Thursday, March 6, 2014

Rich Kids, Poor Kids (Part 3)

Rich Kids, Poor Kids (Part 3)
Bert Whitehead, M.B.A., J.D. ©2014

This is the third of three related blogs covering a broad topic:

  • Part 1: A View of our World Through our Grandchildren's Eyes in 100 Years
  • Part 2: Intergenerational Tax and Financial Strategies to Leave a Family Legacy
  • Part 3: The Most Important Lesson to Teach Our Children Now

The foremost lesson for children is to always save 10 percent of all of their income—whether from their allowance, babysitting earnings, or gifts, as well their gross earnings and investment income. Even during retirement, save 10 percent of your income.
Often people think that “save” means to put money away for spending later, rather than investing their savings to grow their financial base, or building “investment capital.” When we refer to savings in this context, we are referring to saving money for investment, not to spending the principle.

As children develop the habit of continually saving 10 percent of their income, their total capital will grow. This is an opportunity to teach them the basics of investing, starting with a savings account or money market. Once they have accumulated enough, move their investments to an S&P 500 Index mutual fund; these are offered at a low price by Vanguard and other no-load funds. They have very low minimums if automatic investment is selected, so savings can be transferred monthly from the savings account to the mutual fund.

Once the child’s investment capital savings reaches a total of more than three times their annual savings, they will experience the “Miracle of Compounding.” This is the tipping point when they will realize that the amount earned from their investment capital now exceeds the amount they are saving each year. At this point, their capital mushrooms exponentially and their wealth is created through their savings and investments.

There is a widespread misconception that rich people become wealthy by taking money away from poor people. The truth is that wealthy people are rich because they always invest part of their earnings. Poor people who spend more than they earn always stay poor. Even people who make a lot of money often still spend more than they make, so they never become wealthy. But people without much money are never broke if they always save 10 percent!

Tyrone Solee wrote an article that beautifully explains the difference between people who are wealthy, and people who are simply rich. To summarize:

The main difference between being rich and being wealthy is knowledge. Wealthy people know how to make money, while rich people only have money. Being wealthy is defined as that status of an individual’s existing financial resources that supports his or her way of living for a longer duration, even if he or she does not work to generate a recurring income. Rich people, on the other hand, may get money in an instant such as inheritance or winning a lottery. However, because of lack of proper mindset and poor money management skills, all of it can be lost in a short period of time. In essence, wealthy people are financially free while rich people are not.

The name of this game is Capitalism and the winners are those who at some point are able to live off the earnings from their money instead of by the sweat of their brow. This is true freedom and an important lesson for all of our children. Rich kids always save 10 percent of their income and poor kids always spend every last dime!