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Parents need to have ‘real world’ money talk with kids

Every parent at some point probably has "the talk" (as in, the birds and the bees) with their children, but not everyone with kids attempts "the financial talk."

With the start of a new year, new semester or any new phase in life, discussing how to lay the groundwork for a stable financial foundation is a vital conversation to have with your children.

While a college diploma may reflect the achievement of a broad base of knowledge in certain areas, it often fails to prepare graduates for the basic life skills that can make the difference between prosperity and hardship.

The anticipation of transitioning from collegiate life into the workforce can often distract students and parents from taking a step back to contemplate and analyze important choices in a rational way. It's easy to focus on a glamorous-sounding job title or exciting new city, but it's important to know how to evaluate life options so that unanticipated financial burdens or obligations don't take you or your child by surprise down the road. The topics below are often forgotten, but critical to cover with your kids when discussing life in the "real" world.

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Budgeting

One of the most important financial lessons a parent can share with children is how to budget. Financial independence is not limited to rent and groceries. It also means taking complete responsibility for all living costs, including rent, health care, phone bills, loans, etc. In order to save and invest money, your children need to calculate what money is required for necessities and begin to actively track their spending.

The excitement of beginning a career can overshadow the importance of immediate investing for retirement, selecting the appropriate health-care plan and paying off debts. A formalized budget offers the opportunity of viewing the percentage of money being spent and saved.

Setting up a budget earlier on in life can be beneficial in the long run. As a parent, take a moment during the financial talk to reflect on what has worked or not worked in your own personal finances and advise how to minimize spending and maximize savings.

While "budget" can sometimes feel like a negative term, consider the idea of managing yourself like a business. You can then look at yourself as a business that generates, say, $100,000 per year. In that case, what percentage of your "business income" should you allocate to housing, food, clothing and incidentals? That may make your calculations less emotional and more oriented to your bottom line.

For young professionals, there will be plenty of job movement and possible relocations. It is necessary, when having your financial talk, to stress the importance of comparing current salary and cost of living with new salary and cost of living. While the new job may be a pay increase, the new city may be twice as costly to live in.

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Moving from Atlanta to New York is a big difference in cost, and your children need to know if they can live comfortably on their new salary. There are online tools that help compare the cost of living in different locations, which can also be used as a jumping-off point to negotiate a higher overall compensation.

Debt

Debt is not something you can ignore, but certain debts take priority. For instance, credit card debt is normally the most expensive form of debt, with interest rates in the double digits. Make sure your children know the only way to stay debt-free is to never charge more money than what is in their bank account and always pay the full payments. Although paying the minimum balance may help in other financial areas, the interest rates add up and will keep you in debt for an extended period of time.

If your children took out loans to pay for their education, they are part of the 68 percent of students who financed their public or nonprofit education with loans, according to The Institute for College Access and Success. If your children took out government loans, the interest rates are generally fixed and can be tackled with monthly payments.

For private loans, however, interest rates can be higher — some greater than 18 percent — and they do not offer flexible payment options. That being said, focusing on the private loans first will save money from increasing interest rates.

Advise your children to prioritize high-interest debt. For instance, credit cards over low-interest debt such as car loans. Make sure they know that making more than the minimum payment is the best option and the fastest path to zero debt.

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Health care

A new job typically presents the opportunity to sign up for the company's health-care plan. Since most providers stop covering children at the age of 26, the discussion of what to do next should be included in your discussion. Adults without the proper health-care information risk the chance of paying out-of-network costs when visiting the doctor — costs that can be as high as double the in-network rates.

Before choosing a new insurance plan, advise your children to evaluate the typical health-care costs. What was their deductible last year? Did they hit their deductible? If your children are relatively healthy and have enough in savings to cover a health-care emergency, a high-deductible plan may make sense.

That's because a high-deductible plan means lower monthly premiums. But it also carries a risk of losing more money if a medical emergency were to happen. Comparing the average preferred-provider organization plan with a high-deductible plan is a good way to evaluate how much coverage is necessary.

Retirement

For young professionals, retirement seems like a lifetime away, but as parents can attest, it comes quicker than expected. If your children do not start saving immediately, chances are, they will have to work past the average age of retirement, currently 66 years old. Before allowing a financial advisor to invest for your children, make sure they know the differences between financial advisors vs. fiduciaries, low-cost index funds as opposed to actively managed funds, and high fees vs. normal ones.

"There's no better time than the present to start looking ahead to the future, and the time to have the financial talk with your children is always sooner rather than later."

Another area on which to advise your children is the types of funds to invest in. While everyone may have an opinion about whether a low-cost index fund or an actively managed fund is more profitable, low-cost index funds are typically the safest routes, especially for young professionals. A low-cost index fund is easily managed and has much lower fund fees because the funds buy and hold stocks or bonds in the Standard & Poor's 500 Index or Dow Jones Industrial Average.

An active fund requires analysts and managers to find hot stocks and bonds to invest in, resulting in higher fund fees. The only way to offset the fee difference is to have an active manager who can beat the index, a difficult feat to achieve.

Investing in an actively managed fund comes with many more fees than a low-cost index fund; however, all 401(k) plans involve different fees. Many plan participants are unaware of the fees they are paying in their employer-sponsored plans. Some fees include an investment-management fee, an administration fee, 12b-1 fee, etc. Your children need to do the research to know exactly what they are getting for their money before paying thousands of dollars in fees over the course of their working lives.

Advice

An important part of being financially responsible is seeking good advice. A common misconception is that financial advisors are solely there to help strengthen your portfolio and make the client the most money possible. The reality is that, to be a financial advisor, there is no formalized process, and limited regulation monitors their activities. And don't forget: These advisors make money off the plan you choose, so heed their advice, but be sure to do your own research as well.

Financial advisors go by many different names: financial consultant, wealth manager, etc. According to the Financial Industry Regulatory Authority, these are "generic terms or job titles and may be used by investment professionals who may not hold any specific credential."

Fiduciaries, however, are advisors who are registered with the Securities and Exchange Commission and are required to put investors' best interests first. It is very common for investors to confuse the two terms and potentially end up with poor investment choices.

These five points don't have to be covered in your first financial talk with your kids, but before they leave home, make sure they can navigate their way around these issues. Don't hesitate to share your own experiences. Did you make an investment you regret? What did you do right? Don't be afraid to share your hits and misses. Trial-and-error is a great way to learn, and you'll feel better letting your children learn from your errors rather than their own.

There's no better time than the present to start looking ahead to the future, and the time to have the financial talk with your children is always sooner rather than later. The more they hear the messages of thoughtful responsibility and planning ahead from their parents and see it in action, the more likely they will lead a happier, more financially sound life.

— By Jane King, founder, and Caroline Hedges, associate, Fairfield Financial Advisors