put in the “do not touch” category.

When you decide to cut back in a particular area, try not to be overly aggressive at first. The objective is not to deprive yourself, but to gradually steer spending momentum away from things that are of lower value in your life, and toward your true goals. Put the money where it counts the most, and remember that a little saved in a few areas adds up to a lot each month.

One helpful way to keep your goals in front of you is to put your list of goals on your refrigerator or next to your bathroom mirror. When something on which you want to spend money comes up, take a look at your list. Ask yourself, “Is this new leather jacket more important than saving to go to Europe?” By keeping focused on your goals, passing up that leather jacket will not seem like deprivation.

It’s all about personal choices based on facts—not sacrifice. It’s about funding your goals and living a life right now that is consistent with what is important to you.

When compared with the amount of knowledge most people have of their personal finances, just finding out where all your money goes in a month is a major accomplishment. To follow through by identifying and writing down your goals is even rarer. To complete the process by reallocating your spending to reach your goals—well, happy are the few who dare to venture this far.

Try it. The journey will be worth it.

Putting It All Together

The third part of a Personal Spending Plan is to make the all-important lifestyle and spending decisions based on the facts you have gathered. You want to determine how you can alter the way you spend money so that you can indeed accomplish your goals—without deprivation.

The reason you determine your top goals prior to making any changes in your spending habits is that without this data, your efforts are doomed to fail. I’ve never seen people stop spending money simply because they thought they should, or because someone told them to do so. It takes dedication to a deeply held desire to achieve lasting change in your spending habits, and this focus requires a clear definition of what’s important to you—your goals.

One of my favorite examples of this kind of dedication is Jeff.

I was leading a seminar for a group of hair salon stylists. One thing about hair stylists is that a lot of cash goes through their hands in the form of tips. For most of them, it’s easy come, easy go. They usually don’t know how much they get in tips, and they don’t keep track of where they spend it. I took them through the entire Personal Spending Plan process. I had them do a fact sheet on their current spending, identify their deeper passions and goals, and reassess how they were spending their money in light of those goals.

Three months later, we had a follow-up session. Before I could start, a young guy in the front row was waving his hand for me to call on him. It was Jeff.

“Um, is there something you would like to share with the group?” I asked.

“Yes,” he said. “From the goal-setting exercise you had us do, I got very clear about my goals. And I committed to them. I established two goals. I wanted to go to Hawaii or someplace else where it’s sunny once every year. . . .”

“That’s not a bad goal for someone living in Seattle,” I interjected.

He laughed. “Actually, for me it’s a necessity,” he said, “and I wanted a red Mazda Miata convertible. Those were my goals.”

“Sounds reasonable,” I said.

“I added up how much I spent on lattés and eating out in restaurants. In the three months since we were last here, my Hawaii trip is paid for . . . and you passed my red Mazda Miata when you walked in.”

I wasn’t the only person in the room who was visibly shocked. “How could this be?” I asked. “How could you do that in three months?”

“For three months, I went cold turkey on lattés and I learned to make my lunch and take it to work. I didn’t go out for snacks whenever I felt like it, and I ate dinners at home—or let other people take me out and pick up the tab!”

“I counted up how many lattés I consumed during the day. Six! Six lattés with tips is $24 a day. I spent an average of $5 a day on snacks. I went out to lunch everyday and spent about $8 every time. So far, that’s $37 a day. I work six days a week. That adds up to $888 a month. Cutting a few dinners eating out, I ended up saving nearly $3,000 over a three-month period. My Hawaii trip will cost me $1,100, and the remaining $1,900 was enough for the down payment on the car. I can now afford the monthly payments from the amount I won’t be spending on lattés and lunch everyday.”

People in the seminar applauded.

“I’d say you are a pretty committed fellow,” I said.“Congratulations.”

“Yeah, but here’s the thing,” he said. “If you had asked me at the last session how many lattés I drank a day, I would have said six. And if you had told me that I was wasting a lot of money, that I was spending too much—and that all that coffee was bad for me, I would have told you that you had no idea how much energy it takes to cut people’s hair everyday. It’s not only the haircutting and being on your feet, but also having to keep up the conversation. I would have told you that I couldn’t have gotten through my job, talking to those people all day long, if I didn’t have my lattés. I would have told you not to tell me how many lattés I should drink. And I would have told you that I don’t have the time to make my lunch every day. I barely make it to work on time, work long hours, and go home dead at the end of the day. That’s what I would have said to you. Instead, when I saw for myself that the lattés, lunches and snacks were costing me almost $900 a month, I realized I can more than adequately make a car payment and have plenty left over to go someplace sunny and warm every year. I instantly stopped drinking lattés. I got through the caffeine withdrawal—it wasn’t a big deal. And I’m getting up early each day to make my lunch.

“It’s like, once I realized that I could actually have these things, nothing could stop me!”

Jeff exemplifies a great truism about financial planning. When you clearly determine what you are committed to, and when you clearly understand the facts, you are likely to change your behavior.

With a Personal Spending Plan, you know what is really important to you, and you gain the motivation to alter, sometimes dramatically, how you spend money.

This plan is not about deprivation—quite the opposite. In Jeff ’s case, the result was abundance—attainment of the things he wanted most, and in a very short period of time. It also gave him a sense of pride, confidence, and personal power.

If I had told Jeff not to spend money, he would have felt as if I was trying to deprive him. It would have generated resistance: “Don’t preach to me about spending. You can’t possibly know what it’s like to be in my shoes.” But when he clearly understood that he could go to Hawaii and have his new dream car, simply by changing his spending habits, he altered his behavior immediately. He became self-motivated.

Just like dieting, financial deprivation doesn’t work. However, setting your sight on a positive goal aligns your energy toward achieving it. The negative activity just falls away.

That is the reason a Personal Spending Plan works. You first gain an understanding of where your money is going, and then you figure out what it is that you really want. With these two pieces of information, you can easily determine the areas where adjustments in your spending are possible and realistic. In no time at all, your goals become reality—without feeling deprived!

First, become clear about your spending habits; then become clear about your goals. Finally, determine the areas where changes in spending habits could be made.

Dream Big During the Goal Setting Process (part 3)

Now it’s time for step three: figuring out the cost. For many people, this area is one in which obstacles often arise. They have lived with the idea that their dreams are probably unattainable. They don’t want to look at the cost of their dreams because they are afraid they can’t afford them.

That was Abbey’s response. How could she possibly go to a Christo exhibit when the events were always in another country?

“How much do you think it would cost you?” I asked.

“A lot.” She responded.

“Well, you’re never going to save ‘a lot’ of money,” I said. “Let’s figure out how much it will really cost. Although we don’t know which country you’ll be traveling to, a good estimate for international airfare is $1,000. When you are there, how long do you like to stay?”

“Well, I’d really like to stay . . . a week,” Abbey responded.

“Okay, let’s put in a figure for six nights at a hotel and food for seven days.”

We came up with a specific amount for breakfast, lunch, and dinner. We added in some miscellaneous money for gifts or side trips she might be interested in, as well as a small contingency fund.

Once we went through that exercise, we discovered it would cost her $3,000 to go to an exhibit every three years. We divided the $3,000 into 36 months, and the result was that she would have to save $83.33 a month in order to accomplish her goal.

“Well, I can do that!” she exclaimed.

She set up a savings account and began to deposit $85 a month toward her trips.

Eighty-five dollars a month was an amount she could grasp, and it certainly was a lot more achievable than “a lot of money.” Passions and dreams do not have to be denied because they seem expensive. Once you know exactly what they will cost and commit to working toward them, they are often achievable.

Another client, Maureen, has a simple passion—her friends—so she includes an amount in her Personal Spending Plan called “community.” It provides for two weekends away with friends per year, one social dinner a week, and enough money to do six random acts of kindness. This is her number-one financial goal, and she sets aside $163 a month for this category.

Dining out is personally one of the joys of my life. When I was growing up, we could rarely afford to do so. When we did, it was a big thrill. It still is. Going to a restaurant with my family is a special event. My daughter Annie always puts on a fancy dress, and it’s a great occasion. If I walk out in my jeans, she says, “Mom. We’re going out to dinner. You need to dress up!” Going out to dinner once a week is in my Personal Spending Plan. It doesn’t cost very much money to bring my family the pleasure and happiness that our special weekly dinners create.

Once you have determined the cost of a goal, divide this by the number of months left until you want to accomplish it. Come up with the monthly amount necessary to save. Don’t try and figure out if it is possible yet; just do the work. It might be $25 a month to provide a family in India with a new home twelve months from now. It might be $75 a month to help fund part of your child’s college education. It might cost $167 a month for a down payment for a new house in the country ten years from now.

If you have completed the process outlined, you should have your top nine goals: three Immediate, three Short-term, and three Long-range. Beside each goal should be the total cost, when you want to accomplish it, and a monthly amount necessary.

Now, it’s time to put it all together…coming soon in next week’s post!