What Every Student Should Know Before Graduating High School
Posted on July 11, 2008
When young people graduate from high school they are young and naive, especially when it comes to knowing how the real world works. Some will continue their education in college or technical schools, but many will enter the workplace feeling ten feet tall and bullet proof. Their zeal and enthusiasm for life will have them looking into the future and visualizing themselves living in a comfortable home, driving a nice car and prospering financially. Unfortunately, by age 30, reality sets in and outlooks change…unless they understand and follow a simple lesson from Economics 101.
Mary and John are 18 year olds who have just graduated high school and entered the workforce. Both have jobs paying $15 per hour and realize a 3 percent per year increase until age 30. Mary decides to save 5 percent of her gross income and put it in an investment account earning an average of 6 percent per year, compounded monthly. John takes a different path. He has the attitude that you only live once so you should enjoy yourself as much as possible. After all, you may not make it to retirement age. Let’s follow Mary and John during the 12 years until they turn 30.
As soon as he starts his job, John gets a credit card with a $1000 credit limit. The credit card’s interest rate is 18 percent and it has a minimum payment of $10 or 2 percent of the outstanding balance, whichever is greater. The first month he spends his entire income plus an additional $100 that he put on the credit card. Mary deposits $130, which is 5 percent of her gross pay into an investment account and lives on what’s left.
John and Mary are close friends, so in one of their conversations he tells her that he got to enjoy the $100 he charged to his credit card, while she didn’t get to enjoy the $130 she put in her investment account. That means he had $230 more enjoyment the first month than she did. He also points out that his minimum payment the next month will only be $10 and he can handle that with no problem. This continues month after month. John isn’t extravagant, but he keeps overspending about $100 per month. Gradually his credit card payment increases because his balance grows large enough that the 2 percent minimum is more $10, but he isn’t worried. It’s still just a small payment that he hardly misses.
Interestingly, as his balance nears its $1000 credit limit, John receives a nice letter from the bank informing him that due to his excellent payment record, they are increasing his credit limit to $5000. He also begins receiving solicitations from other banks that want his business and they offer him additional credit cards. Eventually he opens several more accounts with credit limits that total more than $25,000. Now he really feels good!
Watching John live it up is difficult for Mary. He seems to always get to do more than she does, but she continues to religiously deposit 5 percent of her gross earnings into her investment account. Because of her sacrifice, Mary eventually notices that the interest she is earning on her savings is growing significantly. She doesn’t mention this to John, but it sure makes it easier for her to keep saving.
By the time they reach their mid 20s, John’s spending habits haven’t changed. He is still spending an average of $100 per month more than he makes, but he isn’t quite as enthusiastic as he was at 18. Their conversations are now center around how he uses one credit card to pay off another so he doesn’t have to use so much of his paycheck to make the payments. Although he always seems to have more and be able to do more than Mary, her savings are growing while his debt is keeps increasing.
Eventually, they reach age 30 and John has an epiphany. He isn’t doing as well as he thought. His credit card debt has grown to over $10,000 and his payments exceed $200 per month. In contrast, Mary’s investment account contains nearly $23,000 and she is earning $160 per month in interest for which she doesn’t have to work. Mary points out that if she wanted, she could increase her standard of living by $160 per month for the rest of her life without ever having to touch her principal. John realizes that he will have to reduce his standard of living for years in order to pay off his debts.
The overall impact of living these two very different lifestyles between ages 18 and 30 is quite revealing. John averaged overspending $100 per month for a total of $14,400 over the 12 years. By funding this with his credit cards and paying 18 percent interest on the money, it cost him over $12,300 in interest and left him $10,000 in debt. While John was “living it up,” Mary’s investment account earned over $9,600 in interest. Mary could buy anything she wants with her $9600, but John paid out $12,300 in interest that bought him nothing. The combined total of the interest John paid and the interest Mary earned was over $21,900. That’s the price of impatience and should be a lesson for all young people…and most adults too. You can’t borrow your way to prosperity!
Here’s a tip! Pay yourself first! Set savings goal and meet it first. Treat your savings as money you never got. Forget about it! Adjust your lifestyle to live on what’s left after you pay yourself. This may seem difficult to do when you’re young and have a bad case of the “I wants,” but if you develop the discipline to do it, you will ultimately have far more in life than those who spend first and plan to save later.
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