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Teaching your kids about basic financial literacy?

by Tony Ryburn, Executive Director, Sharesight

I’ve recently been asked for advice on how parents should teach their kids about the stock market. But while I’m all for encouraging the next generation to find out about share investing, I actually think parents need to take a couple of steps back and ensure that young people have a good grounding in basic financial concepts before they even start thinking about investing in equities.

Over the years I’ve helped many families with their household finances, and continue to be surprised by just how many people put finance in the “too hard” basket.

The thing is, basic financial concepts are just that – basic – and anyone can understand them. But the important thing is to start learning early so it all doesn’t seem too daunting later on.

An idea that helps kids learn about money is to extend the idea of giving them pocket-money. The idea is to increase the amount of pocket money but make your child responsible for paying for various small things that you would have otherwise purchased for them. As they get older and demonstrate that they can spend responsibly, the budget can be increased to cover larger items like clothing.

One of the most important concepts I think we need to teach young people is the difference between short-term, medium-term and long-term financial goals – and how your priority actions for each timeframe will probably differ.

Below are some tips I’ve shared with young people in the past that might help you get started talking to your kids (or grandkids) about their own financial priorities and timeframes.

Short term: set yourself up for success

Understand where your money is going. Keep track of all your incomings and outgoings over 2-3 months. Are you spending more than you’re earning? What proportion of your income goes on essentials (rent, travel, bills and groceries) and what proportion is on discretionary spending (going out, shopping, etc).

Once you understand where your money’s going, establish a savings account that allows you to make withdrawals without penalty. Set up automatic payments that directs a portion of your discretionary spending into to this account each payday so you can’t forget to contribute. Adjust your discretionary spending so that your remaining funds last you until next payday.

Your savings account is not for your retirement, it is your fund for unexpected expenses such as car repairs, and also your pot for those “must haves” such as an iPad or a holiday.

Don’t borrow. If there is not enough money in your savings account for what you want, wait until there is! That will stop you from committing a cardinal financial sin – borrowing money. A little patience will pay handsome dividends over your lifetime. For example if you have on average $1000 on your credit card over the next 20 years at a 15% interest rate you will pay over $3000 in interest. How much better off you would have been if you had waited until you had that $1000 in your savings account!

The only exceptions to the ‘don’t borrow’ rule are if it is for something that will create lasting value that exceeds the interest you will pay. For example a loan to buy a house that will appreciate in value (and save you the cost of renting), or a student loan that will enable you to learn new skills.

Medium term: think bigger picture

Consider saving for those big commitments. What are your financial goals for the next few years? Would you like to buy a property or set up a business, perhaps? If so, you’ll most likely need to start saving for the longer term. Set up a separate account with high interest rates and don’t be tempted to dip into this pot of money early.

Longer term: the road ahead

Consider other investment options. The share market, investment property, bonds… The list of investment options for the longer term (which generally means retirement) seems endless and you will need to think carefully about what’s right for you.

Nevertheless, the most important thing when considering these types of investment options is to only invest money that you are prepared to put away for the long term. While money invested in the share market, for example, will usually outperform most other investments over a period of many years, there will be times when the investment underperforms. That means that if, for example, you need to withdraw money during a period of underperformance, you will crystallise a loss that otherwise would have been recouped when the market picked up.

In my next post I’ll be discussing how to get kids started in the stock market, if and when they’re ready.