10 Principles for Teaching Children about Money

Here are ten principles for teaching children about money written by R Padmanabhan (I found them posted on a Google Group):

1. *Talk about money.* Every time money is involved, parents have a chance to teach their children the values and analysis behind their actions. Money is one of the important topics through which we communicate our wisdom and values to our children. Every purchase, investment, or donation can be a time to teach your children something about your values.
2. *Talk openly about money.* Parent makes a mistake when they keep information from their children. The only way children learn what is a good deal and what is too expensive is by the experience of what their family earns and what items cost. Hiding this information robs children of the financial education they need.
3. *Talk factually about money.* Many parents have strong emotions about money based on their childhood experiences. These emotions are always transmitted to children. Instead of helping children, they can cripple children from growing to make sound financial decisions.
4. *Require chores; pay for optional work.* Everyone in the family has to help complete the work that needs to be done. If you want to pay your children, only pay them for optional work they can choose to do or not to do.
5. *Provide children an allowance they can make real choices with.* Talk about money is important, but children need real-world lab experience to understand the consequences of their decisions. Consider giving them an allowance large enough so that they can purchase some of their own needs. Then continue to give them honest advice, and help them ask the right questions to make wise decisions based on their values.
6.  *Help children prioritize purchases* Ask them if this purchase is better than other purchases they are considering making.
7. *Help children comparison shop.* Help them consider issues such as cost, quality, and convenience. 
8. *Require children wait before making large purchases* Adults should wait at least a month whenever they are making a large purchase. Children shouldn't be expected to wait that long. Here is a good rule of thumb: Children should be required to wait as many days as they are old in years before being allowed to make a large purchase (over a week's allowance). There is always tomorrow and over half the time they won't remember what attracted them to it in the first place. Developing this habit will help make them resistant to impulse buying.
9. *Don't use money as a punishment. * Your priority should be helping to give your values to your children, not buy their outward behavior.
10. *Don't loan your children money.* If their desired purchase is something they should be saving for, let them save for it. If you want to buy it for them for the value of the experience, buy it for them.

The principles are "If they want it, they have to save for it. If you want them to have it, you will buy it for them." Loaning your children money for items they want teaches them they aren't responsible and they don't have to prioritize.

Magic of Compounding

If we could appreciate the “Magic of Compounding” we would understand the benefits of starting early and discipline!

Let us explain the power of compounding with the famous story of the Persian emperor who was so enchanted with a new ‘chess’ game that he wanted to fulfill any wish the inventor of the game had. This inventor, a mathematician, decided to ask for one seed of grain on the first square of the chessboard doubling the amounts on each of the following squares. The emperor, at first happy about such modesty, was soon to discover that the total yield of his entire empire would not be sufficient to fulfill the ‘modest’ wish. The amount needed on the 64th square of the chessboard equals 440 times the yield of grain of the entire planet. Just try converting into money in any currency and you will realize the importance of compounding.

Starting with Rs 1000 and by investing Rs 1000 every month compounded at 10% amounts works out to Rs 78171 after 5 years. In 10 years it more than doubles to Rs 202457. The figures at the end of 15, 20, 25, 30 40, 50 years are Rs 402621, 724986, 1244159, 2080292, 5595607, 1,47,13,428!!

Imagine Rs 100 is invested and it grows at 10% every year. Column 2 is what it will grow to if it was held for the number of years in column 1. So if your great grand father invested Rs 100, 150 years ago, you would have inherited Rs 16 crore.

Are you aware of the Magic of Compounding?

If we could appreciate the “Magic of Compounding” we would understand the benefits of starting early and discipline!

Let us explain the power of compounding with the famous story of the Persian emperor who was so enchanted with a new ‘chess’ game that he wanted to fulfill any wish the inventor of the game had. This inventor, a mathematician, decided to ask for one seed of grain on the first square of the chessboard doubling the amounts on each of the following squares. The emperor, at first happy about such modesty, was soon to discover that the total yield of his entire empire would not be sufficient to fulfill the ‘modest’ wish. The amount needed on the 64th square of the chessboard equals 440 times the yield of grain of the entire planet. Just try converting into money in any currency and you will realize the importance of compounding.

Starting with Rs 1000 and by investing Rs 1000 every month compounded at 10% amounts works out to Rs 78171 after 5 years. In 10 years it more than doubles to Rs 202457. The figures at the end of 15, 20, 25, 30 40, 50 years are Rs 402621, 724986, 1244159, 2080292, 5595607, 1,47,13,428!!

Imagine Rs 100 is invested and it grows at 10% every year. Column 2 is what it will grow to if it was held for the number of years in column 1. So if your great grand father invested Rs 100, 150 years ago, you would have inherited Rs 16 crore.

Personal Finance E-Book

Have you checked out my e-book on personal finance. It's called Monday is Moneyday.

Download link

Clear & Smart Steps to Raise Your Financial Intelligence Levels

Steve Pavlina writes on "How to raise your financial vibration" where he lists out clear and smart goals to adopt to raise your financial intelligence levels.

There was one part which I really relate to and touched me is:

If you double your income, it means you’re contributing twice as much value
to others. The money you earn is an IOU from society. If you have a million
dollars in the bank, it means you’ve given at least a million dollars more value
than you received — that’s very generous. If you’re in debt, it means you’re
taking more than you’re giving. The more value you contribute, the more society
owes you in return. If you allow your income to stagnate, it means you’re
holding back on the contribution side. That’s lazy and selfish. Focus on
expanding your contribution, and you’ll find that society gives you a lot more
IOUs.

Read the full post

Blow by Blow Account of Freddie Mac Fannie Mae being Taken Over

In one of the most sweeping government interventions in financial markets in U.S. history, the Government is likely to take over Freddie Mac and Fannie Mae.

The downfall of Fannie and Freddie stems from a series of miscalculations and deferred decisions, both by their executives and government officials, according to company insiders, regulators, auditors and outside analysts. The companies expanded rapidly in recent years, initially playing down the risks posed by a housing bubble. Then, as the housing slump expanded nationwide, they resisted raising enough new capital that might have provided a financial cushion to weather the storm. Lawmakers, paralyzed by partisan infighting, delayed strengthening regulatory oversight of the politically powerful companies.

Read the blow by blow account of the story
Also check what it means (By Deepak Shenoy)

Why can't we handle Personal Finance properly?

Most of us avoid taking financial decisions or generally do a sloppy job with our personal finances. I was wondering why and I could figure out three reasons. 

One, there is an information asymmetry in this industry. That means that the seller of financial products knows more than the buyer and he uses it to his advantage and not the buyers advantage. The lack of transparency puts off people.

Two, the sellers use a lot of jargons and number crunching which makes people uncomfortable. Probably that’s another reason why people avoid personal finance.

The third reason that comes to my mind is of a psychological nature. In Mahabharata, the great Indian epic, there’s a story of a Yaksha who challenges Yudishthira to answer his questions.

What is the most surprising thing in the world was one of the questions. Yudishthira answers that the most amazing thing is that even though every day one sees countless living beings that are old and dying but no one can imagine him/herself as old or taking that last journey!

That’s why people have a natural tendency to avoid financial planning. Do you have any other ideas? Let me know, please.

Updates on personal finance web portal

Updates on my website on personal finance.

• What is the Cost of your Investments
• How to select Tax Saving mutual Fund
  

• Smart Traders make Rs 1000 crore in a month; Under SEBI scanner
• What to do when you lose financial focus
• Comparison Chart of Exchange Traded Funds
• What are the charges of a ULIP
• Top Mutual Fund schemes based on 5 year returns

Let me know where I can improve.

Does your agent use the information advantage against you?

We hire an expert because he knows more. But does the expert use that information advantage for you or against you? Steven Levitt of the Freakonomics fame, looked at how real estate agents did when they sold their own houses versus those of their clients. You can read the original academic paper here.

Freakonomics is an international bestseller where Steven Levitt and Stephen Dubner explore the hidden side of everything. In a lucid manner they explain how the incentives of the real estate business, for example, encourages the agents to act against the best interests of their customers!

Agents are often better informed than the clients who hire them and may exploit this informational advantage. Real-estate agents, who know much more about the housing market than the typical homeowner, are one example. Because real estate agents receive only a small share of the incremental profit when a house sells for a higher value, there is an incentive for them to convince their clients to sell their houses too cheaply and too quickly. We test these predictions by comparing home sales in which real estate agents are hired by others to sell a home to instances in which a real estate agent sells his or her own home. In the former case, the agent has distorted incentives; in the latter case, the agent wants to pursue the first-best. Consistent with the theory, we find homes owned by real estate agents sell for about 3.7 percent more than other houses and stay on the market about 9.5 days longer, even after controlling for a wide range of housing characteristics. Situations in which the agent’s informational advantage is larger lead to even greater distortions.

How do we reduce the information disadvantage? Internet is a powerful way. We need more information power on sites like one I have started

India's first online weekly onpersonal finance

Does your Financial Literacy level impacts the Economy?

I have a recurring question in my mind about personal finance and Economics being related. Here's what I found in the National Business Education Association's website

• The American Economy is based on a private enterprise system in which the millions of individual choices made by consumers, workers, and citizens, in sum, affect the decisions made by business owners and government officials.
• The preservation and effectiveness of such a system depends on the ability of individuals to make wise economic decisions related to their personal financial affairs, the successful operation of organizations, and the economic activities of the country.

Makes a lot of sense to me. It also calls for greater efforts to bring about higher levels of financial literacy and makes me proud of my own humble site.What do you think? Is there a case for personal finance education in the schools?

WealthSpa: Are you missing the basics of Financial Planning

When I create financial plans for my clients, whether they have a net worth of negative, or seven figures, there are a few tips I give to every client. These basic fundamentals are requirements for every individual and family, regardless of your current phase of life or situation.
Check out below to make sure you have these basic fundamentals in place, before you even start worrying about investment portfolios or retirement plans.

Emergency Fund. You should have cash set aside to pay for emergency expenses, or cover you living expenses in case of job loss or the collapse of a business. These funds need to be easily accessible, and have little to no risk (so not stocks you plan to sell). How much you need exactly depends upon how many people in the family earn income, your tolerance for risk, and your living expenses. Most people should have three to six months of living expenses set aside in this cash account.

You may not need life insurance, but everyone needs as much liability insurance as they can afford. Liability insurance protects you and your assets from lawsuits, for your (alleged) actions or non-actions. For example, from a car accident slip and fall on your sidewalk. Liability insurance is part of your automobile, homeowner's, renter's, and even in a separate umbrella insurance policy. If you don't have many assets, this insurance is still valuable. First, if you loose a lawsuit, they could go after your future assets and income. Second, the insurance pays not just for the damage, for the lawyer to defend you. The more insurance you have, the better lawyer the insurance company hires for you.

Healthcare Directive or Power of Attorney for Healthcare, and Power of a Attorney for Financial Purposes.

You may not need a full estate plan (will or living trust), but everyone, even 18 year olds, need to plan for their incapacity. If you are in a coma or unable to make decisions for yourself, you will need a person designated to make those decisions for you. This person or persons will be able to make decisions about your healthcare and handle your finances. These documents are necessary to protect your family, keep your loved ones from fighting, and protect yourself (especially for when you wake up).

Take Action

Take one action step on either setting up your Emergency Fund, obtaining Liability Insurance, or getting your Healthcare Directive. That may be opening an account, calling your insurance agent, or contacting an attorney.

Elizabeth Potts Weinstein, CFP®, JD, the "Money Maven," helps women achieve their most important life goals through strategic financial planning, coaching, and education. For a free Special Report, How to Avoid the Top 10 Money Mistakes, go to http://www.thewealthspa.com.

Weekly Update No.I

The following are the important events and decisions made during the first week of August’07 which has an impact on our personal finances.

* On 31st July, RBI Governor announced the review of its monetary policy and increased the cash reserve ratio (the deposits that banks keep with RBI) from 6.5% to 7%. RBI also lifted the daily cap of Rs 3000 crore which the RBI had kept on absorption of excess liquidity. The CRR move will lead to absorbing around Rs 15-16000 crore of excess liquidity from the system.

* The RBI has the unenviable task of reducing inflation, keeping the interest rates benign and also keeping the Rupee appreciating beyond Rs 40 a dollar. The three are linked but not exactly friendly with each other. To keep the Rupee from appreciating, RBI is buying Dollars. And that injects extra liquidity in the system which can lead to inflation.

* Facing the wrath of the sub-prime woes in the US markets, the Indian indices plunged sharply on August 1 and this resulted in them ending lower for yet another time on the bourses. The week was witness to one of the biggest intraday declines ever. Coming on the back of a huge sell off across the globe, especially in the US markets, Sensex edged lower by more than 600 points on Wednesday and Nifty too, declined by more than 180 points.

* The markets are nervous and the volatility index, maintained by the Chicago Board Options Exchange, has doubled in recent weeks. Swaminathan S Anklesaria Aiyer, in his weekly column in TOI asks us to hope for the best but be prepared for the worst. Mr Aiyer has visualized three scenarios. One, nothing to worry, things will become normal soon. Two, there is a cyclical down trend waiting to happen. Three, there’s a disaster coming! He remembers the Asian crisis ten years back.

* In Mutual Funds, the total Asset under Management (AUM) reached Rs 4,86,513 crore at the end of July, a jump of 21.5% over Rs 4,00,333 crore at the end of June. That too when the PAN has become compulsory from July 1, 2007 and the MFs were cribbing about it being unfair that the Insurance companies were not subjected to the same regulation.

* UTI Mutual Fund latest offer of Lifestyle Fund takes into accounts the changing demographics. This scheme has an investment objective to provide long term capital appreciation and/or income distribution from a diversified portfolio of equity and equity related instruments of companies that are expected to benefit from changing Indian demographics, Indian lifestyles and rising consumption pattern. There are 242 companies identified for investment and I’m told that the last three year return of these companies is 52% and for the last one year, it’s a whopping 72%!

* ICICI Prudential Life Insurance Company will be focussing on health insurance in a major way. The company has announced the launch of “Crisis Cover”, a policy covering 35 critical illnesses, total and permanent disability and also death. Crisis Cover will be sold through the company’s 680 branches. ICICI Prudential is working on revamping its features of Diabetes Care, a plan launched in November last year. The policy encourages a monitoring regime as per the Diabetic Association of India with policyholders required to undergo three mandatory tests

Impact of Financial Literacy on Indian Economy

I am trying to understand the impact of financial literacy levels on the Indian Economy. Let me elaborate by giving some examples of financial illiteracy:

- There are only 5-6 million Mutual Funds subscribers compared to
approx 150 million Insurance subscribers
- Insurance in India is looked as an instrument of tax arbitrage and
an investment product rather than an insurance product.
- Susan Thomas mentions, " In 2004, there was a flow of Rs.60,000
crore of premium income going into the insurance industry. Of this, as
much
as Rs.6,000 crore, or roughly 10%,went back to sales agents. ".
- Equities give the best returns and you are putting your money in a
professionally managed corporate organisation. Compare this with your
insurance products which give much lesser returns and your money is
invested
in the Government which is inefficient with your money, to say the least.
- The total AUM under Mutual Funds is about Rs 3.5 lakh crores while
LIC alone manages funds worth more than Rs 6 lakh crore

My point is that a more literate populace would buy better financial
products leading to better utilisation of the money. Things like better
saving, improved efficiency of the money in turn might have some effect on
the Economy.

How do we do it? Internet is a powerful medium and I saw these sites by the Australian & USA Governments which are very useful.

How the Financial Sector was Reformed in India

Ajay Shah has uploaded this article by Susan Thomas on how the financial sector was reformed. Insightful and very useful.

While talking about some problems in the Insurance industry, Susan Thomas mentions, " In 2004, there was a flow of Rs.60,000 crore of premium income going into the insurance industry. Of this, as much as Rs.6,000 crore, or roughly 10%,went back to sales agents. "

This makes a case for gigantic efforts on improving the financial literacy levels. What is the way of doing it?

Life Cycle Stage – Financial Needs – Choice of Investment

This is the fourth in the series of Financial literacy series. Previous ones here: 1, 2, 3.

Age of an investor, family situation and health are important determinants of financial goals. Also financial goals and plans depend on the income, expenditures & cash flow requirements of an individual.

For the purpose of ideal financial planning, investors can be segmented according to certain stage in their life cycle

Stage I : Ages: 20 to 30 (Unmarried, Young Professionals)
Stage II : Ages 30-45 (Married, With or Without Kids)
Stage III : Ages 45-55 (Pre Retirement)
Stage IV : Ages >55 (Retirement)

Let's start with the first stage: Life Cycle Stage I : Ages: 20 to 30 (Unmarried, Young Professionals)

• Continuing higher education or just started working
• May or may not own home
• May or may not have dependents

Financial Needs Are Immediate & Short Term

• May still have some support from parents
• May be saving towards future family needs - say buying home
• May be paying off education loans
• Likes to spend money

Ability to Invest :

• Limited due to higher spending

Choice Of Investments :

• Liquid plans & short term investments.
• Some exposure to equity and pension products,
• Term Insurance plan

The second stage comes in another post!

Financial Literacy Series: Functions of Financial Markets

I kicked off a series on financial literacy by setting a backgrounder and something on financial systems .

The term `financial market’ refers to the means through which buyers and sellers are brought together to transact the financial products. The Major Functions Performed by the Financial Markets
o Price Discovery
o Liquidity
o Lower Transaction Costs

Price Discovery

Financial markets provide a centralized place for trading in financial products. This `place’ need not be physical. It may be virtual such as the online trading system of the National Stock Exchange. This feature enables the prospective buyers and sellers to discover the going price and take appropriate decisions.

Liquidity

Financial markets also provide a mechanism for the investors to sell their financial assets. For example, if an investor wishes to sell his shares, the equity markets offer an easy exit.

Lower Transaction Costs

Financial markets save a market player the cost of locating counterparty to his transactions. The counterparty can be readily found by going to the appropriate market.

We will discuss Financial Market Segments in the next post. Crossposted on my website's Learning Centre and Blog

How do you get in touch with your Advisor?

How do you get in touch with an Advisor when you need one? Depend on your friendly neighbourhood guy who is more of a family friend?

I have realised that my friendly neighbourhood finance advisor does not have the knowledge of all financial products and at best he gets work done in his/her area of insurance, mutual funds, stocks or some other financial product. And the knowledgeable financial planner are too hard to find. Media tells me to take my own decisions based on my own risk appetite and financial goals. So the ball is back in my court.

And there are over 700 mutual funds, 5000 stocks, 300 insurance policies and hundreds of other financial products to choose from.

Internet enables information sharing in a powerful manner and is a medium where we can help each other in matters of personal finance. That brings me to the thing I have done!!

Take a look at this one. This is to be launched in August but I’m giving you a preview!!

Financial Advisors Directory: We invite professional and net savvy advisors to register and provide the information needs. This one is a first in India to the best of my knowledge…..

Suggestions are welcome.

My Squidoo Lens on Personal Finance

Squidoo is the world's most popular site for people who want to build a page about their passions. Highlight books, blogs, vids, online shops and/or just spread the word about your stuff.
So that's what I did today. Made a lens about Personal Finance. Go, take a look.

And Seth Godin is the man behind this amazing squidoo!! It's fast, free, and supereasy. So if you have something to talk about, why don't you build a lens for yourself too. It also makes sense for the SEO guys to have your blog/site talked about at a high PageRank site. Go, help yourself.

What is your Investment IQ?

I scored 19/20 in the Investment IQ test by MoneyControl !! I would have scored less than 10 some months ago before I started this blog. :)

Use this tool to evaluate whether you should manage your investments yourself or whether you should approach/ use a professional manager.

This evaluation will consider your temperament, aptitude and technical knowledge. It should take you between 5 and 8 minutes to answer the 20 questions.

Scores on temperament(5), aptitude(5) and technical knowledge(10) are taken. The qualifying score( 15) is a Moneycontrol recommended benchmark and it refers to the minimum you need to score if you want to manage your money independently.

As I said, I wouldn't have scored 19 if I was not doing this blog. In fact I was very miserable with all this personal finance. But I have learnt that finance is not rocket science and I owe it to my family that I manage our finances better.

Maybe you score less than 15. But does it mean you should start finding a professional manager? Or should you try and build your financial literacy (backgrounder) levels. Choice is obviously yours!!

Financial Literacy Series: Financial System

I have been busy working on the financial literacy programme for me and you. If you have come here without looking at this backgrounder post, It will be my request that you take a look at the introduction post too.

Before we discuss in detail the various instruments available in the financial market and their role and significance in personal financial planning, it would be helpful to have a brief overview of the financial system in India.

The Financial System Consists of
o Financial Market Segments,
o Players in the Financial Markets
o Financial Instruments

The financial system basically facilitates transfer of funds from the cash surplus economic units to those who need it, and does it in the most efficient manner.

There are three major types of economic units.
a. Households where personal finance is involved.
b. Business entities which resort to Financial management and we can refer it as business finance
c. Government where we come across fiscal and monetary policies.

Usually, the business entities and governments are fund deficit units and require funds to finance their capital and operational expenditure. The householders as a group are net savers and channelise their savings to the other units through the mechanism of the financial markets.

So you and me are surplus economic inits and the government and business use our money and make us look like beggars!!

This fund transfer from the surplus units to deficit units may be done in one of the two ways – directly or through financial intermediaries such as banks or insurance companies.

In case of direct transfer, the deficit units sell financial claims on themselves, which are purchased by the surplus units. An example is the debentures issued by a company. These debentures are sold at a price. These represent financial claims on the issuing company in the form of a promise to pay periodic interest and principal repayment. This method is more cost efficient as no intermediary costs are involved here.

However, deficit and surplus units may not be in a position to access each other directly. E.g. the households are interested in a wide array of assets, and evaluate investment vehicles based on their return, risk characteristics as well as tax treatment.

The corporate houses want to get the best possible price and keep the cost of funds as low as possible. Financial intermediaries (FI) such as banks and insurance companies help bring these two together. They pool funds from the investors, invest money on a large scale.

They are able to diversify their asset base that is rather difficult for individual investors. These intermediaries also gain expertise in the course of their business that enables them to give a better deal to the investors. , FI are able to reap the benefits of Economies of Scale, Lower Transaction Costs, and Reduction in Information Costs due to their intimate knowledge of finance.

The Government simply passes taxation legislation (bullies us) and gets load of money from us to fill its coffer and serve the social needs!

Financial markets can be over the counter (OTC) or organized. In case of an OTC market, the buyer and seller directly meet each other, may negotiate the price and strike the deal.

In case of organized markets (say securities exchanges or Stock markets), buyers and sellers give their price quotes and the exchange facilitates matching of buy and sell orders based on compatibility of price quotes. In fact, the same instrument may be traded either way. For example, if an investor buys units of a mutual fund directly from the fund, it is OTC. However, units of certain mutual funds are also listed and traded on the securities exchange.