Inflation (price increases) means your money will get you less tomorrow than it will today. This concept is important because it has an impact on salary increases as well as savings rates. Here is one example: Tell your child you are giving them a salary of $1 for the month and with that $1 they can buy a favorite treat for $1. Next month, increase the salary by 10% or $1.10. Aren’t they feeling great? They have $1.10 now when they only had $1 last month. However, the cost of the same item has gone up 20% to $1.2. Ask them whether they can buy the treat now? The answer is no. Inflation makes goods more expensive over time and to keep up financially your salary/wages have to grow at least at the same level or more than the cost of the goods. Here is another example: Sometimes retailers try to hide inflation. They do this by not changing the price of an item, but by making the amount that you get for the same price smaller. Give your child $1 and let him or her buy one item with the money. Next month, give the child $1 and let him or her buy a smaller version of the item with the money. Does the child feel better off or worse off versus last month? The price has not changed, but the amount that the person can get for the price does. Why does inflation make the price of things go up? This will probably be a question. The simple answer (and there is no really simple answer) is that costs of material, salary increases for employees, etc. all contribute to making the price of items increase. If your salary does not increase accordingly, you have lost money without even being fully aware of it at first.
One may be tempted to buy on credit, but the next time you decide to buy something using a credit card go through this little exercise with your child. Suppose you buy a pair of pants for $40 using a credit card at a 19% annual interest rate, compounded daily. Compounded daily means you owe more and more on your credit card every day that passes. Most credit card companies compound interest daily after the initial grace period. It is interest-free money during the grace period. Now, suppose it takes you three years to pay off the credit card. How much did the pants really cost you? $40 cost of the pants x 19% interest x 3 years with interest added daily = $71 The $40 pair of pants will cost you $71! Cost of debt: $71 – $40 = $31 How much did the television really cost you? Let’s look at an example of an even bigger ticket item like a television at $500 using a credit card at a 19% annual interest rate. Suppose it would take you three years to pay it back? How much did the television REALLY cost you? $500 cost for the television x 19% interest x 3 years with interest added daily = $884 The $500 television will cost you $884! Cost of debt: $884 – $500 = $384 Here is a good calculator if you ever want to double check before deciding to make a purchase: https://www.calculatorsoup.com/calculators/financial/compound-interest-calculator.php We used the Compound(n): Daily (365/year). In most cases it is cheaper to save the money and buy the item without using a credit card or pay off the credit card within the grace period before the interest begins to calculate. However, some of us can’t resist temptation (I struggle too), so then it is better to avoid a credit card (have one stored somewhere for emergencies only), but try to use a debit card or cash for purchases. Regardless, you need to be aware of the true cost of using a credit card. The credit card companies know. You should too. Recent Posts Teachable Moments Series: Budgeting Basics
Budgeting is not instinctive for most of us. The word itself can induce all kinds of emotions including nausea. Budgets restrict. Budgets prevent. It’s not in the budget. Do you like hearing those words? Contrary to many beliefs, however, budgeting is a great way to keep control of your finances and keep you on financial track. It can be liberating. If you haven’t done so already, try to think of budgeting in a new light. Why do you think every major company has a budget? One of our goals is for you to start thinking about your money as a business does. You’ve worked hard for it, so you don’t want to waste it. You can instill the budgeting business sense early by using this teachable moment. What goes into planning a birthday party? a) Invitations b) Decorations c) Food and Drinks d) Party Favors e) Location f) Entertainment Steps to make this moment teachable: 1) How much do you want to spend in total dollars? Have your child help you decide how much you want to spend for the total cost of the party. For example, you may decide that you want to spend $100 on the party. This might mean that you have to plan to bake the cake, make some of the decorations yourself, etc. Discuss with your child what you can do yourself to save money, how many people you can invite based on the budget, and what you’d like to buy. Also, look around your house first. You might have some items that would be perfect for the party that will not cost any additional money, since you’ve already purchased it. That’s called a sunk cost, since the money is already spent, you might as well use it. 2) How much do you want to spend by category? Once you’ve figured out what you need to buy and how much you can spend in total, work out a budget for each category (example list above). Decide how much you want to spend per category that comes up to the $100 total. This may require making a more detailed list depending on how many people have accepted your invitation. This is why we always include and RSVP some time before the party in order to be able to shop around the final invitation list. Mention that letting people know if you are coming to the party is a polite way to help a person plan accurately. A list of possible categories is shown below: 3) Go shopping around the budget but be flexible enough to revise. Decide to stay within the budget by category or decide to allocate more or less to one category or another if you’re expectations change as you shop. Do your best to stay within the overall budget (ex. $100), however. 4) Keep your receipts and label them by category, so you don’t forget. Consider writing them in a notebook or get fancy and put them in a spreadsheet. 5) After the party, compare your actual spending to the budget. A budget is useless if you do not check whether you’ve actually stayed within the budget. Flexibility may mean that you’ve gone over or under within certain categories. The overall should be within the budget. Checking by category is still useful if you plan to make the budget again. You’ll know whether you need to spend more or less this time than you had expected the last time. This exercise is a great way to teach a child the first steps of budgeting. You can do the same with Christmas shopping. Create a Christmas gift list by name (use the names instead of the categories above), decide how much you will spend per person, go shopping, stay within the overall total but be open to some flexibility, and check whether you’ve accomplished staying within the budget.