Blog: Financial Prudence - Catching them Young
Reasons why inculcating expense hygiene and financial literacy is important for the young adults in your family
One of the biggest differentiators between the generation z and the earlier one is their approach to finance. The younger population seem to be particularly inclined towards ‘spending’ than ‘saving’. They strongly believe in asserting their opinions rooted on the idea that, ‘We live only once and we better live it up!’ There is also a fear of missing out on good things in life if they don’t experience them early in life.
The older generation on the other hand is keener on saving and have a more stoic approach to life. They believe that fruits of labor are best enjoyed in leisure and in later days of life. While they are largely successful in creating comfortable savings and nest eggs for their children, the biggest compromise they had to make was missing out on enjoying their youth. They ended up putting off living, to after retirement and sadly ill-health and other related issues prevents them now from eventually enjoying their retirement.
The relative merits of both the approaches can be debated endlessly. Interestingly, both approaches have their own advantages. However, wisdom lies in striking a balance between both and taking the middle road which is spending right and saving wise. As a generation which has seen a lot of upheavals in the financial world, we have learnt a lot of lessons. One of the biggest contributions we can do is teach our younger generation to avoid the pitfalls we fell into or managed to avoid in life.
Some of the critical lessons are distilled here for you to pass on to the young adults in your family and network.
Do not spend the money you don’t have – Spending beyond your means is a dangerous habit and in no time, you could end up being very unstable financially. Credit cards are a huge bait that encourages you to do just that. Unless you have the earning capacity to pay the bills by the due date, credit cards can be considered as just loans with exorbitant interest rates. Sticking to paying with a debit card ensures that what is spent goes from your checking account and your savings. Cash is another viable option for payments without dependency to external agencies.
Keep aside money for emergencies – Emergencies like a job loss or a critical medical issue could crop up anytime. Life is way more uncertain than we would like it to be. The financial planners globally are of the opinion that an emergency fund equal to approximately six months of your income would be a wise amount to set aside. This is to be created at the earliest opportunity and never to be used unless the unfortunate emergency arises.
Educate yourself about the basics of the financial world – Most people fall for quick money-making schemes and other financial scams purely due to lack of understanding of the basics of finance. So, speaking to family members on how banking, loans, investments etc function would be a good start. Your auditor could also be a good source of information. There are also various online platforms offering free tutorials on financial literacy for youngsters or whoever wishes to upgrade their knowledge. Always remember when it comes to returns promised, ‘If it is too good to be true, it most probably is!’ Financial literacy makes one aware of what are reasonable returns that can be expected for investments and be wary of instruments and organizations that offer more than that.
Understand the power of compounding – Compounding is one of the magical phenomena of the financial world. Essentially, you not only earn interest on your principal but also on the cumulative interest that has accrued over a period of time on your principal. In Compounding growth doesn’t happen linear but happens exponentially. For compounding to be most powerful, the savings should start at the earliest. Hence a person starting to invest a way lesser amount at say 21, tends to grow his savings to a much higher amount than someone starting a bigger amount at about 45 or 50. Time you stay invested and consistency of investing makes one extract the best benefits out of compounding.
For example, let us say $10,000 is held in an account that earns 5% interest annually. After the first year, the total in the account has risen to $10,500 with $500 in interest added to the $10,000 principal. In the second year, the account again earns 5% growth on both the original principal of $10,000 and the $500 of first-year interest, resulting in a second-year interest of $525 and a total balance of $11,025. After 10 years, assuming no withdrawals happen and a fixed 5% interest rate gets accrued, the account would grow to $16,288.95.
Have financial goals and learn to budget for achieving them – It could be goals to buy a house, car or make any other investment or it could be saving enough for a cruise or a break year from work to travel. Financial goals give you direction to take and discipline needed for saving right and saving enough. Combined with a clear budget, achieving the goals becomes easier. When there is a goal, one can work backwards on restricting the expenditure to make achieving the goal possible.
Start working on a retirement fund – No one wants to work for ever. Like it or not we are mortals and there is surely a retirement period we should be prepared for. Planning for it should start early as it is a sure event in future. Even here the effects of compounding can be availed best if the fund creation initiatives start early on in life. While living in the moment and enjoying it is essential, youngsters should be made to see that sunset years are for real and there is nothing worse than a financially unstable old-age.
Understand taxation and inflation – A lot of what we earn goes away as tax. Similarly, inflation impacts all our future earnings and life as well. Very simplistic ideas of investing would not help you tide over the challenges created by taxation and inflation. Reading up and understanding the implications of tax and inflation on your present and future earnings and how to overcome them is a key part of financial literacy. The lure of a high salary should not be the only factor that sways your decision on a job offer. The breakup of salary and how it impacts your income tax should be considered before the choice is made. Similarly, budgeting expenses should be done keeping in mind the eroding value of money due to inflation every passing year.
Have insurances in place – Medical, health, accident, home and property insurances are important to be had to avoid the sheer difficulty and financial burden, not having one can cause. A small accident, ill-health or a theft can completely wreak havoc on your budgeting and finance. For a much lower monthly or annual premium you can mitigate the risks associated with emergencies or accidents.
In the context of insurance, I am reminded of a quote from George Elliot’s famous novel Silas Marner, “The lapse of time during which a given event has not happened is constantly alleged as a reason why the event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent.” This is the only way to approach insurance. It protects you against clear and present future risk.
If you are looking for some help in preparing your team to be future ready in financial and investment discipline or equipping them for a smarter life with any kind of soft skill coaching, do write to us at harish@harishrao.world to know how we can help you with it. We would love to work with you on this or any other business coaching needs you may have!