Ideas to Help Our Youth Get a Strong Financial Head Start, part 1: Outrun the Debt or Don't Be In A Pickle!

In an earlier article I quoted James Taylor, but since the topic here is youth let’s borrow a line from James’s younger brother Livingston: “I could barely hobble when I needed to run.” What does that have to do with America’s youth getting ahead? Well, when it comes to their finances, hobbling is what most of our children find themselves doing as they enter adulthood, mostly due to high levels of debt. But it doesn’t have to be that way. It’s still possible for them to move through the dangerous Debt Accumulation stage of the Financial Life Cycle quickly – if they run a smarter race.

More temptations, more debt
Young adults today are entering a challenging work environment. In addition to living in a world with less job (and therefore less income) security, they also face new temptations to spend carelessly as well as the burden of historically high debt. If mishandled, these financial challenges could set them back for years at a critical time when they should instead be moving ahead.

One temptation is plastic. Plastic payments (credit and debit cards) now account for 53% of consumer purchases compared to 43% in 1999 (1), and they are increasingly accepted and used for even incidental purchases under $10. Usage rates are highest among young people. The danger of course is that plastic is painless…until the bill comes due, that is. Letting credit card debt accumulate at an early age is an accident waiting to happen.

-- For our children, the American Dream of doing a little better than their parents is still within reach - if they learn to manage their finances smarter. That starts with getting ahead of debt quickly. --

In addition to credit card debt, there is student loan debt. College seniors who have taken out loans to fund their college education now owe a record-high average of $25,250 at graduation (2).

Then there is also the temptation of making their first car a new one. With it comes a debt in the form of a monthly loan or lease payment. And the debt burden grows.

So, debt is the danger…specifically, debt accumulation. As explained in our e-booklet, Wealth is Good, Cash Flow is Better, Debt Accumulation is the first stage in the Financial Life Cycle. It is defined as when your total debts (liabilities) are greater than your total assets, which means you have negative net worth. You want to escape this stage as quickly as possible and move on to the Asset Accumulation stage, and then graduate to Debt Reduction. The more quickly you move through these early stages of the financial life cycle, the faster you can reach the final stage, financial independence.

So what strategy should young people follow to outrun debt and move into positive territory in the Financial Life Cycle?

Minimize then Prioritize
The best way to outrun debt is to not join the race in the first place. That is, make every effort to minimize borrowing. This requires a certain mindset. It’s a mindset exemplified by our parents and grandparents – Americans who lived through The Depression and World War II. The shared experience of that generation conditioned them to sacrifice, postpone purchases, and pay with cash rather than credit. So the best first step is to think like a member of The Greatest Generation and minimize debt whenever possible.

Of course, debt can’t always be avoided. In some cases there might not be any alternative than to borrow for an important investment. A student loan is a good example. For debts already incurred, the focus (dare I say, the obsession) should be to pay them off as quickly as possible! Start by prioritizing them and then pay off one at a time. Unpaid credit card balances are always a good place to start, given their high APRs and long repayment terms (often 15 years, which means almost none of your minimum payment goes towards reducing principal).

Once the first debt is paid off, monthly cash flow that was previously committed to that debt is now freed up. This newfound cash can be used to pay off the second debt on the priority list, perhaps an auto loan. When that’s paid off, even more cash flow becomes available to pay off debt number three, maybe a student loan.

The key is to attack the debts one at a time. For each one, establish a payoff deadline and then commit to a specific monthly savings amount to achieve it. Coincidentally, we’ve established a tool – the 8020 Worksheet™ -- to help not just young people but ALL people do just that. (We’ve now reached the shameless self-promotion part of the article.)

But regardless of the debt repayment approach you choose, the overall goal is to escape the Debt Accumulation stage quickly. Unfortunately, a growing number of people classified as young adults not too long ago have failed to do so and are now older adults still stuck with heavy debt burdens. Unpaid credit card debt is often the culprit, but a surprisingly high number haven’t been able to get ahead of education debt. Over 37 million Americans now have outstanding student loans, owing in excess of $870 billion – that’s more than all the credit card debt in this country ($693 billion) and all of our auto debt ($730 billion). (3) After many years, millions just haven’t been able to outrun that debt. As a result, their prospects for achieving financial independence anytime soon are fading.

The title of the Livingston Taylor song referenced above is, “I’m In a Pickle (I Ain’t Got a Nickel).” The last thing we want for our children and the next generation of Americans is to fall behind in the race to pay down debt. Accordingly, our advice and the challenge we make to young adults is: Don’t be in a pickle, outrun the debt!

(1) American Bankers Association and Dove Consulting credit card usage survey, 2011
(2) Student Debt Project report by the Institute for College Access & Success, 2011
(3) “Grading Student Loans” post by scholars at the New York Fed, March 2012