While sitting at the kitchen table with my client at Carroll Lutheran Village during one of our financial planning meetings, I was given a task. The client asked, “What can I show my grandchild to teach him about money without spoiling him?”
I had always helped my clients make smart decisions with their money, but in this case, I had to help my client teach their grandchild, without me there! This was daunting, yet my mind started racing. Lessons like this don’t happen in one sitting, they occur over-time and by example. This is why our clients value a “whole family” approach to financial management.
Thankfully, we had a head start. The grandchild, we will call him Tommy, had a good shoulder on his head. He was an A student and already applying for colleges. He was lucky in that his parents and grandparents helped him financially, so he could remain focused on his studies. However, he needed to eventually learn how to handle money on his own. I immediately thought of several life lessons that would put any child on the right path:
• Never stop learning. Knowledge is power and will help you earn a higher income and thus accumulate more to save.
• Understand the “purpose” of your money. The best lesson is to cherish life “experiences” rather than accumulating “things.”
• Finally, start a business or save a high percentage of your salary. The most successful people in the world own a business and control their own destiny. If you aren’t entrepreneurial, then save. This will give you the flexibility to work for who you want. for how long you want and on your own terms.
Next, I instantly thought of one chart and a quote from Albert Einstein that could change Tommy’s life.
• “Compound interest is the most powerful force in the universe.”
• “Compound interest is the greatest mathematical discovery of all time.”
• “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.”
Clearly Albert was obsessed with compound interest, which is the ability to earn interest on top of the interest you previously earned. It is a snowball rolling down a hill. Let’s see how this works by looking at the example of a penny that is doubled every day for 30 days straight:
This chart amazes me every time. While you only had $163.84 after 15 days, through the power of compound interest, your penny grew to over $1.3 million after 28 days and by day 30 you ended up with $5,368,709.12!
Einstein was pretty-smart, so how does Tommy use his advice if there isn’t an investment that can double a penny every day?
What we advised our client was to show him the following chart about compounding interest:
The first thing Tommy should do with the money grandpa gifted to him was to invest for the long-term. I am not talking about speculating on bitcoin or putting it all on black in Vegas. I am talking about good old-fashioned stocks, bonds, mutual funds and exchange-traded funds (ETF’s). Easy to understand investments that have been proven to grow over time. By investing in stocks, you will have the greatest opportunity for long term growth. This growth doesn’t happen in a week or a month but takes place over years of disciplined savings.
However, we need to also teach him about risk of loss. The more risk you take, the more you can lose. The more you lose, the greater the return needed to recover your losses. For example, let’s start with $100. If you lose 10% ($90), you only need an 11% return to break-even. However, if you lose 50% ($50), you need to double your money, a 100% return, to break-even. In plain English, the more you lose, the longer it takes to recover!
For this reason, it is important to monitor the risk in your investments. Tommy may have 50+ years to recover from a big loss. However, Grandpa doesn’t have this amount of time, so he will take less risk and sprinkle in some bonds or more cash to prevent a big loss.
Financial Planning is not just about managing investment portfolios. More importantly it is about having someone you trust to guide you when the unexpected occurs and to make sure your family has a trusted resource to rely on. We aren’t just advisors, we are financial coaches, trainers and accountability partners.
At Abel Financial Management, we are an independent, fiduciary, financial planning firm with a mission to help you make smart decisions with your money. Steve is a CERTIFIED FINANCIAL PLANNER and Partner at Abel-Financial Management. He can be reached at email@example.com or at 410-307-1202.