This is a topic that has always intrigued me – how do I teach my kids the right lessons about Money Management? When do they start handling money independently? Let’s discuss a bit about the top few questions about Kids and Money in this post.

1. What’s the most important tool for teaching kids about Money Management? The answer is simple – It’s education. The best tool you can provide your kids is the knowledge that they’re getting things from life very easily – which their old man/woman did not. I admit that all of us want our kids to have the best in life and do not want to deny them the comforts of life, however, we need to stop going overboard.

As an example, a friend’s daughter who’s now going to the Third Grade in her school wanted a Nintendo DS. The reason was that everyone else in her class had one – and when the weather was bad outside, the teacher encouraged all the students to play with video games instead.

Now, in the above scenario, my suggestion would be to talk to the teacher and ask her to tell the students to read books from the library or work out in the school gym instead. How is playing video games everyday going to improve their lives? You might have your own view, but I believe that the idea of a teacher asking kids to buy video games is wrong.

2. When should kids start to have money of their own? I’d say – Right after they are born. I mean – it’s important for you to provide financial security to your kids, right? So as soon as you can, invest for them, their financial security and their education.

For example, when my friend had a son, as soon as the baby came home, my friend updated his pension, life insurance and retirement related accounts to reflect the baby as a beneficiary. Another friend buys a Savings Bond as a gift each year, on her kids birthday.

3. No seriously, I mean when can I provide my kids money to spend aka allowances? As soon as they can count is my opinion. One of the first things you will need to buy them is a Piggy Bank. All of their spare change must go in there. The larger monetary gifts (such as cash from Grandpa on the birthday) should go into their Savings Account that you control.

The earlier you start the better. We recently bought our daughter a doll that she really liked. She played with it for all of two weeks and the next time we were in the store, she wanted another toy. Fortunately, both my spouse and I were in sync and we instantly replied with a firm “No”. We did take the time out to explain to her that she wasn’t going to get everything she wanted – because there was a financial constraint on how many things she could buy in a month.

4. What’s the best way to teach kids to save and budget? This one’s easy. The best way to teach your kids to save and budget is By Example.

Think about it. Where are your kids learning their fundamental values in life from? Who teaches the kids what’s right and wrong? Who teaches the kids to be frugal. You do. So why should you not be teaching them to save and budget as well?

The best way to teach the kids to budget is by limiting their spending. Each month, every kid gets a certain “salary”. Out of the salary come their clothes, books, toys and so on. The salary must be carefully structured so that they have all their essentials, but need to save to pay for luxuries (such as a new Nintendo DS game, for example). As soon as the kid is old enough, he/she must be involved in their spending and encouraged to save.

One excellent trick to get the kids to save is to provide a “match” for their savings. A friend has an arrangement with his 10 year old so that at the end of the month, he pays her a dollar for every dollar that she saves from her allowance – up to a 100 dollars.

5. At what point should my kids be part of the family budget and goals? From their teens. Hopefully, if you have followed the practice of encouraging your kids to save and budget, by the time they reach their teens, they are responsible with money. This would be a good time to have them sit down and have their say in family finance matters.

For example, should we redo our deck first or buy that big screen TV for the family room right now? Decisions such as these would do with input from all the responsible members of the family.

Do you have more ideas, questions or thoughts? Please post them in the comments.

Last week, we explored in some detail how the small time US Banks of the 1950s slowly grew into global International players. We saw how the small banks of yesteryear began to dip into their war-chests and started to use that money as well as floated shares on the exchanges to get the common man to invest money into themselves. Additionally, we realized the importance of the lifting of the Government 15:1 restriction which forced the banks’ Investment arms to stop lending at 15 times what they really had in their vaults.

Now let’s fast-forward into the year 2002 and beyond and look at our very own Growing Up Bank (aka GU Bank) to see what’s happening.  As we discussed earlier, the Bank has taken complete advantage of the easing of the 15:1 restriction and we’re in the stage where the Bank has 50 million in the vaults, but by wiping out our “rainy-day funds chest” and selling a large amount of stock, the Bank has successfully loaned out about 5 billion. In other words, GU Bank’s loan to deposit ratio is a cool 100:1 (compared to 15:1) as the Bank has managed to leverage it’s deposits to loan out 100 times that amount. You, the Chairman and CEO are at the zenith of glory and you spend a lot of time jet-setting around the globe as you strive to control and grow the Bank’s business. Everything’s going great.

There’s one small problem. It’s called the law of “Supply and Demand”. No matter how high your connections, no matter how much money you have, this simple principle is something that’s out of your control. Here’s the problem: When money was tight, your Bank always ensured that before you granted loans, you looked at the credit-worthiness of the borrower. Which is why borrowers hardly ever defaulted. However with all of this excess cash available, the law of Supply and Demand has kicked in. The amount of cash in supply in the market has zoomed while the demand for it has not. Our Bank’s Executives have hence come up with two simple solutions:

1. GU Bank decides to lower the strict standards of evaluation to determine which borrowers are eligible to get loans from the Bank – in other words, GU Bank is about to increase it’s lending activity to subprime borrowers. In other words, the new mantra for GU Bank is: Need a Loan? No Problem
2. GU Bank’s Investment Management unit will use surplus cash to purchase mortgage-backed securities – in other words – the Bank will buy housing loans made by other banks as well. After all, the markets are going wild, GU Bank is just joining the flock.

Let’s now fast forward a little more to year 2008.

You’ve received an urgent call about a slight problem. You check your emails and the news on TV to hear a catastrophe – there’s a big subprime crisis going on. What’s worse – your bank is right in the middle of it. What the hell happened – you ask at the crisis meeting in the office? How did Growing Up Bank suddenly turn into Going Under Bank? Here are the answers you get:

1. Of the large number of subprime borrowers that GU Bank had provided loans to, a substantial number are defaulting on their loans. Worse, the effect of this has pushed a large number of others on the brink too, so they may be defaulting soon as well.
2. Of the large number of mortgage-backed securities that GU Bank had invested in, a substantial portion were related to subprime borrowers, so they are taking a toll as well.

As the crisis goes on outside, the Crisis Management Committee in the Bank is brainstorming for solutions. This is what’s on the table:

1. You authorize Bank officials to look at the “Rainy Day” accounts of GU Bank to provide some relief from this sudden lack of cash that has arisen. As expected, the officials come back to you with the bad news that while these “Rainy Day” accounts do exist, the contents are woefully inadequate since everything was raided long ago (at your own orders, they add).
2. The Bank tries to use stakeholders money, but there’s none left because the Bank loaned it out long ago. Worse, the shareholders are in a tight spot because all of their investments are in trouble (not just GU Bank – obviously, you were not their sole banking investment).
3. Officials look at the vault to see what’s available there, but there’ s not much left. Remember for every unit in the vault, the Bank made loans of 100 units to borrowers. The market is tight and new depositors are hard to find. Even worse, thanks to #2 above, depositors know GU Bank is in trouble and are not eager to invest more money.
4. Trying to get credit from the market is extremely difficult because every other financial institution out there is in the same fix and is struggling to find a means to stay afloat.

After all options have run out, the Crisis Committee decides to go to the Government for help. At this point, the crisis is so acute that if the Government backs out, the Bank will collapse and hundreds of employees jobs will be lost (not to mention the thousands of people who life savings will be wiped out too). From this point on, any financial news channel or news website will tell you what came next: The near collapse of several major banks and the subsequent bailout by the Government.

With the background in this (and the previous post), you should be well on your way to understanding how the subprime mortgage crisis affected today’s financial institutions. Feel free to look up references on the Internet – they exist in plenty. Below are some resources I found interesting that you might want to look up as well:

1. Confessions of a Subprime Lender: An Insider’s Tale of Greed, Fraud and Ignorance – Richard Bitner (Amazon)
2. Subprime Lenders Gone Too Far – A Time Bomb Waiting to Explode – Article by Michael Dawson @ EZine Articles
3. How to stop the Banks’ Bleeding – No easy choices – Article in Time Magazine
4. Leverage by the numbers – Article @ Option Armageddon
5. Bank of America tops Leveraged-Loan Business – Article in CFO Magazine
   

OK – Let’s give the Recession a break this time around and talk about something else for a bit. The Holy Grail of Life – the Secret to being successful.

It must be more than a coincidence – I looked closely at some immigrant families that  have migrated to the US,  and I saw that almost all of them have characteristics that fall into several of the following : Successful, Highly Educated, Thrifty, Rich, Happy…you get the drift. So I thought to myself, what are these folks doing that makes them so successful? They must have some magic mantra chant. My research led me to the following facts which seem to have a major influence upon their success:

1. Relationships are for keeps - If you want your partner to be perfect, then you’d better be perfect too. Since being perfect is impossible, it follows that neither you nor your partner is ever going to be perfect. So, once you enter a relationship, don’t take the easy exit. No relationship is going to be perfect, so learn to live with imperfections.

Financial Impact – No messy divorces, no alimony, peace of mind.

2. Stretch your legs only as far as the edge of the blanket you own - in other words, learn to live within your means. Of course, use credit if you must, but use it wisely. A friend of mine confessed that he was able to save about 45% of his monthly take home salary (ok, no mortgage), but isn’t that great? This rule would also mean – no maxed out credit cards, no new flashy car till the old one breaks down, no Bahamas cruises….and so on.

Financial implications – More money in the bank, more savings, emergency fund, secure future.

3. If you want something, be ready to give something up too - In other words, Sacrifice is the name of the game. You want an emergency fund in the bank? Then cut the cable TV out and watch TV online instead.  You want to visit your family back home abroad each year? Then skip that expensive 1080p Plasma TV. You want that nice family home in 10 years? Then replace the BMW buying plan with the Camry buying plan instead.

Financial Impact – Excellent long term returns.

4. Make your kids successful, sacrifice for them - We all want our kids to be successful. To ensure this, make sure you sacrifice your personal time. Are the kids exams nearing? Then, cut down on the outings to the mall and the TV times. Kids grades slipping? Punish the entire household by cutting TV time, Gifts, Movies and Outings. Ensure that the kids get the message that studies are critical – to everyone in the family. Who are the kids hanging out with after school? Make it your business to know.

Financial Impact – Comfortable old age. Rich kids pick out fancy nursing home for you in your old age.

5. Learn the value of money and teach it to the family as well, be frugal, not a Scrooge - Practice thrift and teach it to your kids too, but don’t go overboard. Buy the right stuff in the right place. Use coupons but avoid a coupon obsession. Cut the Plasma TV, but buy a good TV for the family room.  Buy that purse you liked, but stay within budget but buying it on sale instead. Get the kids the Wii, but only as a Birthday gift. Switch off the lights when you leave the room, but even more critical, ensure that the kids do it too. Give the nephew that birthday money, but as a Savings Bond, not cash to spend.

Financial Impact – More money in the bank, financially educated family, Excellent long term returns.

Welcome to part 2 of the Recession series.

In our last post, we talked about what a Recession is and how it occurs. We looked at a model of the Baby Sitters Co-op that gave us an understanding of how a recession actually occurs. We realized that a recession does not mean lack of resources, it just means lack of resolve to start using those resources. If you haven’t read my last post, please do so first.

We ended last week with a question: To counter the recession, the co-op managers forced a mandate that each couple would need to go out twice a month and have their child baby-sat by others. In other words, there would be some artificial demand created by this and there would be more babies being sat and consequently, more baby sitters. Do you think this will work?

Most of the readers who read the post reverted to me with the same answer – the above measure will NOT end the recession. And they were right. What the above measure will do is to force the couples to spend two (and only two) baby sitting coupons per month. Instead of increasing demand, this will only cause resentment in the couples because they are now being forced to spend coupons in a time-based manner instead of spending them at their own free will. Also, the number of coupons being circulated would be rather limited and fixed.  In the real world, since each couple will end up receiving coupons regardless of demand and supply, the incentive to perform better baby sitting would be taken away too.

So what is the solution? Luckily, one of the couples knew an Economist who suggested a solution. Here is how it worked: The Co-Op board went wild and printed a large number of coupons and provided a bunch of  ‘bonus’ coupons to each couple for use. Each couple was provided with a large number of coupons to spend. Couples soon realized that since they had so many coupons available to them now, there was no more need to hoard them and prepare a backup reserve.

Couples who realized this fact eagerly started to go out and have their kids baby-sat by other couples. The other couples in turn had a surplus of coupons and started to spend them liberally by going out more and spending more coupons and on and on it went. The end result was that there was a healthy circulation of coupons and the Baby Sitters Co-Op came out of recession.

Although this is a simple example, we can immediately draw some parallels with the real world. First, the Baby Sitters Co-Op is the entire USA and the Board of the Co-Op is the Federal Reserve Board. The “coupons” is our currency. Now you can complete the analogy and realize why the Fed is pumping billions of dollars into the economy.

In simple terms – the Fed is trying to:

• Get those of us who are hoarding and saving money in bad times to go out and start spending some of it in the stores.
• This will lead to the stores having more money and selling more
• This will lead to a need for more employees i.e. more jobs and more employed people
• The newly employed people will get paid salaries, some of which they will spend in the stores

and the above cycle will repeat till the economy comes out of the current recession.

Credits: The complete credit for the example goes to Paul Krugman and his book – The return of Depression Economics – and the Crisis of 2008 from W. W. Norton. I strongly recommend reading it, if you can.

If you stand outside and stop the first person you see walking on the street and ask them: “What do you think about the economy today?” – the answer will almost certainly be – “The economy is in a recession. Don’t you know that?” – and most will follow up with – “What hole have you been living in? Don’t you know that the entire world is in the grip of a severe recession?” – and the person will probably walk away disgusted and angry with you. It does not matter if the person is man or woman, old or young, the answer will always be the same. Make no mistake, as of January of 2009, most of the world is in the grip of a severe recession. Most major stock markets are at all time lows and a large number of jobs have been lost across the world.

I have often wondered and the question has been asked to me by so many friends and acquaintances – We know what a recession is, but what causes it? What is the solution to a recession? The truthful answer is: I didn’t know either. Of course, I knew what a recession was and it’s deadly effects. But I had no idea about what caused it and how to get rid of the problem. That is till I read an amazing book titled The Return of Depression Economics – and the  crisis of 2008 by Paul Krugman – Winner of the Nobel Prize in Economics. I was deeply impressed by the author’s ideas and explanations. I haven’t finished the book yet, but when I am done, I will try and do a review of the book as well.

But on to recessions – what are they? To understand this, let’s consider the example given by Paul Krugman from his book. Krugman talks about a Baby-Sitting Cooperative, an association of young couples with kids who were willing to baby sit each others children.

This co-op was large with about 150 couples, so there were plenty of couples ready to baby-sit and managing the association was a non-trivial task.

Like many such associations, the co-op issued it’s own scrip or currency -  a coupon. Each coupon entitled the holder to one hour of baby-sitting. In other words, when a couple went out for the evening, they would leave their baby to be sat with another couple and for each hour, the sitter would receive one coupon from the baby’s parents for this service. The system was shirk-proof: it automatically ensured that over time, if a couple wanted to use the baby-sitting service, they would have to also contribute and baby-sit other babies to earn their coupons.

However, the system was not as simple as this sounds – for smooth running of the system, there was a need for a sufficiently large number of coupons to always be in circulation. Couples who had several free evenings would attempt to “hoard” coupons by trying to baby sit as many babies as they could and build up a “saving” of coupons. Obviously, this hoarding was matched by a depletion in the savings of other couples.

This kept on happening till one fine day, there were relatively too few coupons in circulation. The cause is not very important, but the effect is.

Couples who felt that their “savings” of coupons were insufficient became anxious to babysit other couples babies. However,  one couple’s decision to go out was another couple’s opportunity to earn a coupon, so opportunities to baby-sit became harder to find. This made couples even more reluctant to go out and to use their “reserves” except on special occasions, which made baby-sitting opportunities even more scarce, which made couples even more reluctant to use their “reserves” and so on and on it went until…

The Baby Sitters Co-Op went into a recession. No couple was ready to go out and spend their hoarded coupons and consequently, no one was available to baby-sit a baby because of the total lack of demand.

If you are with me so far, then let’s go ahead. If you are feeling a little lost, go back and read the paragraphs again. I had to read them more than once to grasp the complete concept – but when you have done so, you’ll realize that it is really a brilliant example.

Now, let’s conduct our own analysis and try to visualize the effects of the same. Let’s assume that to counter the recession, the co-op managers forced a mandate that each couple would need to go out twice a month and have their child baby-sat by others. In other words, there would be some artificial demand created by this and there would be more babies being sat and consequently, more baby sitters. Do you think this will work? If yes, how and if not, why not?

Let’s continue this discussion next week.

Credits: The complete credit for this example goes to Paul Krugman and his book – The return of Depression Economics – and the Crisis of 2008 from W. W. Norton. I strongly recommend reading it, if you can.

Buying a car

Let’s face it – a car is the first big purchase that one usually does all by oneself. The universe of cars is huge and at every step, you ask yourself – Am I making a mistake? This is exactly the situation that I found myself in a few weeks ago. My family and I had decided to buy a new (or maybe a used) car. While it will take a lot of effort to describe exactly how and why we decided what we did, the reason I’m writing this post is to highlight the best things to do and the best things to avoid.

One of the first things you do is to hit the Internet and look for tips on car-buying. Here are the top five tips and my take on each of them:

1. Lease or Buy – Almost every site that I read had the same view – it’s always better to buy than to lease. The only exception is if you are the type that changes card every two to three years – in which case you should consider leasing. However, for almost everyone else, buying is the best option.

My take – Unless you are in the business of impressing your friends with the latest trendy sports car every two years (and have a millionaire father to feed you), stick to the Buy option.

2. Used or New – Again, most websites recommend buying a slightly used car – one that is about two years old and has less than 25000 miles on the odometer. The common word is that new cars depreciate the most in the initial two years, so by buying used, you get the best bang for the lowest buck.

My take – Decide on the car based on several key questions – how much driving experience you (or your spouse has). For example, even if you are a great driver, your girlfriend may be a novice. In such case, stick to a 6 year old used car. How much you have saved – if you are a student still in college, stick to a cheaper car that you can junk after a few years. How long will you keep it – If you’re like me and intend to keep your car for 8 years or more, buy something that’s less than two years old and less than 20000 miles.

3. When to buy – Most websites advocate buying used cars in the November to December time frame because that’s when dealers are desperate to sell the outgoing model and will lavish out discounts.

My take – The above is true only if you are buying the current year’s model new. If buying used, go for the March to May period after winter. If buying new, September to October is best for the current year’s model so that there’s something left on the lot for you and December for the new year’s model so that the euphoria for the new model has died down and prices are more reasonable.

4. Finance – where to get it? – Most websites advocate getting finance from your local bank of better yet, a Credit Union.

My take – Who cares? Go for the lowest total payment you can afford. Do your homework well. Go to all the banks you can as well as all the Credit Unions and get the best deal that you can and get it written on paper. At the dealers showroom, show them the letter and ask them for a match. You’ll be surprised how effective this can be. Keep in mind at all times the total interest you will be paying i.e. monthly payment x number of months minus loan amount. Ensure that the option you choose from has this value as the minimum.

5. Trade In – The tipsters say you should trade in only if you must. Dealers are more interested in selling you a new car rather than giving you a good deal on your old one. You are better off selling it to a private party yourself.

My take – They are right on the mark on this one. Trade in only if you absolutely have to. You are better off detailing your vehicle and then selling it to a private party. use Craigslist and auto sales websites extensively and you will save a pile of money.

Do you have any more car buying tips? Let me know.

I just stumbled across a reference to the Money Aisle website and thought I should share it with all our readers.

The site is an interesting concept and once you’ve registered with them, it allows you to input an initial dollar amount and then choose if you want a high-yield savings account or an online CD to put it in. Once you make that choice and enter the other necessary details such as your zip code, state of residence, your term (for CDs), it will actually post these values to several banks that will compete online and bid for your business. What’s more, the process (the site calls it an auction – which in a sense it is) runs into several rounds (up to 10 in fact) and then provides you with the winner who has offered you the highest possible rate.

The best part of the site is that there’s a trial mode that allows you all of the above, except that it withholds the identity of the winning bank from you until you register.

For example, in trial mode, I put in an amount of $5000 for a CD of term 12 months and entered my state of residence as PA. There were 93 banks competing for my business. The auction began with a rate of 2.60% APY in round and ended with a rate of 4.05% APY with 168 total bids. Since I was in trial mode, I could not see who won the bid, but I liked the concept nevertheless.

Safety features – The site provides a clear notice right on the homepage that confirms that all of the banks it deals with are FDIC insured (which means that your investments up to $100,000 are insured). The service has also received rave reviews from several sites such as the New York Times Business Section, Smart Money among many others.

I haven’t yet tried it, but I’m eager to. I do most of my High Yield saving with ING Direct, so I’m going to try this the next time one of my CD’s is up for maturity.

Have any of you tried out this service? Do you feel strongly about it? Let us know.