How does a teenager create a strong financial future?
I was approached by a couple who have fabulous children. Their oldest, Olivia, is 16 and has spent the summer working hard in a local business. She was making some pretty good coin during the school holidays and she has found herself with that wonderful problem, too much cash sitting in the bank.
She is a switched on kid and thankfully her first thought is not where to spend all of that money, that would be a waste, but where can she put it instead and what should she do with it when she is not even sure what she is going to need it for?
So, I’ve been wracking my brains as to how to concisely explain to her a clear financial path forward and I want to do it in such a way that I don’t turn her interest in getting financially sorted off. I figure that because she is not my own daughter, that I constantly drop little nuggets of financial wisdom to on a weekly basis (for which I am SURE she will thank me one day), I want to as my nephew would say, GIVE IT A RED HOT GO! Part of me would also like to become a memory worth keeping for when she is older.
Here is how I imagine this memory goes:
So that’s the vision! Making the flowery introduction to this blog was the easy bit, now let’s make a start on the harder stuff…
Olivia, I wrote this entire blog post out where I detail a strategy to show you how to make your money work for you and then I gave it to a nice fella called Sonnie Bailey to critique, he is an Authorised Financial Advisor (AFA), so he knows his stuff. He owns a business called Fairhaven Wealth and is an independent financial advisor who gives his clients high quality, tailored financial advice. No fly by night AFA for you Olivia, this is the real deal! So, you are getting the wisdom of my 44 years and the knowledge of his thorough education in all things financial.
Olivia, creating a strong financial future for yourself is not actually about becoming rich, you should not make that your priority, instead it’s about creating enough wealth so that you don’t have to worry about money and it gives you the freedom to do almost whatever you want to do, whatever that may be. More options and opportunities open up to you when you are not restricted by cash flow.
Trust me when I say that you will never live more cheaply than you do right now. Everything is free AND you also have a maid service when you live at home with Mum and Dad. Yeah, they make you load the dishwasher and take the rubbish out but that is nothing compared to the enormous amounts of menial tasks that are going to take up your day as you get older and also the money you are going to have to fork out to make stuff happen. At the moment when your pay is deposited in your bank this is ALL YOURS, but it’s not going to stay that way for much longer.
You are working really hard these holidays (except for going on that all expenses paid camping holiday your parents have just taken you on) but you can’t keep up that amount of work when you go back to school and your working hours will be hugely reduced. So, you are about to take a massive pay cut.
Olivia you would have worked out by now that if you leave your money at home in a piggy bank, when you next check you have exactly the same amount of money. Now I know that you have moved on from a tin of money on the shelf in your bedroom and you now have your own bank account but when you look at the money sitting there you are probably pretty tempted to spend it on yourself and you are probably wondering what you should be doing with it?
Just like you and I money needs to be given a purpose. If you didn’t have structure in your day: get up, eat breakfast, argue with your siblings, go to school… then you would wander through your day feeling lost and pointless. It’s the same with our money, it needs to be given a job to do so it can be useful, because lazing around all day in a bank account at the moment, your money is being lazy and unproductive.
So, the trick is to put your hard earned money somewhere else where your money can go to work for you. Money makes money if you let it.
Let’s take that apart a bit more and look at the key to your future financial success. Two concepts for you:
If you put $100 in your bank in a savings account, they agree to pay you 5% interest per annum (after one year). So, you come out with $105 dollars after one year. Happy Days! You will also need to pay tax to the government on that but we won’t worry about that just now.
Now you take that original $100, plus the $5 interest that you earned and invest that again at 5% per annum. You now earn interest on that original amount (the principal) AND on the interest you earned. Your money is now making money. You just need to keep repeating this strategy. That’s how compound interest works and it’s a beautiful thing!
If you only take one thing out of this blog let it be understanding the power of compound interest and the huge effect it will have on your savings over TIME.
Check this out Olivia... I am going to offer you two choices:
You can either have $1,000,000 right now
1 cent doubled every single day, for 30 days
Which would you choose? Which is the best choice? Decide your answer and then take a look below?
The sum of a cent doubled everyday for a month totals over five million dollars! You know how there are “seven wonders of the world”, well many consider COMPOUND INTEREST to be the eighth wonder of the world because it is such a powerful math equation. And I know you are good at math.
Now, in the real world I’m sorry to tell you that the chances of doubling your money every day are remote BUT hopefully this gives you some understanding of the power of saving your money somewhere where it can make you some additional money or what’s called a "return on your investment".
The next concept to get your amazing young stretchy brain around is saving.
Just SAVE Olivia!
Save without knowing why you need the money, those answers will come later. After all you go to school each day and learn, without knowing what job you are going to be doing in ten years time, but each day you go back and learn some more. It’s the same with saving your money, just consistently tuck money away each payday. Always be a saver and not a spender because spenders never get ahead, they are always chasing their tail to get more cash in the bank, so they can spend it and those people end up in jobs they don’t like with a life they never planned for. Always spend less than you earn, strive to save 50% of your income and invest that money. When you live at home for free this is easy for you to do. HOWEVER, worth keeping in mind is that your savings rate will fluctuate over time and that’s OK. If you go to Uni it’s unlikely you will be saving such a large percentage, or even at all, or if in the future you stop work to have a child it is likely your savings will drop too. But in the near future whenever you work for money you should be aiming for a high savings rate. If you can afford to save, then save.
Have you ever looked at your bank account and wondered where your money went? You were sure you had $200 in there, but now there is only $150. Where did it go? Learn to budget early in life Olivia by creating a spreadsheet on your computer, or simply writing it in a notebook that has three columns. By budgeting you will work out where you waste money and you will work out exactly where you are spending and saving it. Create something that works for YOU but it might look something like this:
What I have found with investing is there are a lot of tips and tricks out there but it is rare that someone will straight out tell you what you should do, and that is really frustrating. So, I’m going to give you a plan to follow and Sonnie who is an AFA has cast his eye over it too. Now this plan will be a darn good place to start and as you earn, save and then invest your money from your part time job you are going to learn what works for you along the way and adjust where you stash your cash.
So here goes:
Your bank has one sole purpose: to make money OUT of you, not for you. When you put $1,000 into a savings account they may give you a 3% return but they will take your money and lend it to someone else and earn 5%. What happens to the other 2%? They keep it as profit. There are many banks in New Zealand and you can change banks whenever you like, just find one that you are happy to use.
Having money sitting in your bank is handy, you can access it at any time, but it’s never going to earn you much of a return.
So, here is what I propose:
Have four bank accounts:
Account 1. HOLDING
All of your pay goes into this account. This is just a place to hold your money until you give it a job to do.
Account 2. SAVINGS + INVESTING
Every payday, 50% of your pay gets moved into this account. This is your savings account. Have no more than $1,000 in here at any time. Push the rest into your investments (more on that shortly).
Account 3. SPENDING MONEY
Every payday, a set amount goes into this account and this is your spending money. How much goes in there? I don’t know, how much do teenagers spend these days? $40? $50? You only ever use this account for spending. So if you go out for lunch with your mates, you pay from here. When it’s gone IT’S GONE and you don’t dip into your other accounts to top it up. You need to wait until payday rolls around again.
What do you do when the inevitable happens and Apple release yet another phone? It’s no point this 44 year old woman preaching to you about how forever updating your phone is a COMPLETE WASTE OF MONEY. Just know that it is. Peer pressure yadda yadda, I get it! But you know, right, that when you buy that phone it’s worth stuff all shortly thereafter, particularly once the screen gets broken?! All I will say is that when you are 16, its the latest $1,500 phone you want, when you are 25, its the latest $35,000 car you want, when you are 30, its the $600,000 house you want. And on and on and on it goes. There will always be something shiny and new to suck up all of your money. And some.
Dare to be different Olivia because I’m telling you that a lot of those people who look like they have it all are actually stone cold broke and I don’t want that for you. Build wealth with your money, don’t buy into consumerism and buying crap that has no value shortly after you have purchased it.
There’s a difference between BEING wealthy and APPEARING wealthy.
Account 4. BUY IT WITH CASH
But IF YOU INSIST on buying the latest iPhone then you don’t get to borrow the money to do it, you have to save up for it and BUY IT WITH CASH. You can’t go to the bank of Mum and Dad and ask to borrow the money, all that is doing is teaching you how to be in debt. Instead you open a fourth bank account and each payday, after you have put money into savings first, you put a set amount of money in there until you have saved up enough to buy the latest phone. And when you finally have enough I hope you feel the weight of handing over all of that money that you worked and worked and worked for. By all means buy stuff you absolutely think you must have but always do it with cash and NEVER stop your “normal” savings accounts being regularly added to!
EXTRA IMPORTANT NOTE: Make a firm rule with yourself right here and right now, NEVER borrow money to buy a car!
And just so you know, if you invested that $1,500 instead at a (very optimistic) 9%, compounded yearly, this is what you would have after:
10 years $3,551
20 years $8406
30 years $19,901
40 years $47,114
50 years $111,536
60 years $264,046
C’mon, you have to be impressed by that!!
OK, thats your bank accounts sorted.
Now let’s do some investing.
KiwiSaver is the logical place to start and you are already in it. You can’t touch this money until you hit 65 which I know must feel like a lifetime away. They lock this money away because otherwise many Kiwi’s can’t keep their sticky mits off it and would spend it all and be broke when they retire. Chances are you are unaware what fund you are with and that it charges you a lot of fees that you are not even aware of and that even they have trouble explaining to you. I suggest you change to a company called www.simplicity.kiwi. It is VERY easy to change funds, just go to their website and you can do it in minutes. You need to be in a GROWTH fund because regardless of the KiwiSaver provider you are with, simply switching from a “conservative” fund to a “growth fund” could well mean you have $100,000 MORE in retirement than you would have had! Sonnie told me to advise you to “tell all of your friends to do the same!” Tell your employer you want to put 4% of your pay towards KiwiSaver and this will be automatically done for you. Do nothing else. When you turn 18 the government will begin to give you $521 dollars a year just for being in the scheme (as long as you have contributed $1042 from your wages or voluntarily during that year). Take the free money, yehaa! Once in a while go online and take a look at your balance, its fun watching it grow and Simplicity have a nice clear user interface so it’s easy for you to understand what is happening with YOUR money.
You have heard of the stock market right? Almost every country has one. It’s a club if you like where all the bigger companies get to join. Why do they want to be there? Well, companies need money to conduct their work day to day and to grow their business. You and I can buy bits of their company, or a share, by handing over some of our money for them to use in their business. And what's in it for you is that they will pay you for lending them some cash. Its called a dividend.
Now, hopefully the company you have shares in does amazingly well and they make a lot of money, profits are up and they pay you out a nice dividend once of twice a year. Sweet! But sometimes a company tanks and even though you lent them some of your money, there was not enough to pay you out a dividend this year. Bugger! Dividend returns are never guaranteed.
Think of the stock market like a giant supermarket where you can go shopping for companies to buy a little piece of. Just a few companies that you might have heard of in NZ are: Air NZ, Fonterra, Sky and TradeMe.
Now the biggest problem is picking a winner, one that is going to pay you out a nice dividend. The only way you can do this is to research the heck out of a company. You will need to learn everything you possibly can which is really really difficult. Short of joining the company and sitting in on all of their important meetings there is no easy way to work out how their business will perform next week, next month, or next year. And to add to the confusion is the fact that the company you have been researching may have had ten years of awesome growth and made pots of cash... but that does not mean it will continue next year.
You also need to be aware that if you’re trying to pick winners, you’re competing against other people who are trying to pick winners. Professional investment managers are paid a lot of money to try to do this. They’re smart, they work hard, and they have a lot of resources at their disposal (including those fancy Bloomberg terminals you see on TV and in the movies). You’re not playing hockey against other 16 year olds. You’re playing hockey against the Black Sticks or the Hockeyroos.
Well, heck, how on earth is a 16 year old going to work this out? Well Olivia, fear not, stick with me. You have heard the phrase “don’t put all of your eggs in one basket?” Even if you spend all your spare time researching just two companies and decide to buy in, you are only invested in two companies and there is a chance that one of both could fail or succeed. So, you need to diversify, you need to spread your risk so that that scenario is unlikely to happen.
The solution is to not buy a piece of just one company, but to buy a piece of every company at the supermarket instead and hallelujah I’m please to tell you that you can! They are called Exchange Traded Funds or ETF’s for short or Index Funds (investing likes to make things complicated so they have a lot of lingo for essentially the same thing).
So, instead of going to the company supermarket and picking just a couple, you pick every single company in that supermarket. All of those companies at the supermarket make up what is called an INDEX. And you don’t actually need to know ANYTHING about each company. You just drop your money into the fund and it is dispersed across each of the companies in it, so you own just a teeny tiny piece of each.
They all go about their business day to day and at certain points in the year they all announce how poorly or how well they are doing. Collectively this gives you an AVERAGE return and you are paid a dividend based on this average Olivia. Being average is actually quite awesome. I’ve done it my whole life and I’m doing just fine!
Humans think they are pretty brilliant in most things when often times they are full of hot air. Humans think they are amazing at picking a company that is going to boom and make a fortune and sometimes they get this right, but a lot of times they get this wrong, mainly because humans are still pretty poor at predicting the future AND they want to be above average in the returns they get. But with an Index Fund, the humans stay the heck out of it and they don’t buy and sell and muck about with things, so as a result over long periods of time the returns for you, while still average, are far better than if you had tried to pick individual companies to invest in. And because there is no human involved in a Index Fund that wants to be paid for their time, the fees to run these funds are a lot cheaper. It is really important that you pay low fees when investing, otherwise they will eat up all those good returns you get AND they will still charge you when your returns are low! Scoundrels!
But what about RISK? Tell any adult that you are invested in the share market and they will tut tut and say “Ooo, that’s risky, I remember the stock market crash of 1987…”
With investing in an Index Fund you are playing the long game Olivia. You are thinking 5, 10, 20, 30 years into the future. During all of that time the businesses that make up your index fund will have boom years where you make great returns and they will have bomb years where you will make little or no returns. There is EVERY chance that will happen, but remember that average we talked about? Over all that time all of the returns average out so you will be fine. AND because you are buying into your Index Fund every month without fail, some months you will buy shares and they will be expensive and some months they will be really really cheap. It all averages out.
Phew, that’s exhausting and I hope I have not lost you?
TAX... Just like you pay tax on the money you make in your part time job, you will pay tax to the government on the money you make from your investments. These taxes help the government run a country and there is nothing we can do about it except accept it and suck it up. The benefits of living in beautiful New Zealand far outweigh the taxes we pay!
So, here is how to BUY Index Funds.
Unfortunately you are just a little bit too young to strike out on your own with buying these in your own name, you need to be 18, BUT your Mum can help you here. When you turn 18 you can transfer it all into your own name. She can get set up as an investor and you can have a sub account under her name. She needs to fill out the online forms but make sure you sit with her and help out so you understand the process too: Go to www.smartshares.co.nz
A good place to start is buying the New Zealand Top 50 companies and this fund is called FNZ. There are a number of other good funds but this is a very good starting point for you, you can look at other funds down the track. No rush.
Now go to this link on my blog and it will talk you through how to set yourself up: Buying shares in 27 minutes...
You need to make an initial lump sum investment of $500 and pay at least $50 a month going forward. This will come from your Number 2 bank account so you need to make sure there is enough money in there each and every month to cover the $50. If you are saving more than 50% of your income there should be more than plenty! I suggest you just start with this amount and then see how you go. You can adjust the regular amount you pay at any time AND if you have too much money in your bank account you can make extra lump sum payments.
Every month your $50 will buy you a different amount of shares because the share price fluctuates up and down but remember that over time it all averages out and the fancy term for this is ‘dollar cost averaging’. Every month you are buying a little slice of 50 of New Zealand’s top companies. How awesome is that! Extremely awesome Olivia.
What happens when you need some money to do something that is going to benefit your life, like going to university, putting a (huge) deposit on your first home, heading off on your O.E? You can sell your shares at any time. Once you are set up and buying your Index Funds each and every month (and there is no rush to do this next bit) you will open a share trading account and this is where the money will go IF you decide to SELL your shares. Of course I would love to see you NEVER sell any but you have a lot of costs heading your way and you are going to need some dosh at some point because you are young and awesome and opportunities are going to come up.
Olivia, I have not guessed this entire blog, I’m writing from my own experience because I’m an investor myself and I know that this strategy is working for me. I own everything I have and I owe nobody anything and that is the position that you want to find yourself in. Every month I spend less than I earn and I invest that leftover cash. Slow and steady wins the race and I invest without fail each month. Sonnie and I both suggest you do the same and make this a habit.
One of my subscribers said the following:
“As far as advice for a 16 year old, I would let them know the importance of mindset! All the mathematical equations for compounding interest etc don’t mean much if you don’t have patience or can’t resist temptation to buy/spend and most of that is driven by the pressure to have the latest and greatest... AND I wish I had started tracking my budget sooner”.
You are already in KiwiSaver, you are already an INVESTOR so you are simply adding to your ‘portfolio’. Congratulations, if you have done all of the above, you now own a small piece of 50 (FIFTY!!!!) New Zealand companies!! Now when you hear, say, TradeMe mentioned you will be able to think “I own a tiny slice of them”! It is a pretty cool feeling. Once you set yourself up you just need to consistently add a bit of money each month without fail, so you can buy a little more of each company, in good times and bad, and then you don’t need to do ANYTHING ELSE. Just take a look at your accounts from time to time to see how the balance is changing.
The only thing I would ask you to do as an Investor is to also become an EDUCATOR. We girls have to stick together and help each other OUT and UP in life. You can even help the boys, cause god knows some of them need it too! Tell your friends what you are up to, explain how you did it, share this blog, and teach them to be good with money from a young age so that they too can get on a good financial path early on in life.
Ask me absolutely ANY question you like about money, and I will do my darndest to answer it for you. And I hope that when you hit forty you are living the life I envisaged for you right at the start of this extremely long blog post. I was also trying to prove the point that teenagers do actually have a long attention span and can see something to the end! Well done! You are indeed awesome Olivia.