Illustration: Colin Daniel

“So where will the money come from?”

“Out of the [ATM bank] machine,” was the reply from the three-year-old who wanted his grandfather to buy him the sparkling red bicycle in the shop window. And here lie the seeds of a problematic attitude towards money that could result in a lifetime of grief.

A no-strings-attached approach to money encourages false expectations and bad financial habits that later in life manifest in instant gratification, uncontrolled debt and chaotic finances.

The sooner young children are taught the correlation between what money buys and its real source, the more likely they will grow into financially responsible adults. Children should learn from an early age that being financially responsible is about making hard choices – and there are very few free lunches.

This article provides you with 10 things you can do to put your children or grandchildren (because grandparents can also play a role) on the road to a lifetime of sound financial habits. This is not something that can be achieved overnight. It is a gradual affair that will be dictated by your child’s level of understanding and ability.

Educating your children about finances will require that you set the right example, Peter Stephan, the senior policy adviser of the Association for Savings & Investment SA, says. “It is not a case of ‘do what I say, not what I do’.

“If you are not capable of saving your money, how will your children learn? If children see you buying whatever you want using a store card, they will grow up thinking that buying without actually having the money is the norm.

“If this is the example you set, do you also share your anxiety with them at the end of the month when you cannot afford to repay all your cards?”

If your finances are chaotic, the chances are that your children, who are great mimics of their parents, will follow your example. So do not leave bills unopened (and unpaid) and do not “max the plastic” and impulse shop, but budget so that your salary will last the month, and save – and let your children observe and understand the choices you make.

Sugendhree Reddy, the director of banking pro-ducts at Standard Bank, says the lessons of money management are best learned when young. By teaching children about money – how best to use it and the value of saving – we teach youngsters vital lessons that will carry them through life.

“Money management begins with the basics, and it is often grandparents and parents who get the process going.

“Children who have learned the basic disciplines involved are more likely to become young adults who understand money, manage it correctly and handle it effectively, to their ultimate benefit. Teaching children when they are young about money matters is therefore one of the greatest lessons a parent can teach,” Reddy says.

1. SILENCE IS NOT GOLDEN

Many parents whisper about their finances out of earshot of their offspring – perhaps because they are embarrassed about the state of their finances. But for children this silence may imply that money management is not important.

You should involve your children in the household finances. You do not have to be explicit to the extent that little Johnny blurts out the details of your pay package at school – and school is not where little Johnny is going to learn much about financial responsibility or even how financial products work.

Too often, parents and the educational authorities regard finance as something for “adults only”. Even pay packets, when they still existed, came in brown envelopes. If the schools are not teaching this very necessary life skill, it is most definitely a job for parents and grandparents.

The not-in-front-of-the-children attitude has resulted in many adults not acquiring sound financial habits and knowledge, leaving hundreds of thousands of people exposed to bad financial products sold by commission-driven, under-skilled product floggers, not to mention the billions of rands lost by individuals who fall prey to outright scams.

The belief that people should be educated about finances only when they reach adulthood is absurd. It is probably one of the reasons that the first tough life lesson young adults learn is that “maxing the plastic” can have dire consequences.

Money management should be taught in stages and in various ways, such as giving children pocket money and involving them in discussions about the family finances. For example, you should set aside time once a month when the family gets together to review the bills and decide how the money that is left over will be spent. It should be a fairly formal occasion, but even the youngest member of the family should participate.

Eventually, you can involve your children in drawing up the family budget, setting long-term savings goals and allocating how much to spend on essentials such as food, clothing, school fees and transport.

Involving your children in budgeting will help them to understand why you cannot afford to buy them everything they want. This may encourage them to find their own sources of income to supplement what your income cannot provide.

By the time your children are in their teens, they should be making electronic fund transfers to pay bills (but do not simply give them the passwords for your bank accounts!), budgeting by using spreadsheets on your home computer and playing an active role in prioritising spending.

If you want to break the silence about finances effectively, you will have to follow a curriculum over a number of years that takes your children through all the aspects of correct financial behaviour. Drawing up such a curriculum may entail your having to fill in many of the gaps in your own financial education. This does not mean that you have to become an expert on butterfly spreads or the gearing concepts in the options market, but you will have to know the basics about things such as investing. Fortunately, with the advent of the internet, much of the information you need is freely available online.

The other good news is that the financial services industry is starting to educate children about money management. For example, the industry has established the South African Savings Institute, which prioritises the education of children. And every year, during National Savings Month, droves of volunteers from the financial sector spend time in schools teaching sound money habits to children - and, in many cases, their teachers.

Nedbank has started the All Aboard Western Cape Education Initiative for children in grades one to seven. The initiative aims to introduce children to the principles of saving, and enables them to understand the power of money and how to use it wisely, to encourage healthy financial management.

Lisa Linfield, the Nedbank executive in charge of transactional products, says the first stage of the programme was rolled out at 29 schools in Mitchells Plain during 2010. An additional 11 schools were incorporated into the programme during the first term of this year.

2. LIFE IS ABOUT CHOICES

As Forrest Gump said, “Life is like a box of chocolates: you never know what you’re gonna get.” For most of us, if we choose one thing, we have to do without something else. The issue is to make the correct choice. Often, our choices involve deferred spending, and to do that we need to distinguish between a want and a need.

The inability to appreciate the difference between a want and a need (or even wanting to know that there is a difference) is where so many people go wrong in their finances – all too often wants take preference over needs.

The difference between a want and a need can be taught to children in many ways, such as choosing an educational toy or book over something that will be broken and forgotten within days.

You should explain what the choices are and their associated advantages and disadvantages. You can start with simple things, such as whether your children want to forgo buying sweets so that they can afford to buy something more durable and useful, such as a bat and ball. It is, however, important that your children make the final choice, albeit with your subtle guidance.

As your children grow older, you can progress to involving them in choices about the family budget, such as, “Do we buy a new car this year or next?”. And when you buy the vehicle, you should explain to them why you have bought a Toyota Corolla and not a fire engine or a Ferrari.

3. WORK LEADS TO REWARD

One of the most important lessons you can teach your children is that money is a precious resource – it is something for which someone has had to work, Stephan says.

“By giving your children what they want, and by handing them money whenever they want it without having to earn it, you foster the attitude that money is something that simply falls into your lap. Children will only learn to understand the real value of money if they have to earn it and if they have access only to the amount they have actually earned,” Stephan says.

Children need to understand that money does not simply arrive in the ATM, and there is a direct relationship between the work their parents do and how much the family has to spend.

They also need to learn that it is far harder to earn money than it is to spend it. If you give your children never-ending gifts for any reason, you are training them to think that there is a box of gold out there that regenerates itself.

Probably the best way to start is to give your child some money so that he or she can pay for an item or items at the shops. This will enable the child to begin to learn the relationship between money and goods. The item or items can be for the household, and not simply a “gift” for the child.

Pocket money is the best tool you have to explain the correlation between work and reward.

The first decision you must make is the age at which it is appropriate for you to start paying pocket money. It is pointless to give pocket money to a toddler, who is more interested in the paper in which a gift is wrapped than in the gift itself.

You should pay pocket money only once your child can understand the concept of pocket money, and why and how it will be paid. As your child grows older, how pocket money is structured and the obligations your child must meet to obtain it can be made more sophisticated and instructive.

Children should learn that pocket money is finite. Once you have decided on an amount, there should be no additional handouts once it has been spent. This will teach children that money must last from payday to payday.

Pocket money, or an allowance, can be structured in a number of different ways. These include:

* A bonsella system. This is simply a regular no-strings-attached payment. It does not depend on your child doing anything. The bonsella system is of little or no benefit. Apart from fostering a sense of entitlement, the only thing your child may learn is the purchasing power of money.

* A reward system. This system rewards your child for good behaviour and/or helping with the household chores. Payment is made every week or month. Initially, it is probably better to pay the money every week.

Many parents start by paying an allowance based on good behaviour, setting an amount that will be paid every week and deducting money for unacceptable behaviour. However, you need to explain beforehand what will constitute bad behaviour and, when you deduct money, what the child did wrong. The danger of this carrot-and-stick approach is that, if applied strictly, it could result in a child not receiving any pocket money week after week. Without a reward, the child may feel it is pointless to resist the temptation to, for example, bully his or her younger siblings or throw food across the table.

The reward system is difficult to police and apply fairly and consistently.

A better reward system is one based on the child doing household chores, because it associates reward with labour. Typical chores would include washing the dishes and making the bed.

Some parents pay a set amount for the successful completion of chores. The advantage of this is that there are consequences for not doing the assigned chores and there is a reward for doing them. In other words, the system provides positive reinforcement and punishment.

The danger of the reward system is that it could encourage your children’s desire for money at the cost of their sense of responsibility as part of “team family”. Your children should clean their rooms and help with the dishes regardless of any allowance.

* An income system. This system is designed to imitate real life. You pay your children for doing chores that they are not normally expected to do – for example, clearing the gutters in autumn, baby sitting a younger sibling, and washing and vacuuming your car once a week.

You and your children must agree on how much a particular chore is worth. Write down the chores and the agreed-on payment. Some tasks, such as washing the car, will have a fixed amount, whereas others, such as baby sitting, will be paid at an hourly rate.

The income that your children receive will vary and will be irregular, but this system will do far more for your children’s financial future than the bonsella or reward system.

The nature of the job is not as important as the lesson your children will learn by being paid for completing it: they must achieve something in order to earn money. In other words, work leads to reward - and learning to make the connection between work and reward is one of life's key skills. The income system encourages a work ethic.

Children will soon learn it is far harder to earn money than it is to spend it.

Doing jobs around the home can also teach children life skills that will be useful for the years to come, such as how electricity works (by changing light bulbs) and garden maintenance (by fertilising the lawn).

Make it your children’s responsibility to keep a record of the work they complete. You can use this record to audit their pay claim.

Do not tolerate excuses by your children that they have not done their normal household chores because of the pressure of their paid jobs. One of the benefits of the income system is that it will teach children basic time management. They will have to choose which jobs to do, based either on enjoyment or the pay scale – a skill that will benefit them when they decide on an occupation as adults.

Reddy says one of the best ways for your children to appreciate the value of money is to earn it themselves.

“Earning money is a matter of pride, so encourage your child to get a part-time or holiday job. A child then begins assigning a value to acquiring things and balancing the need for an item against the hours that need to be invested to achieve the objective,” she says.

As a start to finding their first job, you could encourage your children to approach neighbours and relatives to do chores for them. Your children will not benefit as much if you apply for the jobs for them: they should learn networking skills themselves.

* A self-support allowance. This system can overlay whichever pocket money structure you decide to adopt. As children grow older, part of their pocket money should go towards paying for essential items, such as clothing. This will encourage children to prioritise their spending. Discuss with your children how much money you will give them to cover the costs of clothing, transport and entertainment.

The danger is that your children will spend the money that should have been used to buy, say, clothing on entertainment, but you can start in a small way. For example, you should keep paying for absolute essentials, such as school fees and uniforms. As your children become more responsible, you can increase the items on the self-support list.

4. BANKING

Banking is the backbone of any financial system. It allows for lending and the aggregation of wealth, and facilitates the transfer of money between parties. No economy can operate without a banking system, and no one can really control their finances properly without some sort of banking facility, even if it is only a savings account or a credit card.

Opening his or her first bank account will be a memorable occasion for your child. While you may decide on which bank to use, you should involve your child in the process of opening the account; do not simply come home with a bank debit card.

Take your child to the bank, and let the bank’s consultant “sell” an account to your child. Get the bank to explain the advantages and disadvantages of the various account packages and the necessity for responsible money management. This will make opening the account an educational exercise in itself.

Stephan says a debit card is the answer if you want to provide your child with some transactional ability. You should explain how a debit card obviates the need to carry large amounts of cash.

The amount of cash you can withdraw or the amount you can use to pay for anything is finite: you will get no more than what you put in, apart from any interest earnings.

You should pay pocket money into this account and encourage your child to pay for purchases with the debit card.

Every month, you should present your children with their bank statements so that they can see how much they have and how much they spent.

On the same day you open the bank account you should also open a computer file (if you are receiving electronic statements) or buy a binder to keep paper statements.

In most cases, you will probably transfer cash into your child's account electronically. However, it may be exciting and educational for a least the first few times to actually go to the bank to deposit the money.

To encourage your children to save, you could also open a savings account and discuss a split of their pocket money between the two every month, Stephan says.

The major banks have accounts aimed at children, and some banks tailor their accounts for specific age groups (see “What the banks offer youngsters”, below).

Children under 18 cannot open a bank account themselves. They need your permission as a parent or legal guardian. An exception is that a minor between the age of 16 and 18 may open a savings account without your say so and assistance. After the age of 18 they are free to undertake any banking activity as long as they meet the requirements of the National Credit Act and the bank.

The following are required to open a bank account for a minor:

* The child’s bar-coded identity book or a certified copy of his or her birth certificate;

* If your child is under the age of 16, the bank will require your consent and proof of identity; and

* The bank will require a utility account issued within the past three months, to verify your residential address.

5. BUDGETING

Drawing up a budget can seem more like a penance to your children than something constructive. It is up to you, as a parent, to make it fun – for example, by throwing a few silly things into the family budgeting process.

Children need to understand that a budget is basically a saving and spending plan. You need to show your children how to save and spend wisely, and how to get the balance right. The emphasis should be on saving and not on spending.

But saving simply for the purpose of saving is not going to foster much enthusiasm for budgeting in your children. They need to know why they are saving and how long it will take to reach a savings goal. This relates to the point about not providing your children with an endless stream of gifts, because this will result in an absence of items that your children can acquire only by realising their savings goals.

Stephan says that budgeting will cultivate the adoption of good savings habits by you and your family. These include trying to save at least 10 percent of what each family member earns every month. “To achieve this, draw up a budget and follow the KISS principle: Know where your money goes. Impose controls on your finances. Spend wisely. Save carefully to build your financial resources,” Stephan says.

The younger a child, the less likely it is that he or she will appreciate long-term savings goals, such as at four years starting to save to buy a car at age 18. For younger children, the savings target will be to buy cheaper items, such as a cricket bat or an iPod.

A carrot-and-stick approach is again a useful way to go about things. For example, you could help young Jill or John decide on a savings goal and then discuss how it can be achieved. Saying “I will give you R50 every month to save for your goal” is not going to teach a child anything. The money must come from making a choice – a choice that involves deferring spending the money on something else.

A good way to start is decide how pocket money will be structured. In other words, why pocket money is being paid, what the child must do to receive the money and how much money will be paid.

The decisions should also include how to “spend” that money, with “saving” as the first item of spending. The 10 percent-of-what-they-earn rule is a good place to start. They then get used to saving from the first rand.

6. SPENDING

Spending is the natural consequence of earning money. If it was not for the things we need and want, we would not bother to earn money. The problem for almost everyone is that our shopping list is larger than our income.

The two most important things that a child needs to learn about spending are:

* The difference between needs and wants. I “need” a meal a day, but I “want” caviar and champagne, or, in the case of little Arnold, he “wants” a sugar high of soft-serve ice cream, but he “needs” one protein and three veggies.

* Deferring spending. There simply is no way that anyone, unless they have the earnings of the band Queen, will “get it all and get it now” as Queen demanded in their hit song, I want it all. I want it now. Paradoxically, when lead singer Freddie Mercury thought he had it all, it was all pretty pointless. But for most people, the price of instant gratification is the enormous penalty of debt.

The earlier children learn how to prioritise and limit their spending, the better. Children will not learn if you simply tell them how to spend their money; you have to teach them about making choices. And you will not make it easier for them to make those choices if you meet their every demand.

It is acceptable for children to want things (and to want them badly), but they need to learn that those things must be earned and paid for. Unfortunately in this regard, the odds have become stacked against us by a culture of instant credit. Gone are the days of frugality. Why wait when you can get it now on credit?

But another message may be creeping home as more and more people retire with insufficient capital and have to rely on their children to survive. If your family budget has to support grandpa or grandma, not only should you point this out to your children when the monthly budget is prepared but you should also discuss the reasons their grandparents are not financially independent. No doubt, the main reasons are that they did not save enough, because they spent too much and borrowed excessively – and had to pay interest for doing so.

7. SAVING

Children should not be given a choice of whether to save. Saving must be a given. The choices involve how much to save, the period over which to save and which savings vehicles are appropriate.

Reddy says we usually introduce our children and grandchildren to the idea of saving with the age-old piggy bank. “This is where we can teach our little ones to save with a goal, perhaps for stickers or a toy that they have been eyeing at the corner shop. Encourage children to put away money they get as gifts from relatives, and to save the seemingly insignificant coins, impressing on them that these coins when added up will get them that so-wanted item,” she says.

Using a glass jar as a piggy bank for coins will enable children to see their savings grow.

Reddy says there are many things that you can do to teach children that saving can be fun. She suggests that if they have their hearts set on a new bicycle or doll, you can help them to understand how long it will take them to save enough money by drawing a money tree or a thermometer chart to put on the wall. Every time the children save money, place a mark on the chart so that they can see how close they are to reaching their goal.

The final choice of how much to save should be made by your child and not you. The things you should discuss with your child are:

* The amount, which should be a percentage rather than a fixed amount, particularly because a child’s income will vary if he or she receives cash as a gift. The time horizon is likely to affect the percentage. If a child wants to buy an item sooner, the percentage will have to be increased.

* The savings goal. In setting savings goals, the first target is to make sure your children understand that saving from the start of the month does not mean spending it before the end of the month.

Initially, the savings target should be simple and for a single item, to avoid confusion. The older a child, the more likely they will settle for longer-term targets, such as buying a motor vehicle at 18.

There is nothing wrong with directing a portion of the savings towards paying for a tertiary education.

One wise grandparent associated with Personal Finance has adopted the following carrot-and-stick approach: for every rand his grandchild saves, he matches it with another rand. But if for any reason the money is withdrawn before the goal is achieved, the grandchild has to repay R2 for every rand withdrawn. So far there have been no withdrawals.

Children also need to understand that inflation is one of their biggest enemies when it comes to saving. If, for example, inflation is running at six percent a year and their investments are earning only four percent, their savings are decreasing in value by two percent a year. To understand this, it is best to use an example of how inflation affects the buying value of the rand or what its real (after-inflation) value is.

For example, if your child has R100 saved today and receives a zero return but the inflation rate is running at an average of six percent, that R100 will be worth only about R75 in five years’ time. Or to put it another way, if he or she bought an item for R100 today, the item will cost R134 in five years’ time if inflation is running at six percent.

Understanding the effects of inflation is also important when teaching your children about compound interest: why their savings must be in an inflation-beating investment.

Compound interest is the secret of the rich. The rich get richer because they do not spend all their money; instead they invest their money to get richer.

Children have youth on their side: the earlier they save their first rand, the more likely it is that they will become millionaires.

The effect of compound interest/returns is one of the most important things you need to teach children if they are to develop a desire to save for the long term and to re-invest whatever interest or growth they have received on their savings.

The following example may help to explain the concept: Jack and Jill are the same age. At age five, Jill starts to invest R50 a month. At 15, she stops saving. At 15, Jack starts to save R50 a month. Jack saves R50 a month for the next 30 years and yet he will never catch up with Jill’s savings. The reason is that by the time Jack starts to save, Jill is earning more interest on her savings than the R50 that Jack is saving.

Taking advantage of compounded returns may be the best way to mark the birth of a child or grandchild. Assume you invest R1 000 in the name of the newborn on the day he or she is born and that the money earns 10 percent a year. This is what will happen to your investment:

* At the end of year one, you will have R1 100. Your R1 000 has earned you R100.

* At the end of year two, you will have R1 210. R10 has come from the R100 your investment earned last year.

* End of year three: R1 331.

* End of year five: R1 611.

* End of year eight: R2 144. Your investment has doubled in value.

* End of year 10: R2 594.

* End of year 15: R4 177. Your initial investment has now quadrupled in value.

* End of year 20: R6 727. The investment is worth six times more. The annual interest earned is R512.

* End of year 25: R10 835. The original investment of R1 000 is now earning more than R1 000 a year.

You might think that this is a slow way to accumulate wealth, but remember that the calculation is based on saving a single amount. If you contribute R1 000 a year, the picture alters dramatically:

* End of year one: R1 100. A repeat of what happened at the end of year one above.

* End of year two: R2 310. You are already starting to leap ahead.

* End of year three: R3 641.

* End of year five: R6 716.

* End of year seven: R10 436. By saving R1 000 a year instead of only R1 000 once, the investment now almost equals what it took 25 years to achieve. In the process, you invested R7 000 and you earned R3 436 in interest.

* End of year 10: R17 531.

* End of year 15: R34 950. You have earned almost R20 000 in interest.

* End of year 20: R63 002. You have earned R3 727 in interest on all the interest earned to date.

* End of year 25: R108 182. Now we are talking real money. Remember that you have invested a total of R25 000, while the balance of R83 182 is entirely the result of interest earned.

Incidentally, to hit a savings target of R1 million in 25 years based on our calculations, you would have to save R833 a month.

The Rule of 72

Here is a rough guide for working out the effects of compound interest. It is called the Rule of 72. The Rule of 72 derives its name from the calculation that, at a compounded rate of interest of 10 percent, your investment will double every 7.2 years.

With the rule you can work out how often savings or investments will double in value depending on the rate of interest or growth. Here are two examples:

* At an interest rate of six percent, it will take 12 years to double your money (72 ÷ 6 = 12 years); and

* At 15 percent, it will take 4.8 years to double your money (72 ÷ 15 = 4.8 years).

The Rule of 72 can also be used to calculate what compound growth or interest rate you need to double your money in a chosen number of years. Here are two examples:

* To double your money in four years: interest of 18 percent is required (72 ÷ 4); and

* To double your money in eight years: interest of nine percent is required (72 ÷ 8).

8. BASICS OF INVESTING

Gone are the days of share certificates. In some ways this is a pity, because in wealthy families it was a tradition to provide a new grandchild with a share certificate or two, to be closely guarded and not realised until some future date or event. Given enough time, the dividend payment on the shares would exceed the initial cost of the shares by many times. Over the years, the child benefited (and not just materially, but also by being educated about investments) from the cash flow of the dividends and the increasing value of the share.

Although share certificates are a thing of the past, the concept still holds true.

But the years have also brought new ways to invest, particularly opportunities such as collective investment schemes (unit trust funds and exchange traded funds). Pooled investments have advantages over single share investment. A single share can be expensive and there is greater risk of something going wrong. Collective investment vehicles are investments for the people. Anyone with relatively small amounts can own exactly the same share portfolio as someone who is ultra wealthy. The only difference is the rand values will be considerably less.

Collective investments have lots of advantages. You require far less money to buy them, you can invest small amounts on a regular basis, you are spreading risk across a number of companies or different types of assets, and the dividends and interest can be added back into the investment to make them grow faster. In fact, they are the ideal gift for a grandchild, particularly when they are ear-marked for a particular purpose.

Stephan says that a parent or legal guardian can open a unit trust fund account in a child’s name. While the child will not be able to transact, the parents or other family members can make tax-free donations, up to the annual exemption, to the account. Parents should, however, note that any taxable income that results from such donations will still be deemed to be theirs for tax purposes while the child is a minor.

Collective investments also provide great opportunities for teaching children about investments. Every quarter, collective investment companies send out statements that tell investors what their investments are worth. Companies also send out newsletters and brochures about a fund’s underlying investments and why some funds are performing well or badly.

Your children can learn a lot if you discuss the quarterly statements with them. This can start at a very crude level, such as “look at how rich grandma is making you” or “I think grandpa may have chosen a different investment to make you rich”.

Discussing the performance of your investments can lead to looking at performance tables and comparing funds. This will teach children about asset classes, about volatility of markets, of assets and individual companies, and why certain selections are made. This is particularly illustrated in the play-off of returns against risk. Most importantly, it will teach them about the power of compounding returns – or put another way, time in the market rather than market timing. As a child becomes more astute, you can step up the level of education.

Hopefully, after a few years little Tembi or Dube will have saved enough money to start investing themselves, or if you are investing on their behalf, you can involve them in the decision-making.

If they or you do not have enough money to invest, you can develop a phantom portfolio.

Phantom or real, you should keep proper records. For instance, set up an Excel spreadsheet that can be updated once a quarter with the new values, as well as new investments. If you do not know how to do it, ask Tembi or Dube – they will teach you.

By diligently tracking their investments, Tembi and Dube will learn about the vagaries of stock markets and how they rise and fall, but generally rise. This will teach them not to fall prey to one of the big mistakes that many investors make: panicking and selling when the market bottoms and buying when the market is booming and shares are expensive. They will learn that it is better to ride out the volatility. This does not mean that you should invest in high-volatility or risky assets: a big fall may result in disillusionment and cause your children to lose interest.

A major benefit of educating children about investments is that they will, in the process, have to learn about the world at large if they want to make wise investment decisions. So Tembi and Dube will need to brush up on geography (for example, to know why the JSE is overweight in resources stocks); keep up to date with current events (the effect of a major event on markets); they will need to read up on history (the dates of major market crashes and their reasons, such as the 9/11 terror attack in New York); they will need to know about politics (for example, how nationalisation and privatisation affect investment markets); and they will need to learn some economics (for example, how inflation and interest rates affect investments).

And once Tembi and Dube start to take a deeper look at their investments – for example, the various industries and individual companies in those industries – it may help them to decide on career choice. At the very least, it will help them to decide what they do not want to do.

The research need not be boring and dreary. Try this URL: http://a.media.global.go.com/investorrelations/newsletter_dec2010.pdf. It is really quite cool.

There are a lot of good websites nowadays where the language is simple and the explanations are good. Try the Personal Finance website at www.persfin.co.za or www.investopedia.com

Stephan says since collective investment schemes should be seen as a long-term investment, general equity funds could be considered. Over the long-term, equities have consistently out-performed all other asset classes.

“Another good option would be a domestic asset allocation fund. These funds invest across the equity, bond, money and property markets, with the asset manager deciding how much money to invest in each asset class. These funds have become popular with investors and advisers alike, since they provide diversification across asset classes within one fund, with an expert fund manager deciding on the appropriate mix. Funds, ranging from low-equity to high-equity exposure, are available within the asset allocation class,” Stephan says.

9. COST OF DEBT

It is essential that you start to teach children about debt as soon as possible, because debt is the biggest destroyer of wealth and happiness.

South Africans are overwhelmed by debt. Uncontrolled debt has enormous negative consequences, and yet everyone wants to lend you money. Your bank wants to lend you money; your clothing store wants to lend you money; motor car dealers want to lend you money; furniture dealers want to give you credit. Open any newspaper and you will find advertisements with offers to sell you something on credit. Easy credit has fuelled the culture of instant gratification.

Children have to learn that there is no free lunch and that debt can be crippling in many ways.

Probably the best place to start is by explaining that interest on debt compounds. It is the antithesis of the interest that compounds on an investment. You could, for example, discuss with your child whether to save to pay cash for a car at age 18 or to buy it on credit. Explain that you can negotiate a discount if you pay cash. So if the vehicle is priced at R100 000 and you negotiate a discount of five percent, the car will cost R95 000.

But if you borrow the money at an interest rate of, say, 15 percent a year and the loan is repaid over four years, the monthly repayment will be R2 783.07, which means you will pay a total of R133 587.40, of which R33 587.40 went to interest payments. Paying cash resulted in a saving of R38 587.40 (the R5 000 discount plus R33 587.40), so the vehicle will cost almost 40 percent more if you buy it on credit.

As every adult knows, there are times when debt cannot be avoided. Children need to understand that there can be both good debt and bad debt, and they must be able to distinguish between the two.

Bad debt can best be defined as anything bought on credit that is consumed, such as food or clothing, or that loses its value the moment you buy it, such as a computer or a motor vehicle. Children need to understand the concept of a depreciating asset. So if they buy an iPod that costs R1 000 but later want an upgrade, they will receive very little for the initial purchase. They need to understand that if the item was bought with borrowed money, in no time it could be worth less than the debt.

A good way to illustrate this is never to give a child pocket money that is more than the agreed amount. If your child wants extra money to purchase something, such as a ticket to a “never-to-be-repeated” concert (which will have no value the next day apart from the experience and boasting rights) or a set of second-hand drums, lend the money at the interest you would pay. Then assess the value while the debt is being repaid and record the total amount of interest paid.

Good debt can best be defined as money borrowed to purchase an item that will improve in value – an appreciating asset. The usual example is a mortgage bond on a home, because most property improves in value over time. But this is difficult to explain to children who enjoy free board and lodging. However, once they are old enough, you can use the example of the mortgage bond on your own property to explain the concept of good debt.

The chances that children will incur good debt are fairly slender. However, there is one area that can be used as an example for both saving and borrowing: paying for their education.

The need to save to meet the high cost of education – particularly tertiary education – should be explained to children (see “Funding your child’s education”, below). Children also need to accept that if they cannot save enough and you cannot afford a tertiary education, they may need to borrow to make up any difference.

You also need to teach children about the different types of interest rate structures, such as:

* Borrowing and lending rates, and why you earn a lower rate on the money you save than on the money you borrow.

* Prime lending rate. You should explain how the banks vary their interest rates around this rate. The average borrower can expect to pay above the prime rate for unsecured debt or if he or she is considered a high risk, whereas borrowers tend to pay below the prime rate for secured debt, such as a home loan.

You should also explain the necessity of having a good credit record and how a poor credit record will result in paying a higher rate of interest, even on good debt.

* Variable interest rates, and how they rise and fall depending on what is happening in the economy.

* Fixed rates, where the rate cannot be increased or decreased over the period of the loan. It is worth pointing out that very few loans have fixed rates; most fixed rates apply when you save money in a bank account.

Then you need to educate your children about why interest rates rise and fall. This includes explaining inflation and how the South African Reserve Bank uses interest rates to manage inflation.

10. PROTECTION

Insurance of any kind is about sharing with others the risks that you cannot afford to bear alone. A good example is your children's education. Most people will only have saved sufficient money for their children's tertiary education by the time their children are ready to go to university or college. But how will your children afford to pay for their education if a family breadwinner dies or is unable to work due to disability when they are, say, nine years old?

Stephan says that young people rarely think about the possibility of dying or becoming disabled, and therefore cannot see the point of buying life and disability assurance.

The reality is that most people will need life cover at some stage of their lives to cover debt (such as a mortgage bond or vehicle finance), their financial obligations towards their dependants and for estate planning purposes, Stephan says.

It is important to teach children from an early age the importance of life and disability cover, he says.

“Talk to your children about the fact that you have made provision for them should something happen to you. While this is a topic that most people prefer to avoid, it is important to share this information with your children. Not only will they feel secure in the knowledge that they will get to keep their home and lifestyle should something happen, but they will also grow up understanding the importance of life and disability cover.

“You should also tell your children about the importance of short-term insurance cover to protect the items they own, as well as medical cover. When an event occurs that forces you to claim against insurance, talk them through the process. It will help to prepare them for when their turn comes to purchase insurance cover as young adults,” Stephan says.

Many people do not understand insurance, whether it is insurance of belongings or assurance against things such as premature death or disability. They often see insurance as a grudge purchase that will probably not pay off. In other words, there are better things than insurance on which to spend your money. This incorrect attitude towards insurance can be passed on to your children.

Stephan says the chances are that most 20-somethings with no dependants and no debt have no life or disability assurance. But this can be a mistake, because the younger and healthier you are when you buy life cover, the greater your chances of obtaining cover at a low premium.

If you develop a serious medical problem later in life or engage in dangerous activities, you may find it difficult to find a life assurer willing to insure you. And if you do, you can expect to pay hefty premiums – the higher the risk you pose to the life company, the higher the cost of your life cover.

“You may not yet have dependents or mortgage bonds. But what you probably have is good health and a low risk profile, meaning that insurance companies are prepared to provide life cover at very affordable rates,” Stephan says.

Your premiums are determined by the amount of cover you require and the risk factors, such as your age, gender, state of health, and the nature of your occupation and recreational activities. A smoker will, for example, pay a considerably higher premium than a non-smoker, and premium rates for women are much cheaper than for men.

The good news is that if you took out life cover in your early 20s and opted for level premiums, you will keep these lower premiums for as long as your life policy is valid. And if a guaranteed period applies, you still benefit from very competitive premiums, even if your premium is adjusted after the guaranteed period expires.

Consider the following example: a 25-year-old man (the example is based on a man, because women generally qualify for lower premiums) with a university degree and a monthly income of R15 000 takes out life cover worth R1 million. The life company classifies him as low risk because he is healthy, does not smoke and does not participate in dangerous activities. The cover, with premiums guaranteed for 10 years, costs him R170 a month. (Risk criteria and premiums may vary depending on the life company.)

Stephan says if the man waited until he was 35 before opting for R1 million in life cover, his premiums would start at R215 a month, provided he did not substantially alter his risk profile by developing a serious illness. Let's assume that the man takes out cover only once he marries and buys a house in his early 40s. At age 45, he would be paying a monthly premium of R380 for the same amount of cover, provided his risk profile has not changed and he is still insurable. And at age 55, the premium would amount to a whopping R830 a month.

Stephan says you may argue that the 25-year-old would have saved just over R20 000 in premiums by not taking out live cover at age 25, but rather only at age 35. However, it is important to remember that, in return for the R170, he enjoyed life cover of R1 million, he might no longer qualify for life cover by the time he reaches 35, and his premium at 35 would be higher than would be the case had he taken out life cover when he was 25.

WHAT THE BANKS OFFER YOUNGSTERS

The banks provided Personal Finance with the following information about their accounts aimed at the under-18 market:

Absa Bank

* MegaU is a transactional savings account designed for under-18s. You need at least R10 to open an account. The account has a debit card. You can also bank by cellphone. MegaU offers Notify Me, a free SMS transaction notification service, and free cash deposits for amounts below R500. There is no monthly administration fee. The MegaU account has two charge options.

* MoneyBuilder is a flexible, card-based savings account for people of all ages. A minimum deposit of R20 is required to open an account. MoneyBuilder offers tiered interest rates on balances above R20. There is no monthly administration fee. You have immediate access to your funds. You are allowed two free Absa ATM cash deposits, inter-account transfers, balance inquiries and mini-statements a month.

* FuturePlan enables anyone – parents, grandparents, other family members, guardians and friends – to contribute towards saving for a child’s education.

The account can be opened in the name of a child or his or her parents. Parents can manage the account until the child is old enough to do so. A minimum of R100 is required to open an account. There are no monthly administration fees or broker fees. Deposits can be made from any account.

Interest rates are tiered: the more you save, the more interest you earn. If the term of the account is 12 months or longer, Absa will pay, over and above the normal interest earnings, interest of 3.5 percent for deposits to a maximum of R1 000.

* For further information about Absa’s accounts, go to www.absa.co.za

Capitec Bank

The Daily Savings Account is available to all Capitec Bank clients. Minors thus receive the same interest and cost benefits as do other account holders. A single account also eliminates the need for a minor to change accounts once he or she turns 18.

If parents or grandparents want to restrict a child's access to the account, they can retain the Global One Gold Card. If a minor does not have the card, he or she cannot transact on the savings account. Once the parents or grandparents believe that the child is ready to transact, they can simply hand over the card. The account is already in the name of the child, so no paperwork is required to enable the child to transact.

For further information, go to www.capitecbank.co.za

First National Bank (FNB)

The Fluid Account is a transaction and savings account for clients who are no older than 18.

There is no requirement for a minimum balance, but, if you maintain a minimum balance of R1 000, you will not pay a monthly management fee. Otherwise, the management fee is R5 a month, which includes two free qualifying transactions. Qualifying transactions include FNB ATM cash withdrawals, payments, transfers, debit orders, card purchases and prepaid purchases. If you maintain the minimum R1 000 in your account at all times, you also qualify for the two free transactions.

The account can be accessed via ATMs, a cellphone, a telephone, the internet or at an FNB branch.

The FNB Fluid debit card gives you access to discounts on a range of products, including: up to 20 percent off educational toys and videos; up to 20 percent off baby accessories; 20 percent off cinema tickets; 35 percent off 70 magazine titles; 15 percent off music CDs; 10 percent off airtime; up to 20 percent off the recommended retail price of various computer games and gaming instruments; up to 10 percent off computer and cellphone accessories; up to 15 percent off various bus services; up to 15 percent off most major airlines; and 15 percent off various tour packages.

For further information, go to www.fnb.co.za

Nedbank

The bank’s Nedsave account is available for use by minors. Children under the age of 16 can open the account in their own name with the consent of their parent or legal guardian. The following are free: self-service banking, eNote (SMS notification service), the first two Nedbank ATM withdrawals a month, and the first R100 over-the-counter withdrawals and deposits a month. There is no monthly administration fee.

The JustSave product is available to clients of all ages as a pure savings mechanism. The product offers tiered interest linked to your balance. There are no fees.

If you link your JustSave account to your NedSave account, the stop order is free and Nedbank will also credit the JustSave account with R2 per stop order.

For further information, go to www.nedbank.co.za

Standard Bank

* The Sum1 debit card account is available to children under the age of 16. A minimum of R20 is required to open an account, which comes with a debit card.

The card allows you to pay for purchases, withdraw cash from ATMs, and to pay accounts at an AutoPlus machine, online, or via telephone or cellphone banking. The first four debit transactions and cash deposits each month are free. There is no monthly management fee and no internet banking subscription fee. You are entitled to unlimited free electronic balance inquiries.

* The PureSave account pays interest on even the smallest balance. Interest is paid on a tiered basis, so the more you save, the more you earn.

A PureSave account is open to children of all ages, and adults too. A minimum of R50 is required to open an account. Savings may be accessed any time, and any amount of money can be deposited at any time. There are no monthly management fees.

* ContractSave is a savings product with the option of earning interest for someone who wants to save for a big-ticket item, such as a deposit on a car. There are no fees. The minimum monthly investment is R100, and the minimum term is one year. If the savings period is longer than a year, 10 percent of the savings is available after each year. The longer you save, the higher the interest rate you earn. You receive bonus interest at the end of every year, up to four years.

For more information on these options, go to www.standardbank.co.za

FUNDING YOUR CHILD’S EDUCATION

Tertiary education – whether it is at a university, a technical college or a private institution – is very expensive.

For example, at the University of Cape Town the full payment for the year for a first-year student, without residence and books, is R31 500 for a law degree and R34 000 for a Bachelor of Science.

Sugendhree Reddy, the director of banking products at Standard Bank, says that an integral part of being a good parent is providing your children with a sound educational foundation, one that will help them to reach their full potential and fulfil their dreams. “This doesn’t come cheap or happen by chance. You need to start saving from today to ensure that your children have the bright future you envisaged for them the minute you first laid eyes on them.”

Numerous products, from bank accounts to life assurance savings products and unit trust funds, are available as investment vehicles to save for your child's education, Reddy says. You can even pay extra into your home loan account every month and then withdraw the money when you need it to pay for your child's education.

Whichever savings vehicle you decide to use, Reddy says that you should:

* Each year increase the amount you save so that your monthly savings keep pace with increases in the cost of higher education; and

* Ensure that you receive higher interest or returns on your savings, because you are investing over a longer period of time.

Reddy says that you should consider using an endowment policy, because it will be difficult for you to dip into the funds should you experience a shortage of cash to meet your day-to-day living expenses. Although unit trusts are a good way to save, you can cash them in quite easily.

Some good news is that Finance Minister Pravin Gordhan, in his 2011/12 Budget speech, announced that National Treasury is exploring the possibility of establishing a tax-incentivised savings scheme for education as an alternative to the annual tax exemptions on interest earnings.

In November 2007, the financial services industry launched the Fundisa Fund to encourage South Africans to save for their children’s higher education, Peter Dempsey, the deputy chief executive of the Association for Savings & Investment SA, says.

The Fundisa Fund, a low-risk, fixed-interest income feeder fund, is administered by asset manager Stanlib. The unit trust funds invest in bonds, fixed deposits and other interest-earning securities. The unit trusts are managed by Absa, Nedgroup Investments and Stanlib.

The Fundisa Fund is open to investors who want to save for the higher education of a South African citizen or permanent resident. You can open a Fundisa account at most branches of Absa, Nedbank and Standard Bank, or go to www.fundisa.org.za

The minimum investment amount is R40. You can contribute every month or top up your investment when money becomes available.

The main attraction of the Fundisa Fund is that it offers a bonus grant: investors receive an enhancement of 25 percent of their capital every year to a maximum of R600 for each child. So if you save R200 each month for 12 months, the R2 400 you save will grow by R600 to R3 000 at the end of that period. The R3 000 will also share in the overall investment return achieved by the fund the following year.

Dempsey says there is a condition to receive the bonus: the bonus payment (or a portion of it) falls away if the investment (or a portion of it) is withdrawn. The bonus payment added only if the money is used to pay for education at a government-recognised institution.

However, investors can withdraw the savings that result from their own contributions, together with the normal returns on that capital, at any time.

Last year, total bonuses of R2.8 million were paid, more than double the bonus payment of R1.2 million allocated at the end of 2009.

“What makes this bonus payment even more attractive is that it comes in addition to the 8.5-percent return achieved by the Fundisa Fund for the 12 months to the end of November. Adding the 25-percent bonus, this translates to a total return for the year of 33.5 percent on the first R2 400 invested,” Dempsey says.

The Fundisa Fund has 13 522 individual clients with savings of almost R20 million.

You do not have to be related to the child in whose name the account is opened: you can sponsor any child you choose. You will be asked to prove that the child is a South African citizen or permanent resident by presenting his or her identity document or birth certificate.

In fact, the account does not have to be in the name of a child: you can open a Fundisa Fund account in your own name to save for your tertiary education.

The person in whose name the account is opened must start studying by the time he or she is 35 years old at a public college or university that works in partnership with the National Student Financial Aid Scheme (NSFAS), the government agency responsible for paying the educational institutions.

Anyone who opens a Fundisa account must have a Mzansi or other transactional bank account and a green bar-coded identity book. You also need to provide proof of your residential address – for example, a utility bill not older than three months that shows your name and residential address. All the money you save belongs to you until it is paid over to a public college or university that is recognised by the NSFAS.

Dempsey says it is important that you do not hand over money to anyone other than the unit trust companies or banks where you open a Fundisa Fund account. Always make sure you obtain a receipt for any deposits into your Fundisa account.

BENEFITS OF AN ENDOWMENT

The advantage of using a life assurance endowment policy as a savings plan is that you can add life cover to the policy to ensure that the premiums will be paid until the policy matures, Peter Dempsey, the deputy chief executive of the Association for Savings & Investment SA, says.

In most cases where an endowment policy is taken out as a savings plan for a child, a parent or a grandparent is the policyholder and pays the premiums. The child is the beneficiary. The risk of the proposer (parent or grandparent) is normally added to the policy to secure the premiums if the parent or grandparent dies prematurely or, as a result of disability, is unable to work. The life cover will ensure that the assurance company will continue to pay the premiums for the term of the policy, Dempsey says.

The alternative is to take out the policy in the name of the child (a parent or grandparent pays the premiums). The risk of this approach is that once the child reaches 18, he or she, as the legal owner of the policy, will have full contractual capacity. The child could liquidate the investment and use the money as he or she pleases.

While a savings policy can be taken out on a child’s behalf, by law only a minimal amount of life cover may be added to the policy until the child is 14 years old, so you would normally use a pure savings policy.

Dempsey says now that 18 (previously 21) is the age of majority, a person over the age of 18 can enter into a contract, including a life policy, without the consent of their parents or guardian.

One of the most valuable gifts you can give a young adult is a life policy, Dempsey says. However, parents or grandparents who want to buy a life policy for a child or grandchild once they are 18 or older face the moral dilemma of not wanting to benefit from the child's death. To avoid this dilemma, your child could nominate a charity as a beneficiary until he or she has dependants or has to cede the policy to cover debt.

The benefits of a life assurance savings policy are that the money cannot be accessed before the term of the policy is up, and contributions must be paid every month, which encourages disciplined saving, Dempsey says.

However, he warns that, because an endowment policy is not as flexible as a unit trust fund, parents or grandparents must ensure that they commit to a realistic monthly premium and policy term.

This article was first published in the 2nd quarter 2011 edition of Personal Finance magazine.