Personal Finance

4 Financial Lessons to Teach Your Children When They Are Still Young

We can't expect our children to know everything about managing their money the moment they turn 18. As parents, we need to teach our children how to be responsible and understand the value of money. In this blog post, we will go through 4 significant financial lessons that can have meaningful impact on our kids' lives.

Everyone wants her children to lead a happy and healthy life. However, there's a big difference between indulging children's every desire and actually teaching them skills and lessons they need to grow up to be responsible adults. Here, we discuss some of the major financial lessons that are essential for children to learn early in their lives to ensure their financial wellbeing.

There’s No Free Lunch

This is one of the most crucial lessons that a child can learn. Those who understand this principle realises that a wealthy and comfortable life comes with hard work. In some ways, this is most obviously reflected in the people's income by their highest qualification attained in school, as shown below. Clearly, investing in one's education early increases his ability to lead a better life later on, while slacking off now will eventually have negative consequences. Of course, your child doesn't have to crack PMT or IIT-JEE to lead the kind of life you want her to. However, simply instilling a sense in them that everything has a price can really help them make more thoughtful choices in life.

Average salary by highest education attained in India varies from Rs. 4,575 to Rs. 20,431

How to teach such a lesson: The main thing that you want to teach your children is that they have to work to earn and get what they desire. The best way to do so is to give them an allowance in exchange for doing certain chores. You can also give them a bonus for doing something good, like scoring 90% in a subject or winning a competition. Over time, this can teach them that hard work often pays off. 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: Providing your kids with an allowance is an excellent way of teaching them to be financially responsible. However, being too severe with penalties for bad behavior runs the risk of driving your child to moral hazard. If you keep deducting allowances for a child who misbehaves, the deductions could add up to a point where the child loses all hope of recovering from the "debt." For example, if your kid misbehaves long enough that he has to make up Rs. 2,500 of allowance before he receives even a rupee, he may just give up and keep behaving badly.

Spend Less Than You Can Afford & Avoid Borrowing

Middle-class Indian parents are usually good at sticking to a budget. However, studies suggest that children who grow up while being subject to a strict budget are more likely to spend more than they earn and accumulate a lot of debt. This is why it is even more crucial to teach your children to spend less than they can afford so that they can save up for a rainy day fund. Life is unpredictable, and sometimes one emergency is all it takes to derail your financial life. In such cases, a rainy day fund can work as a life jacket when you're drowning in the river. Savings also pave the way to achieving other milestones, like buying your dream home or quitting your job to start your venture.

Indian Rupee Bill

How to teach such a lesson: Children learn by imitating. If you aren't responsible with your money and use credit cards to buy unnecessary things that you cannot afford—like an iPhone or a designer bag—or piling a mountain of personal debt, your child may easily learn to not think twice about over-relying on debt too. Instead, showing them that you save a good percentage of your paycheque every month and explaining to them how your future depends on it can teach them to be great savers just like you.

Caveat: Times are tough, and it is not always easy to consistently save money. However, living paycheque to paycheque doesn’t mean that you can’t train your child to save. Even as you spend, you can still explain to your child how you are trying to reduce your expenses and what expenditures you’re avoiding. The key is to demonstrate the spirit and logic of saving, even if your budget may not leave too much room for it.

Power of Compounding: Start Early

Investing is as important as saving. In a nutshell, what the power of compounding entails is that beginning to invest early in one's life allows his money to earn more money for him over time. When money is allowed to be compounded over time, your wealth can grow exponentially. For example, investing ten years earlier can yield more than twice as much money even if you were to start with the same amount of money and earn the same yield every year. Teaching your child to invest in stocks will help them make significantly more money in their lifetime. Even Warren Buffett once said that "the best thing you can do for your retirement savings is to start investing early."

Compound interest

The concept of compounding can be applied to other areas of life as well. Starting early can help your child benefit from compounding in almost every sphere of life. Take, for example, knowledge and expertise: if your child does slightly better than his peers in school, her teacher is more likely to invest more effort on her, which may lead to your child getting unique opportunities for grants or competitions, which then could lead to encounters with other like-minded people. The results can be unimaginable.

How to teach such a lesson: Compounding can be a challenging concept to explain to a young child. You will have to demonstrate to your child how even the smallest difference in the starting point can lead to 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: You may be tempted to force your child to start learning everything from a young age, even if they don't see eye to eye with you on this subject. However, iit can prove to be counterproductive if you are forcing your child to learn something he's not interested in. Try to get your child to understand and appreciate this concept and encourage them to take on a long-term project that they would enjoy from start to finish, so that they can actually feel and appreciate the practicality of compounding.

Think on Your Own Feet and Be a Little Skeptical

Independent thinking is something Indian parents often neglect as they like to be a big part of the decision-making process. The Indian education system, as well as the social environment in the country, 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 (this is one of the reasons why so many students pursue courses such as engineering and medicine, even if they aren't interested in them). Businesses have exploited this tendency for ages and have been profiting from it. For example, supermarkets always place budget items at hard-to-reach places while those from "trusted" brands are placed at eye level to induce shoppers to "default" to more expensive ones. Similarly, car dealers are known to sell overpriced insurance policies and car loans.

thinking child

Instead of believing in what the companies claim, we should independently evaluate all the facts to make an informed decision about what's best for us. If you demonstrate the power of independent thinking to your children on a regular basis, not only will you save thousands of rupees overtime, you will also create a strong foundation for independent that can help them make well-informed decisions as adults.

How to teach such a lesson: Comparison shopping is one of the best ways you can teach your child to become an independent thinker. If you’re looking to purchase a washing machine, you may take your child along with you to the flagship store and let the salesman tell you about the product's features. Instead of purchasing the machine right then and there, take your child to a competitor brand's showroom to check out another washing machine. Compare the specifications and pick the one that fulfills your needs and budget. Show your children how you carefully consider the facts and how that evaluation ultimately leads to a decision.

Precaution: Don't go overboard when teaching your child to be skeptical. The goal is to ask relevant questions, collect the data, and choose something that suits your needs. This doesn't imply that one has to be skeptical of everything that people have to say, or that you need to spend an exorbitant amount of time to make every little decision in your life. Efficiency needs to balance independent thinking.

Duckju Kang

Duckju is the CEO of ValueChampion. He covers the financial services industry, consumer finance products, budgeting, and investing. He previously worked in the financial services industry, including at such hedge funds such as Tiger Asia and Cadian Capital.