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A Great Gift You Can Give A Young Person
Most of us who are parents (and grandparents) tend to lavish attention on our children (and grandchildren), hoping we can provide the right encouragement, the right environment, and the right examples so these young people will turn into successful, fulfilled adults. We give them our time, our love, and (hoping that a little of it rubs off) the benefit of what we’ve learned in life.
But far too few of us take the time to teach young people about money and investing. As a result, most young adults face an increasingly pressurized and sophisticated world of hype and marketing prowess, all aimed at separating those young people from their money.
WHAT EVERY YOUNG PERSON SHOULD KNOW ABOUT MONEY
If you’re a typical reader of our newsletter, you understand money and investing better than 97 percent of the population. (The actual figure is 97.3468712 percent, but we hope you’ll forgive us for rounding that number down.) That means you already possess a valuable gift you can give to a young person: What you know about finances.
You probably don’t consider yourself an expert, because economics and investing are daunting fields. But I bet you know more than you think. This month I want to demonstrate that by outlining some basic things that many young people don’t know and don’t practice. And no matter who you are or where you are, there’s at least one young person who could benefit greatly if you took the time to teach some of these ideas.
What’s in it for you? There’s an old saying, very true, that "Teaching teaches the teacher," and it explains why so many people find ways to teach, whether it’s formally or informally. Few things in life are more satisfying than passing knowledge to someone who can use it to discover and create new possibilities.
One invitation I never turn down is the chance to speak to high school students. They are old enough to understand financial concepts and they will shortly have some money to put those concepts to work. And they are young enough that smart moves can make an enormous difference to their futures.
Here are 10 easy lessons I share with high school students. I believe these lessons can have an important impact on the financial future of those you care to help.
Please call or drop me a line of you have success with any of these lessons or if there are additional lessons you think are equally important.
LESSON ONE: SAVE MONEY INSTEAD OF SPEND IT
I like to ask high school students what they would do if they won the Lotto. Would they spend all the money they got in 20 years of payments? The answer I hear is invariably "No way!" The reason: Those payments will stop after 20 years, and most of them understand they need to save some of the money for the future. Then I ask what they would do if somebody gave them $50. Would they set some of that aside for the future, too? Usually they wouldn’t.
I SPEND, I SPEND, WITH A LITTLE HELP FROM MY FRIENDS
I ask these students to take a blank piece of paper and on one side make a list of all the people who want them to save money. It’s usually a very short list, made up of parents, grandparents, and occasionally an uncle or an aunt. Then I ask them to write on the other side of the paper all the people who want them to spend money. They usually don’t need much help with that list, which includes every store, theater, and drive-in in town, friends, siblings, boyfriends and girlfriends, credit-card companies … and every advertiser there is.
If you have money, in any amount, you’ll have no trouble getting all the assistance in spending it. But you won’t find much popular encouragement for saving. You might think banks would encourage people to save money. But in fact banks would much rather that you do just the opposite, spending not only money you have but money you don’t have. It’s called credit, and it’s a big danger for many people, especially young people.
SAVE VS. SPEND
Save vs. spend is the most basic fork in the road when it comes to money. The big decisions – what to do when you win the Lotto – are easy to understand. But most of us receive money in much smaller chunks. Every time we get $50 or $100 or $1,000, we’re facing the very same choice as the Lotto winner. Do we spend it all, or do we set some aside for the future?
Why don’t we use the same decision process in both cases? Why don’t we treat every paycheck as if it were an installment of the Lotto and certain to run out in 20 years? I think the reason is that we tend to trivialize financial decisions unless there are big amounts involved. This leads us to:
LESSON TWO: LITTLE THINGS MEAN A LOT
Most of us who care about the future of young investors are aware that if you saved only $1 a day from the time you were born, and invested the money at a modest rate of return, you could retire in wealth. (Review our article: How To Build A Multi-Million Dollar Retirement On $1 A Day.) This is one of those things that everybody talks about and few do anything about. But people could do something about it, especially young people.
If you get the chance to talk to an 18-year-old about money, hand him or her a $10 bill. Ask him what he thinks that $10 will be worth in the future. Chances are, he won’t know. But if that teenager wants to retire at age 60, he has 42 years. If he invested that $10 and let it compound at a 12 percent return, that puny $10 would provide him with an income of about $140 a year for the rest of his life. And the money itself would still be there, only it would be worth nearly $1,167.
This is a good introduction to the concept of saving $1 a day. Point out that $10 represents just 10 days of that savings. Suggest he think what he could have for $365, an entire year’s worth of $1-a-day savings. After 42 years it would provide you with about $5,000 of annual income (as well as nearly $43,600 sitting in his investment account).
This may sound impressive to an 18-year-old. But remember, the $10 will probably burn a hole in his pocket. He’ll be tempted to do something with it to get immediate gratification … and think about that saving stuff later. This sets up the perfect opportunity for you to deliver:
LESSON THREE: TIME IS EVERYTHING
Ask him if he ever had $10 a decade ago, when he was 8 years old. Ask him what he did with that money, and if it still gives him satisfaction. Then point out that if he had invested the $10 back then, it would provide him with an annual income of $3,625 at age 60. That’s more than three times what he could get by investing the $10 now – all because of an extra 10 years. The point is the magic of compound interest, and that magic works best over very long periods of time.
I'm reminded of the mythical story of an ancient Roman rascal who was entrusted with a large sum of money intended to set up a trust fund that would run for 2,000 years. The rogue stole all the money for himself except a single penny, which he invested in government bonds paying 3 percent a year. After 2,000 years, that single penny was enough to do the trick, for the trust fund wound up being worth more than all the assets on the planet today ($472,600,000,000,000,000,000,000).
The point is that when it comes to money, time is magic. That 2,000-year trust fund started out with only a single penny. But that was all it took to capture all the wealth in the world, at least in theory. The biggest asset a young person has is time. Whether he can afford to set aside $10 or $1,000, he should do it now. Remember the Nike advertising slogan: Just do it!
LESSON FOUR: THE FORCES AREN’T WITH YOU
Every young person should have at least an awareness of two great counterproductive financial forces: inflation and taxes. You can’t avoid these two risks, but you can manage your level of exposure to them. And you should do so.
Inflation and taxes are like two unceasing forces of nature, the tide and the wind. Build a sand castle on the beach, and even a light wind will blow those grains of sand back to the beach. This is erosion, and it may be gentle and slow. But on the beach, nature always wins. Likewise, the tide can come in and simply overpower that sand castle, quickly undoing whatever the wind did not destroy. Think of taxes as the tide, inflation as the wind.
Inflation, like the wind, silently erodes the purchasing power of every dollar you save. I like to tell young people another story to illustrate this point, one about one of my favorite topics (which we wrote about here in 1994): the price of a stick of gum. Now personally, I happen to think the "real" price of a stick of gum is about a penny. That’s what it was when I was a kid. Today’s youngsters think the "real" price of a stick of gum is a nickel.
Inflation will keep pushing that price upward, and the effect is especially dramatic over long periods of time. At 3 percent inflation, today’s 5-cent stick of gum in 50 years should cost 22 cents. After 100 years, it’s 96 cents, a price that starts to stretch my concept of reality. Farther in the future, that 5-cent stick of gum sells for $18 in 200 years and nearly $2,500,000 in 600 years.
There’s not much anybody can do about inflation, a silent but deadly financial foe. One of the best ways to protect yourself is to follow Lesson Five, which we’ll get to shortly.
The subject of taxes is much too complex to get into with a young person, and I wouldn’t suggest a detailed discussion except with a budding young CPA wannabe. But every young person should know a few things about taxes, and you ought to try for an audience of at least two minutes on the topic. In that time, try to make these two points:
Always pay attention to the tax consequences of any investment you make. You don’t have to know the tax code, just know somebody to ask. If there’s another way to accomplish something and save taxes in the process, check it out thoroughly before you act, not afterward.
Remember the magic of time. A dollar of tax paid tomorrow will cost you less than the same dollar paid today. You can’t escape taxes, but you can defer them. Do it!
If you can make those points in two minutes, you’re a fine teacher. And you should have no trouble imparting:
LESSON FIVE: KNOW THE DIFFERENCE BETWEEN AN OWNER AND A LOANER
In most cases, young people should be owners, not loaners. In other words, they should own equities instead of bonds. This is the most effective way there is to combat inflation. But much more important, in my opinion, is that they understand the difference.
Today’s young people certainly know about Microsoft, and they’ve probably heard that the company’s stock has made Bill Gates the world’s wealthiest man. So use this company’s history as an exaggerated example of the difference between equity and debt. Ask your student to imagine that it’s 1986 and Microsoft stock is about to go public. Remember the company is then only one of about half a dozen major software companies, and it’s not the biggest. All those other companies are out to eat Microsoft’s lunch. Microsoft at this time hasn’t produced any consumer products, just operating systems and computer languages. And personal computers are still regarded by many people as strange toys. In other words, this company’s future is far from a done deal.
Ask your student to imagine that he has the opportunity to use his entire savings to buy either $1,000 worth of Microsoft stock, on which there is no income and no guarantees he’ll ever get a penny back; or a $1,000 Microsoft bond (though there has never been any such thing), with a promise by the company to pay back all the principal plus interest of 9 percent on December 31, 1996. Which choice would your student have made? The right answer is obvious in hindsight. The loan would have earned your child $1,500 in interest plus the return of the $1,000 loan. The $1,000 investment in Microsoft stock grew to be worth about $143,000.
Of course the potential of Microsoft was not so obvious back then. But the important thing is to understand the difference between debt and equity, not to believe that one is better than the other. Investments come in many complex configurations, often hard to understand. Some of them contain elements of both debt and equity. If you can spot the difference when you see it, and if you know the implications, you’ll be much less likely to be taken in by a fast-talking salesperson.
And that leads nicely to:
LESSON SIX: JUST SAY NO WHEN YOU HEAR THE WORD "LOAD"
If there’s only one "don’t-you-ever" command that you could teach, make it this: Don’t ever pay a commission to buy a mutual fund. There are so many good no-load funds available that there’s just no good reason I can think of to pay a load. A load does nothing for the investor. It does nothing for the fund. It does nothing for the fund’s portfolio manager. It simply compensates a salesperson for persuading an investor to put money in that particular fund. And it costs the investor the guaranteed equivalent of one of the biggest one-day stock market losses in history, because the value of the investment immediately drops.
How do you make this point to a young person? Well, most young people drive cars, and most of them buy gasoline. Ask your student to imagine being hungry and nearly out of gas, with only $10 in his pocket to put some petrol in the tank and buy a hamburger on the way home. Now have him imagine that he sees two gas stations ahead, selling the same grade of gasoline, one for $1.58 a gallon, the other for $1.30 a gallon. The only difference is that one station has an attendant who will pump the gas, while the other one makes the customers pump their own. Which station will your student pull into? The answer is obvious, and so is the reason. Teach your student to buy mutual funds the same way: at the self-serve pump.
By this time you have covered a lot of ground with a young person, and you have probably made a lasting difference in ways you will never know. It’s very understandable if you want to stop here. But if you and your student are still game for more, there are some other basic lessons you could pass along. I’ll try to be brief in outlining the final four lessons, knowing you can fill in the details from your own knowledge and experience.
LESSON SEVEN: WHATEVER YOU DO, MOST PROFESSIONALS WILL THINK YOU’RE WRONG
Whatever investment choice you make, 99 percent of the people in the financial services industry will wish you had made a different one. They will do more than wish. They will bombard you with marketing materials and hype. They will tell you they have found "something better" for you. They’ll warn you of real or imaginary risks you’re taking by not buying whatever they have to sell.
It’s not just the investment industry where you’ll get this pressure. Pick up any financial magazine, newspaper, or newsletter and you’re likely to find articles on the great things that "you should be buying now." The media buy into the hype because that’s how they keep people’s interest. Which is how they keep people reading or watching. Which is how they sell advertising. Your best defense against all this is to become a skeptic. Remember the purpose of the media is not to entertain you or inform you. The purpose of the media is to get you to buy things.
If you understand why you are doing what you are doing, it will be a lot tougher for somebody else to talk you out of it.
LESSON EIGHT: DON’T PUT ALL YOUR EGGS IN ONE BASKET
Diversify your investments no matter how sure you are that you have found "the one surefire winner." In investments, you simply have to expect that the unexpected will happen. Your first piece of diversification can come from buying a mutual fund that invests in numerous companies in numerous industries. Later you can buy more funds and diversify further.
The time may come when you believe you know enough about some investments to concentrate in them. If you are so inclined, you may want to emphasize certain industries or types of funds or securities that you understand. But always be skeptical about the extent of your knowledge. Remember you’ll be competing with professional investors who are dedicated, well-educated, and backed up by awesome computer power – and who spend all their time trying to find ways to "beat the market." Few of them succeed for long. Are you sure you are smarter than they are?
LESSON NINE: STICK TO YOUR PLAN, AND GET SOME HELP
The most successful people in every walk of life have some sort of plan and they stick to it. The second part of that sentence … sticking to the plan … is at least as important as the first. Too many investors are forever in search of the "perfect" strategy for making a killing in the market. They flit from fund to fund, from stock to stock, from system to system, often investing heavily in last year’s or last quarter’s winners.
These people might sometimes land on a really excellent strategy. But they wouldn’t have any way to know it, because they never give any plan enough time to work. Don’t become one of those people. Do your homework thoroughly, find a plan that seems to make sense to you, then carry it out and stick to it.
The second part of this lesson is to get some help. Just about anybody can benefit from having a mentor to bounce ideas off of. Be wary of would-be advisors in the financial services industry. Most of them have a vested interest in getting you to do certain things. That’s called a conflict of interest, and young people should be taught that concept and taught how to recognize a conflict of interest.
One good place to find a mentor is in a local chapter of the American Association of Individual Investors. Join a chapter, and you’ll generally find people who have spent plenty of time and money learning about investments and who will be happy to pass on what they know to you.
How will a young person make such a connection? Just tell your student to sign on to the World Wide Web and type in this address: http://aaii.org/. (Trust me, young people will know how to do that.) That Web site contains a lot of good information that is not tainted by sales pitches.
LESSON TEN: LEARN TO RECOGNIZE OPPORTUNITY WHERE EVERYBODY ELSE SEES DISASTER
When the next big bear market hits, the popular press will treat it as a disaster. What else could the media do after leading a whole generation of Baby Boom investors to believe that the current long bull market is the new norm, the way things are supposed to be?
Young people at an impressionable age should not take such talk too seriously. It’s normal for markets to go up and to go down. That is the market’s job, and when it goes only one way, it is not doing its job well. People in the media don’t like to hear that. They like to paint everything as black or white, good or sinister. That’s easy for writers, editors, and producers to understand. And easy for readers and viewers to understand.
But life isn’t that simple. The very long term trend of the stock market is upward, and young people should not abandon their investment strategy or permanently bail out of the market just because some stock index goes down a few hundred points. Really astute investors welcome bear markets, knowing that lower prices bring opportunities as well as pain.
If you want to end this lesson on a philosophical note, you can quote a philosopher whose name unfortunately I cannot give you: "What the caterpillar calls death, the Master calls a butterfly."
Source: http://www.fundadvice.com
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