Commentary (Page 425)

Many people give their children an allowance. It is a common practice that has many goals. Some (but not all) of those goals are:

1. Teach the child how to count money.
2. Teach the child the value of money and its ability to buy things.
3. Not insignificantly, teach the child to stop begging for special treats or toys when on a shopping trip with the parents.

I contend that it is possible to use an allowance to teach a child to invest as well. Teaching investment philosophies can pay off in a big way. The power of compound interest is most pronounce if a young adult starts investing early in life. Therefore, if you can teach a child about investing, hopefully that child will invest more regularly as a young adult. We all want our children to do better than we are doing in life, so if we can teach them while they are young to be wealthy when they are old and gray, we have succeeded to some degree as parents.

One of the most important lessons of investing is to pay yourself first. Quite literally, one must take a portion of every paycheck and immediately set it aside as an investment before paying any other bills. This can seem to be tough to do but it really is more of a mind set and a practice than anything else. If you are setting this money aside from an early age, you will likely set it aside as you grow older. By starting your children off with this practice on their allowance, you will teach them the habits of a lifetime.

It is also important to take care of your fellow man. Let’s face it, if you are reading this blog, you are probably more fortunate than most people in this world. Take some of your hard earned money and help others with it. The allowance for your kids is where you can start to teach them this wholesome habit.

I have raised 3 children.  My kids are old enough that they can drive and get jobs. In fact, they are starting on their own careers. However, when they were young, I gave them an allowance for some of the same reasons that you give your child an allowance. I also gave them an allowance because I wanted to teach them how to be investors.

Once my child was able to start recognizing different coins and counting money, I started them on an allowance.  For me, that was when they turned 6 years old. You may find that you should do this earlier or later. This was also the time when they were able to start taking care of themselves to some degree. I could expect them to pick up their own room and do a special job around the house.

A job should not be tied to the allowance, but it should be required to help the family

For us, the youngest child at the age of 6, would be in charge of making sure that our second refrigerator (in the garage) was stocked with drinks for the family. We don’t drink a lot of soft drinks but bottled water, juice, ice tea, and a few types of soft drinks are always cold for ourselves or a guest to our home. The first job any of our children was responsible for maintaining, was to make sure that this stock was kept current. It would only take about 10 minutes every 2 or 3 days to do the job, but it was a way to uniquely contribute to the family.

As the children grew older, they would get a more challenging job to do (leaving the refrigerator stocking job to a younger sibling). Jobs such as taking out the trash or picking up after the pets were weekly jobs that had to get done that a young person could easily accomplish and take full ownership for doing.

Other seasonal chores such as raking leaves or daily chores such washing dishes were more of a group activity where the entire family is expected to help. The goal of the above job was that my child “owned” the job and it was obvious if it didn’t get done.

I discuss the concept of a job because I want to point out that we did not tie the allowance to the job. The allowance was never set up to be payment for services rendered. Rather, we all want things and need money so the allowance was simply an acknowldegement that this was their money. We also didn’t take the allowance away for bad behavior.

Allowance is $1 for every year of age

Starting at age 6, we gave each child $1 per week for their age. So at age 6, it was $6 every Sunday evening. At age 7, the alowance was increased to $7.

We didn’t just give them the money for the allowance. Rather, we sat with them every Sunday evening and paid them, made them count the money (to reinforce those math skills), and then we worked on dividing up the payments that they had to make.

Since I think that 10% of every paycheck should be given away to those that need things more than we do, that was the first payment. I also think that 10% of each paycheck should be paid to ourselves so that we can invest it.

So when one of our children was 6, the allowance was $6 every week. 10% of that allowance (60 cents) immediately went into a special envelope to give away. That donation money could be given to any cause my child chose. It could be church. It could be United Way. It could be to sponsor a neighbor in a 5K run for a charity. It could be for a jump-rope-a-thon. It really didn’t matter what charity was chosen, but it had to be a donation. It couldn’t be to buy Girl Scout cookies or if the local high school was selling candy bars to raise money for uniforms. It had to be a gift.

The next 10% (another 60 cents for my 6 year old) went into a different envelope that was marked “Long Term.” Long-term money was special because it was set aside and couldn’t be touched for an entire year (this is “long-term” for a child of under 12). Then, between Memorial Day and Independence Day, the child could take their long-term money and buy one thing with it. They could only buy one thing. It couldn’t be for a gift card to spend later. It couldn’t be for 6 different small toys. It had to be one single thing. One way to think of this is that it had to come in one box or package.

The great part of saving this money for the entire year was that it earned great interest! I would pay half of whatever they purchased (this of course is phenomenal interest rate, but remember I am trying to teach the child to save for the future).  So for a 6 year old, the savings for an entire year was $31.20 ($0.60 per week X 52 weeks). The 6 year old could spend up to $62.40 on one thing since I would match the savings. If the child wanted something more than $62.40 then the short term money (the remaining 80% of the weekly allowance) could also be saved to augment the purchase.

This technique taught my children to save money for future purchases. It was amazing what they would save and buy. Over the years, my kids have bought iPods, scooters, and gaming systems with their long term savings (accompanied with the generous interest payments from the parents) and their short-term money to augment.

I stopped paying allowance when my children turned 16. At that age they were able to get a part-time job at a local business making sandwiches or lifeguarding. I was happy that they still saved money for charities to help those less fortunate than themselves. I was also happy that the savings accounts grew for each one of them as they saved for something important to them (such as helping with college tuition and books). When they entered college, each child had several thousand dollars in savings to help with college payments. Unfortunately, college destroyed that savings rather quickly, but that is the subject of a different article.

My oldest son has graduated from college is now launching his career. When he started his first “adult” job, he immediately understood the benefit signing up for the stock purchase plan and the 401K investment plan offered by his employer. Putting that money aside before he paid his bills made perfect sense to him.

I may not have been a perfect father over the years, but it does appear that I taught him how to start investing when he was only 6 years old and it stuck

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There are probably more than 5 things about that you need to understand about investing to be a confident investor. However, none of them are more critical than this list of five. If you get one of these wrong, you are going to struggle being a confident investor.

Here are 5 critical things to know as a confident investor

1. Compound interest is what will make a confident investor rich.

In this hurry up world that we live in, this is frustrating. It also gives credence to the 5th item on this list. It takes time to become rich. Warren Buffett is a great investor, but what makes him rich is that he’s been a great investor for two thirds of a century. Of his current $60 billion net worth, $59.7 billion was added after his 50th birthday, and $57 billion came after his 60th. If Buffett started saving in his 30s and retired in his 60s, you would have never heard of him. His secret is time and consistency.

Most people don’t start saving in meaningful amounts until a decade or two before retirement, which severely limits the power of compounding. That’s unfortunate, and there’s no way to fix it retroactively. It’s a good reminder of how important it is to teach young people to start saving as soon as possible.

This doesn’t mean that all is loss if you are in your 40s or 50s. It does mean that you need to be realistic and not listen to the latest get rich quick scam. As I say in my book, The Confident Investor, I do not believe it is possible to do anything legal and get rich quick.

2. Revenue and profit is why confident investors invest in companies.

Companies that do not generate revenue (and therefore profit), will eventually not be successful. Future revenue or potential revenue or revenue projections are fine but over time revenue needs to come in to the company.

Along the same lines, a company eventually has to be profitable. Profitless growth is fine in some situations, but eventually, the company needs to pay its own bills. Getting money from investors to pay the company’s bills is fine for a young company, but eventually the company has to pay its own way.

The longer it takes to get to revenue or get to profit, the more likely the company has internal problems or a lack of focus. A confident investor will stay away from companies as they are risky and there is no way to be confident that the company will be successful. Past success is the single best indicator of future success – it is safer for a confident investor to invest in growing and profitable companies.

3. Simple is usually better than smart.

A confident investor that bought a low-cost S&P 500 index fund in 2003 earned a 97% return by the end of 2012. That’s great! And they didn’t need to know a thing about portfolio management, technical analysis, or suffer through a single segment of “The Lighting Round.”

Meanwhile, the average equity market hedge fund lost 4.7% of its value over the same period, according to data from Dow Jones Credit Suisse Hedge Fund Indices. The average long-short equity hedge fund produced a 96% total return which is still short of an index fund.

I cover this concept in my book, The Confident Investor, and I have also written articles concerning active funds v. index funds.

4. The odds of the stock market experiencing high volatility are 100%.

Most investors understand that stocks produce superior long-term returns, but at the cost of higher volatility. Yet every time there’s even a hint of volatility, the same cry is heard from the investing public: “What is going on?!”

Nine times out of ten, the correct answer is, “Nothing is going on.” This is what stocks do. They go up and they go down. Sometimes there is nothing going on with the company that is driving the movement. Don’t worry about small variations or even trends that last a week or two.

Since 1900 the S&P 500 has returned about 6% per year, but the average difference between any year’s highest close and lowest close is 23%. Remember this the next time someone tries to explain why the market is up or down by a few percentage points. They are basically describing why it always rains after you wash your car.

5. The industry is dominated by cranks, charlatans, and salesman.

The vast majority of financial products are sold by people whose only interest in your wealth is the amount of fees they can sucker you out of. You need no experience, credentials, or even common sense to be a financial pundit. Sadly, the louder and more bombastic a pundit is, the more attention he’ll receive, even though it makes him more likely to be wrong.

I honestly hope that you don’t think I am one of those people.  🙂

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There is no doubt that some investors still fear the stock crash of 2008. This is even more common when there are so many discussions about the market being overpriced today. Some advisors are once again suggesting that investors should invest in “safer” businesses.

Much of this fear of a stock crash has more to do with availability bias than anything else. Availability bias is a bias that causes people to overestimate the probability of events that are memorable. Memorable events are further magnified by coverage in the media; therefore, the bias is compounded.

Two prominent examples would be estimations of how likely plane accidents are to occur and how often children are abducted. Both events are quite rare, but the vast majority of people believe that they are more common and worry about them. In reality, people are much more likely to die from an auto accident than a plane accident, and children are more likely to die in an accident than get abducted. The majority of people think the reverse is true. This is because the less likely events are more “available” or more memorable. Looking at the literature or even just the interactions of daily life will reveal thousands of examples of availability bias in action.

So is your fear of another stock crash more to do with availability bias than fact? Are you acting irrationally because of fear that can sometimes be common in the media?

Prudent monitoring of your investments is important. With the strategy that I explain on this site and in my book, The Confident Investor, I teach you to get out of the market before the stock crash is so bad that it destroys your portfolio.  In fact, I specifically do investment trade analysis with the time frame of 2008, just so you know that the system should prevent the worst of dire consequences that occurred during that stock crash (see here, here, and here).

You can purchase my book wherever books are sold such as Amazon, Barnes and Noble, and Books A Million. It is available in e-book formats for Nook, Kindle, and iPad.

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