BB & GG only started getting serious pocket money from the start of this school year. Luckily for us, they don’t really spend the money they get as pocket money, instead putting it in a money box. I’ve told them that at the end of the year, we will tally the money they’ve saved and half of that will go into their bank accounts and the other half is for them to spend.
I’ve also opened a trust savings account for them, this was when they were about a month old. Into this account went all the money they’ve received till date – all birthday money and any money that their doting grandparents and other relatives would give to them on festivals and occasions. I’ve also been putting a small sum into this account every month and over the years this has added up to a good amount. The money in this account is meant for tertiary and other education for both of them and I don’t want them to have access to this account ever!
So that BB & GG learn the importance of a savings account and learn to use it responsibly, I am keen that at least by the end of this year, I open savings accounts for them, these will not be linked to the ones I have already opened for them.
So that they know how to manage their finances, I’ve also been reading up on financial literacy. I actually consider this one of the most important subjects that should be, but is not taught in schools and colleges and so I decided to read up and then go on to teach them the same.
So what exactly is financial literacy? One definition I found and which I felt was very appropriate says, “Financial literacy is the ability to use knowledge and skills to make effective and informed money management decisions”.
Income and Expenses and the relationship between them
To be able to make informed money management decisions, the first thing you need to do is to teach your child what income and expenditure are and the relationship between them. In very simple terms, income is what you earn – your monthly or weekly salary plus anything else you earn when you are not working. Expenditure is everything you spend on. The difference between this is your net profit or loss. Profit happens when income is more than expenses and loss is when the reverse happens.
All expenses need not be bad, some expenses, which you incur to obtain something which will stay with you for a while (that is what we call an asset) is probably good expenses. Examples for this can be buying a house, spending money on learning something new which helps you in your day job or paying for your passion, which in turn is turned into a source of income.
However, not everything you buy that stays with you for a long time is a good expense. Now we bring into the picture a term called Depreciation. Simply put, depreciation is the reduction in value of an asset over a period of time due to wear and tear. A good example would be a car. You pay good money for the car, add to this the various taxes and the maintenance you pay for it over a period of time. When the time comes to sell the car, you would not get even half of what you’ve paid for it, this is depreciation. Another good example is electronic items when you buy them, you pay a premium, especially for some products. Then when the next upgrade comes, your current model is sold for pennies!
Spend, Save, and Share
When you earn, it does not mean that you need to save everything except that which you need for daily expenses and necessities. You should also keep some money to spend on things that you like. However, it is always better to divide your income into two or more buckets – to save, to spend and maybe to use for the less fortunate.
By this same token, if you have multiple goals, you can have multiple accounts in your bank
Saving for long and short term goals
The long term goals will be big goals – like a house, a car etc, medium and short term goals can be holidays, electronic equipment, etc and the daily expense account should be your usual account. As soon as your salary gets credited to your account, transfer the agreed upon percentage to each of these accounts. This is called ‘Paying Yourself First’.
Make sure that your ATM card is not linked to these accounts so there is no temptation to dip into them. Make it easy to see the balance online, but difficult to access it online and through the ATM. This will reduce the temptation to use these accounts as back-ups when you find yourself short.
Since BB & GG are not earning members of society nor have any long-term goals at the moment, all their savings will be for short or medium term goals. I am going to get them to write down their short and medium goals so that they have goals to work towards.
This is perhaps the biggest lesson that financial literacy teaches us and one that is often relegated to the bottom when it comes to personal finance. Anyone who deals with money needs to budget it. And when you are young like BB & GG, it becomes important that they learn this when they just start learning about money so that by the time they start earning decent money, budgeting becomes as essential to them as breathing or eating!
Budgeting is a plan you make each month (or week or whenever you get your income) on how to spend your money. Budgeting is important because it allows you to have a plan for your money and also makes sure that you always have money for things that are necessary and those that are important. It also keeps you on-track for your short, medium and long-term goals in life.
When you go to purchase anything, ask yourself always if you can live without the item. If yes, then go away and do not buy. If the answer is no, then still put it back, but think about it for a week or so. If after a week, you still can’t stop thinking about it, either see if you can afford it or if no, then plan to save it for your short-term goals.
Making an initial budget is quite simple – make a list of all income on one side, and then first move money to your savings, then account for the necessities and what’s left will be your fun money or money you can use for entertainment or for yourself without feeling guilty about it.
If you have basic accounting knowledge and know how to reconcile your own accounts, it will help you in own budgeting and financial planning.
The power of Compound interest
One of the biggest advantages when it comes to financial management, especially for those who start saving early on, compounding your money allows it to grow faster. Compound interest happens when the interest that is accrued to your savings account adds to the money into the account and that interest, in turn, earns more interest.
So for compound interest to be really effective, you need to start saving much earlier, rather than later. Even if you put in small sums, but at regular intervals over a period of time, starting from when you first start working (or even earlier, if possible), then with careful planning, you may even become a millionaire by the time you hit 50 years of age!
Here are some images which show you the immense power that is compounding.
As BB & GG grow older and more financially savvy, I want to introduce investing concepts to them. These are all topics for posts which will probably come later as they become more financially lierate.