Today my daughter and I went to Target for some home supplies. As I mentioned in a previous post, my wife and I have not done a great job of really teaching our kids what money is, how it works, and how understanding money can benefit them now.
But today I took a different approach. During the car ride, I asked her some probing questions such as:
- How are you going to earn your own money?
- How long do you want to work?
- Do you want to work because you have to or because you enjoy what you do?
- When will you be able to retire? Do you know what that means?
- If you saved part of your allowance, do you know how much money you could have when you graduate high school?
Not surprisingly, my daughter (who is turning 12 in a few weeks), didn’t know the answers to these questions. And in fact, she was actually quite confused by some of them.
I had to pull examples from her own life to explain what I meant, rattling off the names of some older friends who are retired, for example.
And then, once we arrived at the store, I asked her to help me price shop for the best deals. My wife had asked us to stay under her budgeted amount of $100, so I asked my daughter to help me add up everything we had purchased.
Why Kids Don’t Understand Money
I think one of the main reasons that kids don’t understand money is that they can’t see into the future. They don’t realize that money isn’t something that will always be there for them if they don’t plan and save the money they receive.
Frankly, some kids have been given money (or things that cost money) for so long that they assume that they will always have it.
But as adults, we start to realize that this isn’t always the case.
The adults who have the biggest problems with money are those who are more focused on consuming than saving, and subsequently pile up debt while living above their means. Some adults have a hard time understanding how this type of behavior is limiting their future selves choices and freedoms.
Kids that are raised in a way where they aren’t taught that “money doesn’t grow on trees” will grow up to be adults that are spenders first and fail to plan for the future.
What is Money and Why is Understanding Money Important?
Money is more than just paper bills or coins in your pocket or electronic digits on a computer screen.
Money is a tool. It has the ability to provide you with great freedom and choices to live life on your terms, or to make you a slave to a job and life that you hate where your lifestyle choices are limited.
Money is tied to value.
Everything in this world is tied to value. Different things or services are worth different amounts of money. The more money you have, the more choice you have regarding what you can buy with that money.
Say you want to buy a car when you turn 16 so that you can choose to drive where and when you want. That car will cost money. And typically, it is going to cost a lot of money. At least a lot of money to a 16 year old.
If a car is something you want, how are you going to buy that car?
Are your parents going to buy it for you? Will you save up your own money? Perhaps someone would be kind enough to give you their old vehicle?
The point here is that a car is not free. You will need to pay for it, and that is going to cost you money. If you wait until the day you receive your drivers license to start planning for that car, chances are it will be too late.
But this is what so many adults everyday of their life.
They wait until they want something, be it a car, or a new house or even some new clothes, and then instead of using the money they have been saving to buy it, they borrow money from a bank instead.
As a 16 year old, you don’t have the ability to borrow money from the bank. You are too young and you probably don’t have a full-time job. But as an adult, you can get a loan from the bank or use a credit card (more on these later) to borrow money to pay for something you want, but haven’t planned for.
The problem with this choice is that it raises the cost of what you are buying. When you borrow money to pay for a car, you are 1) raising the cost of that car, and 2) obligating yourself to pay for it over time for 2 or 3 or 4 years (or more).
On the other hand, if you planned ahead and saved for that same car, it would actually cost you LESS because your money is working for you as opposed to you having to work for money.
Money is the Hardest Worker I Know
Saving for a car could save you up to ½ the price of the car itself. You heard that right.
If you wait to buy a car until you have enough money in the bank to purchase it, you will save yourself approximately ½ the purchase price over someone who takes out a car loan (i.e. borrows money from the bank to purchase or “finance” their car).
A car is one of the first major purchases you will likely make in your lifetime (assuming you live in the United States), which is why I wanted to start with this simple example.
Let’s say you wanted to buy a car that cost $2,500. There are two ways you can do it:
- You can borrow money from the bank.
- You can save and pay cash.
Most teenagers do not have the ability to borrow from a bank, so their parents will act as the bank. Your parents may or may not have $2,500 lying around to lend you for this car, and they may or may not be willing to lend it to you.
If they are willing to lend you money for this car, then you will have to pay them that money back, plus interest, over a period of months. The larger the amount of money you are borrowing, the long there term of the loan. The banks do this so that 1) they make more money off of you paying back the loan and 2) to make the payments seem more affordable to you.
Let’s assume that the bank gives you a loan at 10% interest. Here is what your payment would look like (and the total amount of those payments) depending on how long your loan is:
- 1 year ($219.79/month – $2,637 paid)
- 2 years ($115.36/month – $2,768 paid)
- 3 years ($80.67/month – $2,904 paid)
- 4 years ($63.41/month – $3,043 paid)
The average consumer, when presented with these numbers, thinks “Wow! I can just pay $63 a month and get a $2,500 car! What a deal!”
And this is why so many people, young adults in particular, run into problems with money. They don’t see the forest through the trees.
Because not only are you paying $543 or 22% more for that car than someone who pays cash, but you are also limiting your future choices. Instead of being able to enjoy the freedom that car gives you for the next 4 years, you will have to get a job to pay back $63 a month to the bank each and every month until you have paid back everything you owe.
This because when you borrow money from the bank (i.e. your parents), they hold the title to the car. That means that if you decide to stop making your monthly payments, they can take the car back and sell it to get their money back. And while your parents may not do this to you, you better believe the bank will.
But let’s look at this from a different perspective.
As I mentioned earlier, I took my daughter shopping yesterday. Her and her siblings each receive an allowance in exchange for doing chores. They can earn between $0 and $10 per week. I also have provided a standing offer to match any money they put into an investment account I’ve set up for them at Schwab.
Let’s say my daughter decided to do extra chores and earn the max, $10/week. If she decided to save 50% of that money – $5 – and put it into her Schwab account I’ve told her that I would put in an additional $5 of “free” money for her.
That’s $10/week or $520 per year she can choose to add to her investment account. Now, $520/year multiplied by four years does not add up to $2,500… or does it?
$520 x 4 years = $2,080
And this is where most kids that don’t understand money get caught up. They don’t realize that their money, when invested into the stock market, will actually work for them!
So if she were to save $20/month (which is actually $40/month when you add in my matching) over 4 years, she would have a whopping $2,545 when she turned 16! This assumes that she earns a 10% return on her money (the stock market has returned closer to 12% annually since 1975).
By saving up for a car and earning interest, rather than borrowing to pay the car and paying interest to the bank, my daughter would have saved herself $963, almost ½ the value of the car!
Teaching Your Kids About Money is Important
This is just one of many, many examples I want to share on this blog about how knowledge of money and understanding money and how it works will save you a ton of cash in the long run.
It really does come down to a few simple choices that can compound over time to make a huge difference in your life.