Family finance

My staff regularly get annoyed by my insistence that if a seven-year-old child could not grasp the meaning of their message unaided, then they haven’t explained it well. Or they themselves don’t fully understand the topic they are attempting to explain. Often both.

Why seven?

By the time children reach that age they can read and write short sentences. Well enough to scribe a birthday card. Produce a shopping list. Decipher a restaurant menu. Skim a newspaper headline.

An underdeveloped ability that is far from great. Yet one that has cleared the very low comprehension bar that defines “good enough”.

Seven-year-olds still possess that boundless curiosity of childhood.

Combined with the attention span of someone who is easily distracted and has a low boredom threshold.

Who believes that whatever they want in a given moment is more important than all other things.

In short, they bear an uncanny resemblance to your typical C-suite executive!

However, unlike an adult, children will generally accept a plausible, or simply well-told, tale. Possess a desire to learn. A willingness to change their views when presented with compelling evidence.

Not yet a prisoner to dogma. Ego. Preconceived notions. Or tribal identity.

Family finance

One of the things that nobody tells you about being a parent is how hard, yet how essential, it is to let your children fail.

Fail so that they can learn.

Fail in order to gain experience and develop resilience.

Fail because lessons learned by doing leave a far greater impression than those that are academically taught or vicariously observed.

Experience helps us to form our own decision-making framework. Align our behaviours with our goals. Determine priorities. Define our character. Identify our weaknesses. Weigh up risk versus reward.

All essential life skills. Success is unlikely, if not impossible, without them. Many come with hard-won scars, mile markers charting the progress of our journey travelled so far.

Recently each of my children has started showing an interest in money.

My younger son, now aged seven, has realised that the Amazon delivery crew are not actually frequently visiting Santa’s elves. Nor do the Ocado driver and Deliveroo rider, who bring his favourite foods to the house, do so out of the kindness of their hearts.

He has realised that everything costs money. Some people have a little. Others a lot.

Another thing nobody tells you about parenting is how your lifestyle choices define your children’s baseline of what is normal. There is a lot to be said for being an invisible “millionaire next door”.

My elder son is a high school student with a social life and financial needs. He has learned a brutal opportunity cost lesson when an empty bank account coincided with the traditional guilt and obligation of the Christmas giving season. Contactless payments can be dangerously convenient for the unwary!

Several times over the last few weeks I have put my “explain it to a seven-year-old” approach into action. Alternating between explaining financial concepts to an actual seven-year-old, or articulating concepts in such a way that a reluctant teenager couldn’t help but comprehend.

That got me thinking: what would a financial plan for a seven-year-old look like? And how could the process be articulated such they would feel like it had been done with them, rather than to them?

Any good financial plan will contain a combination of goals, tools, and techniques that will facilitate the attainment of hopes and dreams. No matter what age the owner of the plan happens to be.

Goals

Good Financial Planners look beyond mere financial analysis and investment allocation into the realm of behavioural economics and investor psychology. In the immediate term, this may not result in the highest commission, but lifetime customer relationship value is maximised when customers are both happy and satisfied.

George Kinder once posed three excellent questions designed to get adults to look beyond money, evaluate their priorities, and determine what was really important to them.

It occurred to me that in many ways the typical seven-year-old has already attained the end state that many aspiring retirees dream of one day recapturing.

Money isn’t much of a factor in their day to day thinking or decision making.

Providing they have a full belly and a warm safe place to sleep, their top priorities are:

• having fun
• pursuing activities they enjoy
• hanging out with their family and friends
• experiencing adventures limited only by their imaginations.

Isn’t that what all of us are ultimately seeking?

Another interesting parallel is that the typical seven-year-old has absolutely no idea what they want to be when they grow up. Most of the adults I know still haven’t figured it out. I certainly haven’t!

As children, few of us would have been able to predict with any accuracy how we would be earning a living as adults. The truth is that probably doesn’t matter all that much, providing we enjoy the journey getting to wherever it eventually takes us.

What does matter is ensuring that we have implemented a plan that will provide us with “enough”.

Enough that we can provide ourselves, and our families, with a sustainably comfortable lifestyle.

Enough that our lifestyle is sufficiently free from financial pressures that we enjoy a genuine choice about how and where we will invest our time. Just like a typical seven-year-old does.

The third parallel is the unknown longevity that the financial plan must accommodate. Few of us can reliably predict how long our worldly wealth will need to sustain us.

A seven-year-old will potentially live for another 100+ years. In practice this means their plan must work in perpetuity, resilient enough to cope with whatever shocks that life may throw their way. When you think about it, that is an outcome we should all be striving for.

CASHFLOW GOAL: Earn enough money that I don’t need to think about money.

TIMESCALE GOAL: Never run out of money, so I can always play and have fun.

WEALTH GOAL: Have enough money that I can do whatever I want whenever I want.

Tools

The most powerful tool available to a seven-year-old is time. Time for compounding growth to work its magic. Time to recover from losses if risk-taking doesn’t work out. The earlier they start, the better the long term outcome will likely be.

The investment likely to pay the largest lifetime dividends for a seven-year-old is investing in themselves. Learning marketable skills. Maximising their earning potential.

Higher earnings mean having to sell less time working in order to have “enough”.

Enough cashflow.

Enough wealth.

Both in terms of the number of working hours per week sold off to fund their desired lifestyle, and the total number of years where working is a need rather than a choice.

A fee-free current account is an essential tool for the seven-year-old’s financial plan. Somewhere to receive income. A place securely store savings, until they are either invested or spent.

Account keeping fees are a form of idiot tax, much like buying lottery tickets. A discretionary expense that is only paid by those who don’t know any better or too lazy to do anything about them.

Next comes a low fee (or no fee) brokerage account, preferably of the tax-advantaged variety. In the United Kingdom children can open a child’s Individual Savings Account. All income and capital gains generated within this type of account are tax-free for life.

Some folks may be tempted to open a pension account for a child. Locking away funds for half a century or more may provide the child with a comfortable traditional retirement. However, that won’t help them much during the prime of their lives, when they will likely incur vast tuition, housing, and childcare expenses for their own family.

This also leaves the seven-year-old exposed to regulatory risk for an extremely long period of time, as politicians desperate to be seen to be doing something endlessly tinker with pension access and taxation rules.

One area that a financial plan for a seven-year-old differs from that of an adult is use of leverage. Children are not yet old enough to obtain a credit card, margin lending facility, or mortgage.

Deploying leverage can improve investment returns, yet it is something that many in the Financial Independence community actively seek to avoid, to the extent many choose to forgo superior investment returns in favour of paying off mortgages that often incur negligible rates of interest. This should be recognised as a lifestyle choice. Often an expensive one.

BANKING TOOL: Fee-free current account in which to receive income and save money.

INVESTING TOOL: Accessible low fee brokerage account, preferably tax-advantaged.

COMPOUNDING TOOL: Time. Start early for best results.

WEALTH MAXIMISING TOOL: The more your time is worth, the less of it you will need to sell.

Techniques

When it comes to investing, the naïvety and short attention span of the average seven-year-old is a secret weapon.

They don’t want to read annual reports or worry about political developments.

They don’t care about timing the market.

Chart breakouts, momentum trading, ratio analysis, and timing the market mean nothing to them.

They would rather be doing something sensible and rewarding, like playing outside with their friends.

Therefore a low-cost index tracker makes an ideal investment for a seven-year-old. Don’t own one company, own them all. Some will rise, some will fall, but over the long term, the value of their investment will likely rise.

I am a big fan of simplicity. Of only adding moving parts or complexity when the simplest solution is demonstrably unfit for purpose.

It doesn’t get much simpler than investing in a global index tracker, with all dividends and share buybacks reinvested.

Determine how much the seven-year-old is willing to invest each month, then set up an automated transfer from their current account to their brokerage account.

Establish a regular purchase rule within the brokerage account. At a set time each month the rule fires and additional shares are purchased up to a preset nominated value.

Not enough money? No purchase that month.

One opportunistic feature of some dealing platforms is that the brokerage fees charged to purchase via a regular investment rule are significantly less than making the same trade on an ad-hoc basis. Even if you establish the rule, let it fire just once, and then cancel it.

This is the kind of “set and forget” investing approach that takes advantage of our innate apathy and disinterest.

Quietly compounding away for years, or even decades.

Periodically the monthly transfer amount and the regular share purchase amount should be reviewed and amended upwards where possible. A job that takes no more than 5 minutes in total.

Imagine if your parents had established a similar arrangement for you at the age of seven. With a nominal contribution each month, by the time you reached university, the accumulated investment value could potentially pay for your tuition. Or you could leave them alone, and let them continue to quietly compound away in the background. It would certainly be a nice choice to make!

REGULAR HABIT: Establish regular habits, such as saving and investing a set amount each month.

AUTOMATED HABIT: Set up automated transfers and investment purchases to eliminate effort.

PATIENCE HABIT: Get things up and running, then leave them alone and wait.

Outcomes

Seven-year-olds have limited saving and investment avenues available to them. Yet I can’t help but wonder if that enforced simplicity is actually a good thing.

The essentials are all present. Once set up, then left alone, it will tick away in the background quietly generating wealth while requiring virtually no further thought or attention.

Adults could do worse than adopting a similar approach. If a seven-year-old can successfully understand and execute the plan, then there is no reason why an adult couldn’t do it too. Plenty of excuses though!

I challenge you to spend some time over the Christmas break thinking through your own approach to finances. Where your arrangements are more complicated than this financial plan for a seven-year-old, ask yourself why?

Is that complexity quantifiably generating greater returns?

Is the additional investment of time and attention required to manage that complexity worthwhile?

If you cannot honestly answer yes to both questions, then take a moment to validate your approach.

References

• Danko, W. and Stanley, T.J. (2010), ‘The Millionaire Next Door‘
• Money (2015), ‘3 Questions That Will Get Your Finances — and Life — on Track‘

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