There are simple money skills that an average 13 years old child can acquire, yet most people do not have. Below we will discuss my “two cents” about the subject. Before we dive in, try to imagine what this article will be about and how you will use it. I will explain this exercise in the article. For more reading visit here, here, here, here, here, here, and here.
The basic skill I never had
I wish I knew more about money when I was a child. Especially, how to treat it properly. Here are some of the misconceptions I had to overcome as I grew up:
- Money is evil. I was born long ago in a communist state where having too much money was a sign of criminal activity. While in a free market society money is hopefully a measure of value, in some other societies it is a measure of corruption.
- Poor cannot afford honor. When we immigrated during the first year we did not have enough money to buy quality food, so we used to take the food that was destined to be thrown away. Our hygiene was suboptimal, as some treatments cost money. We had to accept social injustice as we did not have money for legal struggles. To be honest, the issue was not so much the loss of money as the loss of professional reputation: the language skills, the connections, and understanding of the culture.
- Education is the way to social status. As a family and as immigrants we invested in education much more than the locals. This single-minded focus resulted in certain blindness and the loss of many opportunities. Some of my friends became very rich without fancy degrees. Some others became lower- mid-class with PhD. Self-education and life-long learning are much more valuable than any degree.
- Financial success is easy if you are talented and lucky. I was fortunate enough to learn engineering and get great jobs. My first full-time job culminated with the acquisition of the company where I worked. I felt like I could be very successful with some luck. Basically, I speculated which is equivalent to gambling and eventually lost all of the money I had.
- Money equals happiness. To be honest, I was never so lonely and misguided as I was when I had money. I was happy when I was trying to earn, doing something useful and building value for the customers and investors. I am quite happy now, helping people. Spending the money I had and chasing after experiences made my life empty and pointless.
- It is too late for financial education. This is the biggest misconception. Financial education can be acquired at any age. The sooner the better, yet with experience, we understand things differently and deeper. I was fortunate enough to recover from my stupidity, and learn a thing or two.
Clearly, with my kids, the situation is very different, and quite likely we make a very different set of mistakes.
The role of money
The true role of money in our is almost as complex as our lives. I will not use scientific definitions, but instead examples from real life,
- The means of exchange. In simple societies, people exchange goods of money and then exchange the money for other goods maybe later. Money used to be made of gold, silver or beans – something which is always valuable. Now money can be something much more abstract with complex electronic signatures, like bitcoins, its role is different.
- Money is the measure of value we attach to something. When we buy or sell, we always attach the value to the item. If we invested our efforts to make the item better or more appealing we will earn money. If we consumed some of its glory, we will lose money. This definition exchanges the complexity of defining money with the complexity of defining value.
- Value is defined by supply and demand. If the supply and demand are fixed, the market is advanced and there is no arbitrage, the economic assumptions might work. Anna has only so much time, so as she has more students the price of her lessons increases. If my wife was a commodity, decreasing the price of lessons would mean even more students. In the thought experiment, if the lessons become very cheap, Anna could have millions of students. This simply does not work this way: the perceived reputation will decrease and nobody would take the lessons. However, if Anna would offer recorded lessons for free and 1:1 for super-premium prices, probably we would make more money.
- In a capitalistic society, money is the means of production. This is definitely true in some scenarios, especially when dealing with production and companies. However, this has very little meaning for an ordinary family. Some money is hopefully invested in some sorts of funds and programs. It does not really matter if we talk about pension funds or ETFs, in any case, the product is very abstract. There are some annual revenues, hopefully positive, which are reinvested abstractly. The rest of the money is consumed.
- In a consumer society money is the means of paying salaries and buying goods and services. Once again we consider an exchange economy, only this time we exchange something more abstract. This could be as abstract as goodwill or reputation or electronic signature. The problem with consumer society is the assumption that everything can be measured in money. This is not always true. The air is critical for life but costs nothing. The lives of our loved ones are very valuable for us, beyond money, but not for our neighbors or social services. Some things like knowledge, freedom or political power are often somewhere beyond valuation.
As our lives evolve, the concept of money evolves with it, and so we need to reeducate ourselves. Remember the exercise in the preface? We imagine what the money is for us and educate ourselves with respect to that aspect of money. Then we grow and learn again. The most important part of financial education is constant lifelong learning.
What even a child should know
Even though there is no limit to learning, we must start somewhere. What are the basic money skills I teach my kids?
- Focus on ROI (here the return of investment, not a region of interest). Try to achieve the best value for every dollar and every hour of your time.
- Think longterm. Most financial concepts, like risk or interest rates, do not work well in a single transaction and short time periods. When considering decades, its a very different thing. Talking to your future self is a simple exercise to make this concept less abstract.
- Keep scores. Write down the key indicators of your economy, whatever this is. With time, the good and bad decisions will be painfully obvious and we will be less likely to make mistakes. My kids keep score of their investment in their music lessons and equipment and review it monthly.
- Do not spend, invest. My wife is more than happy to buy experiences: go to a theater or a restaurant, have a trip abroad or simply visit some friends with a good bottle of wine. I prefer to spend my money on educational toys: computers, 3D printer, photography equipment, guitars for my kids. We separate our spendings for accountability. Also, we both try to minimize the amounts we spend and invest in health, our children’s education, and in financial constructs (ETFs, stocks, crypto).
- Take calculated risks. It is OK to avoid risks. Maybe it is better to take small risks which come with a good premium. Up to some point, we can afford to lose and the premia on risk are good. Then the situation changes, and the risks turn into a dangerous gamble, which should be avoided. For example. I bought my kids quality branded guitars from Japan on ebay. They loved these guitars, but then found a really good looking cheap Chinese guitar and convinced me to buy it. This piece of junk is a small price to pay for the financial education of my kids.
- Limit your leverage. Leverage is the term we often use for borrowed money. The borrowed money often allows us to get to the milestones we want faster and may pay off. However, it comes with its own liabilities. We are not promised to get more using it, but we are promised to pay back more than we take. Taking no leverage and investing no money will result in very low progress, but wasting money on something that eventually fails is even worse. There is some fine balance which can be learned. My kids take money from me to buy guitars and guitar lessons, but then they need to work hard to repay with a small interest. They learn to spend my money wisely.
I built this short list without thinking too much. On a different day, I might build a different list. Above I did not even touch the difference between assets and liabilities, or the importance of scaling. I might do that below. There are myriads of things everybody should know to manage his money, yet we do not know them or do not apply our knowledge on a day-to-day basis.
Spending less vs earning more
A child cannot really earn much more and needs to control the way he spends or invests his money. As grownups we can balance the spendings and earnings. People who earn a lot and spend a lot appear to be wealthy, but this appearance is misleading. There are simple accounting issues to monitor: we should earn more than we spend, watch our cache flow, clearly separate assets and liabilities.
To earn more we often have to spend more. We buy expensive education to get premium jobs. Our clothes, houses, and cars should be sufficiently representative and communicate success for people to want to work with us. And then we spend more on bragging rights, not simply because we love it, but also hoping we will earn more. So we spend a lot, but we are not guaranteed to earn more.
At the opposite pole are the minimalists. They try to reduce their spendings, owning fewer earthly possessions and focusing on communication skills and other skills that require time rather than money. They might have fewer resources for healthcare, emergency handling, and beauty, but they have much less clutter and more meaningful time with their loved ones.
Most of us travel somewhere in-between, trying to earn more and spend less. It is important to understand that beyond some point spending less means earning less, but spending more does not necessarily result in higher earnings or happier lives.
Cache flow vs scaling
We can buy large stocks of consumables cheap and some quality stuff we do not really need if there is an opportunity. This may well be a great way to save money, but we also get stuck with large inventories. Americans have huge amounts of storage space for all the junk they bought and do not want to throw away. This storage space also costs money one way or another (real estates, maintenance, defocus). Also, buying a lot of stuff at once may provide a great discount but is definitely hard for the cache flow. Credit rates are cool, only as long as we can effortlessly return the money we borrow.
There are people who buy only what they want when they need it. It appears to be very wasteful: a lot of time spent buying stuff, high prices of each item, no preparation for crisis situations. However, this on-demand consumpion enables lean living in small places and key locations. Also, there are no huge dips in the cache flow and constant need to borrow money.
Similar ideas apply to companies and whole countries. Americans spend more than they earn, and this is a huge issue in the long run.
Growth vs wellbeing
In Israel, most families have at least three children. Asian families are happy with one or two children. Having fewer children enables more productive jobs and more focus on each child’s education. However, in the long run, the better demography is a strong engine of growth, and the aging population is a liability.
In a similar way, as a family we can spend more on the long-term grows, or on the experiences here and now. What we get here and now is basically risk-free. The future growth is uncertain. Each investment can result in financial failure. Moreover, we may be unable to enjoy its fruits due to some unfortunate consequences. For example, I had a great bottle of whiskey which I kept for a special occasion. Then I stopped drinking alcohol and gave the bottle as a gift. After several years I started enjoying great beverages again, but the bottle was long gone. Maybe I should have drunk it when I could…
Instead of conclusion
You might have noticed that in this article I provide questions rather than answers. I hope by now you want to read more on this subject. Let us invest this interest in financial education, and I also plan to return to it in the future.