Teach Your Children Well

As parents, we want what is best for our kids and want to prepare them to be independent and successful adults.  Two of my three children are in college now and, from my experience both as a parent and working at DWM, I have learned there are some gaps in the financial education and understanding of money in our young people, including my kids.  Money isn’t everything and certainly should be kept in perspective related to other pursuits in life.  That would be my first tip for the young adults in my life.  However, money is a means to an end and it is important for them to understand their own unique balance sheet and learn strategies to successfully manage all the variables that will affect their financial future.

1. Protect and Grow your Most Valuable Asset – YOU!

One of the most important things for college-age or young working adults to realize is that by far their most valuable asset is themselves!  For a young adult, the ability to generate income for the next 40 or so years is their most phenomenal asset.  Understanding the value of this asset can encourage them to look for ways to magnify that potential earning power and minimize the risks to it. Will additional education improve that income potential?  It is also smart for young people to realize that the future is uncertain.   We need to teach them to prepare for any risks, like economic downturns, that may reduce asset growth or increase their liabilities.  This can help them recognize that using resources to maintain adequate disability or life insurance can be as important as insuring your car or home.  Creating good habits in saving, tax-planning and budgeting are important to protect against unanticipated variables.

2. Diversify your Assets

When evaluating net worth, most people tend to think of some of the obvious current assets that you might include – a house or a car, for example.  Looking more deeply, though, will show some differences in those assets.  This is another area where younger people may need some education.  A car’s value, for example, should be considered against the taxes, maintenance, gas and depreciation that essentially makes it worth much less over time.  Same with a boat.  Real estate is usually considered a good asset to offer diversification, if it is appreciating at or above inflation.   An interesting article from the Wall Street Journal notes that as wealth increases, the percentage of net worth represented by a principal residence declines.  Young adults should understand that diversification is an important strategy and having a good mix of assets will make you financially stronger, especially over the long-term.

3. Spend Wisely

In general, a personal balance sheet should include the value of everything you have and everything you owe, even if some of those are intangible.  When you put the potential value of a career’s worth of income in real dollars in one column against the future costs of loans or other debts, it makes the impact more visible.   This strategy can help spotlight the real costs for student loans, houses, cars, trips, credit cards or luxury purchases.  An Investment News article recently quoted a study that found more than half of college bound students had failed to estimate their student loan costs adequately and regretted the decision to take out those loans, once their repayment programs had begun.  Certainly, when evaluating the merits of an educational program or even a business investment, it would be smart to consider potential income benefits against the costs for that investment.  Weighing the purchase of a new flat screen TV or expensive pair of shoes against the value of income needed to finance that goal might make anyone think twice!

4. Save and Invest Early

Finally, it is significant for young people to know that they can really maximize the potential on their balance sheet by saving and investing as early and as fully as possible.  Learning the value of compounding in real terms can be a wonderful eye-opener and understanding the effect of inflation on a dollar over time can be equally enlightening.  Not all saving is created equal.  A penny saved is worth more than a penny earned, when you factor in taxes and compound interest!  It is important to maximize retirement investments and practice the “pay yourself first” philosophy of saving and investing to create a good financial plan.

Also, young workers should be encouraged to immediately sign up for employer retirement plans, like 401(k)’s, and to maximize their contributions to take advantage of any match programs offered by their employer.  If their job doesn’t offer one, opening an IRA or Roth IRA might be a good solution.  Starting a Roth at a young age allows the investor to take advantage of making after-tax contributions while in a lower tax bracket and creating an account that can grow and offer tax free funds for use later in life.  As an example, a 25 year old who makes the maximum allowable annual contribution of $5,500 annually to an investment vehicle that averages a 5% return could have around $700,000 by the time they are ready to retire.

The biggest lesson that our kids and other young adults should be taught is that the most important key for success in wealth management, as in most things, is discipline.  We love to educate our clients and their families.  Please let us know if we can help teach your kids good financial habits.

Financial Literacy for Young People: Math and Family Communication are Key

Child-Financial-LiteracyWe work with families. In some cases, three and even four generations. We love that aspect of our work and we’re often asked about ways to improve financial literacy for young people. Our experience and recent research show that a good understanding of math and regular, excellent family financial communication go a long way.

43 states currently require personal-finance classes to be taught in high school. These classes are intended to produce good long-term financial behavior. Typically, the kids are taught financial facts and strategies long before they even need it. Furthermore, recent studies, including those by Harvard professor Shawn Cole have shown that that these finance classes are not working and there “is virtually no effect of (high school) financial education on (future) behavior.”

However, studies have shown that math has an impact on students’ financial outcomes. Students required to take more math classes ultimately practiced better fiscal responsibility than other students as young adults. This included a greater percentage of investment income as part of their total income and lower rates of home foreclosure and credit-card delinquency. Charlie Wells of the WSJ recently put it this way: “Focus on teaching math-not money.”

Without strong math skills, people tend to use more emotion in their investing, spending and saving patterns. Further, people with less math experience don’t easily understand the concepts and benefits of basic long-term strategies such as exponential growth and compounding. Studies show that people that are comfortable with numbers and making numeric comparisons make better financial decisions.

The other big key is that financial education should begin at home. Unfortunately, that is easier said than done. In fact, a research professor at North Carolina State University has found “parents talk more about sex with their children than they do about money.” Parents need to have a process to include the children in family financial discussions.

Here’s how one family did it. Scott Parker of Encinitas, CA, stopped by his local bank and withdrew his entire monthly salary in cash. In singles. It took 24 hours for the tellers to put his $10,000 request in stacks and bags. At dinner that night, he dumped the money on the kitchen table.

It certainly got the kids’ attention. Parker’s 15 yr. old son initially thought Dad had robbed a bank. After a pause, Mr. Parker and his wife then went through the expenses, taking money off the table for each one. Taxes, house payment, food, car payments, soccer, scouting, tithe for church, hamburger night and everything else. By the end, there wasn’t much left on the table.

This type of exercise is a great example of communicating with your family. Initiate them early, even at 4 or 5, and keep communicating as they grow. Shielding children from the realities of everyday financial life makes little sense, particularly given the financial responsibilities their generation will face.

Communication helps solve a major problem for children. Money is a source of mystery to them. They sense its power and ask many questions: “Why isn’t our house as big as my cousin’s?” Why can’t I get Lego Mindstorms- it’s only $349 and educational?” Adults often do a poor job of answering. They may deflect the question as impolite. Or they may respond defensively. The right way is to use the question as a “teachable moment”- an opportunity to increase the financial education of the child. Of course, this isn’t always easy, especially after a full day or work, school and outside activities.

Over time, the children should understand both the family budget and the choices made in determining it. “What are our needs, wants and wishes?” “What priorities did we determine?” “Why did we make those choices?”

It’s good to have them involved in the decision-making process on certain items. For example, spending money on a high-end family dinner out or putting the money towards the “Disneyland fund.” They see much of the spending. However, credit cards make it difficult for them to quantify items. That’s why Mr. Parker’s bag of money was so instructive.

Wealthy families have special challenges. You may worry that the children will flaunt their good fortune or think they never have to work. Full disclosure may not be the best solution. Rather, involve the children is smaller financial learning experiences requiring math comparisons and making good choices.

Financial literacy is a process. Over time and with regular communication, children will better understand the family budget, key questions, priorities, and choices. And, they will understand the math involved in evaluating choices rationally rather than emotionally. This is particularly valuable when they become teenagers, as they start to make choices about college and student debt and as they move into the working world. A good financial education will help them throughout their lives and hopefully will be passed along to their children someday as well. Our core purpose at DWM is to protect and enhance the net worth and legacy of our client families. Financial literacy for the entire family is a key to meeting that goal. Please let us know if we can help in any way.