This article originally appeared on ValuePenguin
Everyone wants her children to lead a happy and healthy life. However, there’s a big difference between letting kids get whatever they want and actually teaching them valuable (and sometimes painful) lessons so that they grow up to be responsible adults. Here, we discuss some of the major financial lessons that are extremely valuable to children especially if they learn early in their lives.
There’s no free lunch
This is one of the most important lessons that a child can learn with many different applications in life. For example, people who appreciate this aphorism can easily realise that investing in their education early on will eventually help them lead wealthier lives, and that procrastinating now will eventually come back to bite them. Simply instilling an instinct in them that everything has a price can really help them make more contemplated choices in life.
- How to teach such a lesson: You can start by giving them an allowance only when they do a chore or something good. This way, they learn that good work can often be met with reward. Not only that, since this is the only way that they can “earn” money, they will eventually learn to do more of the good things and to save their allowances for a purchase that they really want.
- Precaution: If you are too severe and deduct allowances as a negative reward for bad behavior, you run the risk of driving your child to moral hazard. When the deductions add up, the child could start believing that there’s no hope of recovering and eventually earning allowance again, and just give up. For example, if the child behaves badly long enough that he has to make up S$50 of allowance before he actually receives even a dollar, he may lose hope and just capitulate from the system.
Spend less than you can afford and avoid borrowing
One virtue that never hurts to live by is to save up a rainy day fund. Life is unpredictable, and when an emergency occurs a rainy day fund can be the difference between hell and heaven. Savings also help people achieve their dreams, like buying a house or leaving their jobs to start their own business. There is almost no downside to spending less than you can afford.
- How to teach such a lesson: Children learn best by observing their parents. If they see you swiping credit cards left and right or piling a mountain of personal debt, they will learn to be overly reliant on credit too. Instead, if you can show and explain to them how you save like your future depends on it, they are likely to become great savers just like you.
- Caveat: Of course, not everyone can afford to build up a large savings account. However, this doesn’t mean there is no hope in providing the necessary financial training to your child. Even as you spend, you can still explain how you are doing your utmost best to reduce your expenditures and what other expenses you are avoiding. The key is to show them the spirit and logic of saving, even if your budget may not leave too much room for it.
Power of compounding: start early
In essence, what power of compounding implies is that beginning to invest early in one’s life allows his money to earn money for him over time. When your money can compound over a long period of time, the growth can become exponential. For example, investing 10 years earlier can yield 2x more money even if you were to start with the exact same amount of money and earn the exact same yield every year, as we show in the chart below.
Of course, this means that teaching your child to start investing in stocks early in their lives can actually help them make exponentially more money over their lifetime. Even Warren Buffett said that “the best thing you can do for your retirement savings is to start investing early.” However, this concept of compounding actually applies to many areas out of traditional finance.
The concept of “starting early” can actually help them benefit from compounding in everything they do. Knowledge and expertise, for example, can compound too: if a student does even slightly better than others in class, teachers are more likely to invest more of their effort on her, which can lead to the student receiving special opportunities for competition or grants, which could result in serendipitous encounters with other talented individuals, which could light a whole new set of fires that could result in unimaginable results. No matter how you put it, it’s always better to start early than late.
- How to teach such a lesson: It may be difficult to teach a concept as complex as compounding to a 7 year old child. Instead, you can demonstrate how even a small difference in the beginning can result in vastly different results later on. For example, you can draw two lines of the same lengths with a concurrent starting point. One can go directly up, while the other can be at a slight angle. Then, you can make any number of analogies to help them understand how two people can end up at different places even if they have the same starting points and spend the same amount of effort or time.
- Precaution: It may be tempting to force your child to start early on everything, even while they don’t quite appreciate this concept. Worse, it could be counter productive to forcing a child to invest his time and effort in something that he has zero interest. Instead, try to get them to buy into this concept first, and encourage them to go through with a relatively long-term project that they enjoy from start to finish, so that they can physically feel and appreciate the value of compounding over time.
Think on your own feet and be a little skeptical
One of the most important but neglected skills in life is independent thinking. Our education system simply has never been designed to teach it. Instead, the whole society is bombarding us with information on what’s supposed to be the best for everyone, which most people accept at face value. By exploiting this tendency, supermarkets all over the world have made a fortune by placing expensive products at eye level and budget ones at hard-to-reach places to induce consumers to choose the “default” branded products that are readily visible. Car dealers have also continued to profit from selling people overpriced car loans and insurance policies.
Instead of believing in such claims all the time, we should instead evaluate independently the best option for ourselves. If we can show our children how to do this daily, it could not only help them save money over time, but also instill a habit of independent thinking that will hopefully help them make decisions as adults.
- How to teach such a lesson: Probably one of the easiest ways of teaching independent thinking is comparison shopping. Instead of making purchases on impulse after seeing an advertisement, show your children how you carefully consider the facts and how that evaluation ultimately leads to a decision.
- Precaution: When teaching children to be skeptical, you should be careful not to go overboard. The goal is to help them ask questions, collect information and make good conclusions, instead of merely not believing what people all the time.