Leading By Example

The new Consumer Financial Protection Bureau (CFPB) has been getting ready to start working on behalf of the American people – a first step in the right direction. I am hopeful that this new agency and its website www.consumerfinance.gov  will be more effective than some of the previous and sadly pathetic attempts by government agencies to lead, educate and protect consumers from predatory and deceiving practices of the financial services industry.

Point in case are the numerous agencies claiming to regulate financial markets who all failed miserably in predicting and preventing financial crises or to stop criminals like Bernie Madoff and their Ponzi schemes.

Equally disappointing are websites like www.mymoney.gov which is nothing but a collection of links to yet more agencies. All this sounds confusing to me and we really can’t expect the younger generation to find any leading example in this fog of financial confusion.

When teaching the younger generation about financial literacy, we cannot look to the government for clarity and we definitely cannot expect politicians to lead by example – Democrats and Republicans have both failed miserably. Just look at the recent budget proposal by the current administration. The projected budget deficit for 2011 is $1.645 trillion, that’s $1,645,000,000,000 just for this year. Not sure if you’re ready for this, but take a look at what’s ahead in this neat chart showing the trend of projected US budget deficits (see chart).

The sad reality is that individuals, parents and a few well-meaning educators have to play the lead role and give the right examples when it comes to personal finance. The best way is to use baby steps and drive home the point that you simply cannot spend more than you have.

I like using easy rules of thumb like the 80/20 rule which works really well in business. Convert that 80/20 ratio to a simple guideline for your personal budget. In kids’ terms: If you have $10 in your pocket, try not to spend more than $8. Keep $2 in your pocket or put those $2 in your piggy bank. Imagine what that simple 80/20 rule could do to everyone’s personal finances and how easy it would be for the younger generation to learn from such a simple example…

Reminder: Today is National Money Night Talk

In case you haven't scheduled this yet, I suggest you stay home for dinner tonight, cook a healthy meal and sit down with your children to talk about money, stressing the importance of savings and living within your means.

Cooking a meal at home, rather than going out to eat would be the perfect initiation to bring up the topic.  It's also a good point, mid-way through the month of September, to assess how much the family has spent on eating out (use your judgment how detailed that discussion should be, depending on your children’s ages). 

As a family, list down all the days you went out to eat (lunches and dinners) and record the total the family has spent so far this month on just eating out.  Take that number multiply it by two and you have a rough estimate of a whole month's worth of expenses on eating out.

I am sure the family will be surprised (if not shocked) when they see the total amount spent.  The discussion could now turn towards establishing a sensible budget for eating out hopefully leading to the common goal of decreasing the number of days/nights eating out and making the few nights you’re going out more special.

There are additional benefits you could sort of squeeze in.  Learning how to cook is one tremendous upside, the more you cook the better you get at it and that might also rub off on your children.  Yet another benefit is the fact that you might end up eating a lot healthier.

Most importantly though, you are spending quality time with your family and you can have discussions about money, budgeting and savings a lot more often - hopefully more than just once a year…

The Rule of 72 in a different light

We previously discussed the the Rule of 72 as a simplified way to find out how long an investment will take to double at a given interest rate. Here’s how it goes:

Divide 72 by the given interest rate and you can find out how many years it will take double your money.

The Rule of 72 also works in another way;  you can find out the exact interest rate or rate of return needed if you wanted to double your money within a certain number of years. You can rework the Rule of 72 like this:

72 ÷ # of years = the rate needed to double your money

Here is an example:

Roger is 16 and he’s saved up $5,000 so far. He figures, he can easily double that amount 6 years, by the time he finishes college.  But  Roger is not sure what type of investment or interest would be needed to achieve that goal. Let’s plug in the numbers to see how this could work...

      72 ÷ 6 (years) = 12 (%)

Solution: In order to double $5,000 in 6 years time, Roger will need to find an investment giving him a compounded annual return of 12%.

Sounds like simple stuff in terms of calculations but we all should consider using this as a gauge when talking with your kids about financial planning. If their time horizon is say 10 years (e.g. until they get out of college) remind them that they will need about 7% of compounded annual return to double their money.   A nice side effect of using the Rule of 72 in conjunction with certain milestones, i.e. Graduating from Middle School, High School or College, is that it gives the kids an objective and a time horizon that they can grasp.  This is possibly more effective than telling them they should save for retirement in 50 years, which is a time frame, even most of us parents are unable to grasp.

Real Estate Financial Myths Exposed

The Federal Reserve Bank of St. Louis has some very useful educational resources for kids in Elementary, Middle and High School at: http://www.stlouisfed.org/education_resources/ 

Browsing through their website, I came across a good article which, at the time, should have been heeded by everyone who got caught up in the real-estate frenzy.  This is good reading material for High School Students.  The article could open up some additional discussions in a sense that some areas in the country are showing signs of house flipping trends once more.

Please consider: Just Sign Here: Bottom-Line Personal Finance Myths

The article goes on to dispel the following 3 Myths:

Myth #1: "All that matters is your monthly payment."
Myth #2: "Rising house prices make us all richer."
Myth #3: "It's always better to buy than to rent."

Reviewing these 3 myths with your children would be a good way to start a discussion on how to improve their financial IQ.  As the table below shows, statistics indicate that US households do a rather poor job at demonstrating basic financial literacy skills.  Hopefully the ongoing discussion with your kids will make an improvement for future statistics.

Resisting The Lure Of “On Sale” Items

We have all been there - Browsing through your favorite store and you see that big red tag:

 
Sometimes you see a huge sign right in front of the store inviting you to come in and “save”

Who wouldn’t want to save money and get some new gadgets at the same time?

As luck would have it, that gizmo you previously looked at with a bit of disdain looks a whole lot better now with the “20% Off Sticker” attached to it.  Isn’t it strange how a “soso”, “just ok”, “maybe yes” item now becomes more like a must have item?  And the only difference being the advertized sale price?

Try the following discussion with your kids - and the mental exercise might do us parents good too:

Understand that the word “savings” is a complete misnomer in the context of advertising.  The only way for you to “save money” is to not spend it.  Put your money in a piggy bank or open a savings account – that is saving.  When you go shopping, you may pay a lower price on a sale item, but you are definitely not saving.

Next, appreciate that prices always change buying behavior, there’s simply no way around it. But instead of letting your impulses give in, ask yourself this:  Would you still buy the this gadget or the new dress if it wasn’t on sale? 

If the answer is yes, then you might have a legitimate reason that the item is something you really need.

If the answer is no, go back home and look around the house to find similar items you bought on sale.  Evaluate for yourself if those items are still as desirable as they once were when you fell prey to that big red sale tag.  Are you still using any of these items today, and would you buy them again at the full retail price?

Resisting the shopping impulse is harder when items are on sale but it is an excellent way of learning how to handle money.  Your kids may come out of a store with an itch but it will be a great lesson on how to save money.

 

As always, comments and suggestions are much appreciated.
For questions, please email: clemens.kownatzki@fxistrategies.com

A Spending Diary

Many of us are familiar with Weight Watchers through commercials or actually having tried one of their weight loss programs.  It's a great concept that works on a simple principle: "Watch what you eat".

How about using the same premise to "Watch what you spend"?

We have an easy one-page work sheet that you can use as a budgeting tool to track where your child's money is going. Your kids are far more likely to save money when they see how fast the small things they buy here and there can add up. 

Click on the image below to see the full-size work sheet...

Your kids might need some help in the beginning. You can practice filling out our worksheet together with your kids the first time through and let them handle it from the 2nd week on.

Help them write down what they spent their money on each day.  They should include everything even the dimes and nickels! After a couple of weeks or so, go over the completed sheets and help them figure out where they can save money by evaluating each expense.

A couple of spot checks each week might help just as reminders...

Depending on your child’s age, using different colors for different categories might make the exercise more fun.  That also helps them see how to use categorization as a budgeting tool.

If you would like a printable version (PDF file) of our work sheet please email: clemens.kownatzki@fxistrategies.com

Credit cards and “Savings”

As you may know, credit card companies have to display the following warning on your credit card statement:

Minimum Payment Warning: If you make only the minimum payment each period, you will pay more in interest and it will take you longer to pay off your balance. For example:

While this is a very good development raising some awareness about the dangers of borrowing too much debt, notice the subtle word “Savings” in the last column.  Very clever marketing which draws attention away from the better choice:  You should always pay off your credit card debt in full every month! 

Yes, paying off slightly more than the minimum amount is better than paying only the bare minimum but it is still making the credit card companies far too much and far too easy money and it’s costing You the credit card holder a fortune in interest expenses.

Instead, one should consider to either pay the full amount of $564 now or pay a total of $816 within 5 years.  You DO NOT save by paying anything less than the full payment but you may make the credit card company a little less money by paying a slightly higher amount than the minimum payment.  Still, the credit card companies would rather you pay them in incremental amounts. As attractive as it may sound (Savings), you are better off facing the music now than later.

Let’s look at this from another angle, using the rule of 72 that we mentioned in our previous discussion:

At a typical rate of 20% for finance charges, credit card companies (not you) can double their money they make from you every 3.6 years and here’s how...

72 / 20(%) = 3.6 (years)

Sounds like a real good business to be in...and a bad deal if you don’t pay your credit card balance in full.