Of all of the things that you learn at university – the many courses you take, making friends and social contacts, and learning more about yourself than you ever cared to know – it’s a good bet that financial savvy isn’t one of them. By financial savvy I’m not simply referring just to the ability to stretch a dollar farther, but rather all things financial.
In truth, financial savvy is something you should begin learning as early in life as possible. The sooner you develop at least a basic understanding, the better your entire life will be. In fact, many of the most important lessons about money you’ll ever learn should be happening about now.
Want some examples?
InvestingAs soon as you begin earning your first paycheck, you should already have some idea as to what to do with at least some of your money. That is, you should understand the importance of putting at least some of it aside, and attempting to grow it to into even more money later.
You should also have some idea as to how to grow the money that you save. Sure, you can put it into an interest-bearing savings account, but with interest rates as low as they are right now – and likely to be for the foreseeable future – that could be a losing battle against inflation.
Some of what you should be learning about investing now – at least generally – might include some of the following:
- The basic investment assets, like stocks and bonds
- Mutual funds and exchange traded funds (ETFs)
- The importance of diversification, and how it is achieved
- The various investment sectors that are available, such as growth stocks, growth and income stocks, and various industry sectors that you can invest in
You certainly don’t need to be an expert in any of these areas, but a general understanding will go far in making a shorter learning curve when you start investing with real money.
As a university student, there’s a better than even chance that you have some real familiarity with this financial category. These days, that seems to be a fact of university life.
But there’s more to debt than just signing papers and receiving money to pay for university expenses. Many students go through their entire time at university never fully appreciating the implications surrounding the other side of the debt equation – the repayment of that debt.
While debt is mainly seen as a way to get now what you cannot currently afford, it’s important to understand the implications of repayment. For example, at the time you’re borrowing money you have to consider the income that will be available to make the payments. You should have at least a rough idea as to what those payments will be, and how much of a drain it will represent on the incoming you will earn.
This kind of understanding might help you to limit the amount of debt that you take on when you’re in school, as the reality of repayment can be quite sobering. And consider it a lesson worth learning – it’s a relationship you’ll have to understand anytime you borrow any amount of money in your life for any purpose. It can include a home mortgage, an auto loan, or even a credit card.
Though debt can enable you to buy something right now, the ultimate effect will be a reduction in your income. The earlier you learn that lesson, the better off you’ll be going forward.
The Time Value of Money
This concept is a double-edged sword – it’s an ally to the investor, and an adversary to the debtor. The concept is best illustrated by examples.
Borrowing money. Let’s say you take a mortgage – $200,000, at a 5% rate of interest, over 30 years. Though you only borrow $200,000, by the end of 30 years, you will have paid back $386,512. The difference between $386,512 and the $200,000 you received from the loan is interest in the amount of $186,512. That’s the time value of money as it applies to debt. You can determine the dollar amount of repayment by using a mortgage calculator.
Notice that the interest you’re repaying is nearly equal to the principal amount of the loan you received. In a higher interest rate environment, the cumulative amount of interest paid can actually exceed the original loan amount. The take-away? Borrowing money isn’t all about your monthly payment!
Investing money. If you invest $10,000 in a mutual fund, and the fund has an average annual rate of return of 8%, at the end of 10 years your initial investment will grow to $21,589 – which is more than twice the amount of your initial investment. You can do such calculations using a simple savings calculator.
What’s important to understand is that the time value of money increases your wealth as an investor, and decreases it as a borrower. This is one of most basic financial lessons for any young person to learn.
Most university students have at least a vague concept that taxes exist. Less well-known is how pervasive they are. They are income taxes, property taxes, ad valorem taxes, sales taxes, use taxes, and even taxes on the gas you put in your car and the electricity you use in your home.
Taxes represent a reduction in income. Though a starting salary of $50,000 per year may be attractive to a new graduate, income taxes mean that he will not necessarily receive that income in either his wallet or his bank account. The net amount received – the amount collected after paying income taxes – will likely be something significantly less than $40,000.
There are at least two reasons to have a firm grasp of the impact of taxes:
- Taxes mean that you will always earn less than you think, and pay more than you expect…
- …which is why you’ll want to begin minimizing their impact on your finances as early in life as possible.
This is a complex financial topic, and one that will require awareness early in life, as well as the input of advice from experts in the field.
Some of these financial topics – and they’re actually quite a few more – may seem beyond the scope of the university students life. But soon enough you’ll be stepping into a world where their impact will be very real. Spend some time now developing some financial savvy, that way you’ll be ready by the time you graduate, and you can avoid making some costly mistakes.