A study published by Standard and Poor’s near the end of 2017 found that only 57% of Americans, when given a quiz on basic financial concepts, scored high enough to be considered financially literate – ranking the United States 14th in the world in financial know-how.
As we enter what could shape up to be one of the deepest economic recessions since the Great Depression – with millions out of work and trillions being added to the Fed’s balance sheet – financial literacy will be a key component in our country’s ability to quickly and nimbly recover from this downturn.
But building a strong financial acumen is far easier said than done. While math and economics are staples of a high school education, many schools overlook critical aspects of personal and microfinance, forcing students to interrogate these complex issues on their own time. This difficulty is compounded by the fact that finance is filled with jargon, graphs and mathematics that present steep learning curves.
The foundation of a strong financial fluency often begins at home. We connected with venture capital CEO Amit Raizada, whose career in finance has spanned more than 20 years and a multitude of industries, to gain some insight on how you can help introduce your kids to a few of the most important concepts in finance, business and economics.
Credit is abundant. While it often feels like free money, borrowed funds can be difficult to pay back, Raizada said.
“When you’re talking about borrowing, the key word is interest,” Raizada said. “Lenders need to make money. If they lend you money only to for you to pay back the exact same amount that you borrowed, they glean nothing from the transaction.”
The interest rate, then, is the rate of money that you pay back to a lender, in addition to the original sum you borrowed.
For example, if you were to take out a $100 loan from the bank at a 10 percent interest rate, you would owe the bank the original $100, called the principal, plus 10% of the sum you borrowed, for a grand total of $110.
“Put this into motion the next time your kids land on one of your properties in monopoly,” Raizada said. “It’s a fun way to demonstrate this real-world concept without any actual risk.”
Checking vs Savings
While most children understand that money is usually deposited in banks, an important component of financial literacy is understanding the difference between two of the most common types of bank accounts – checking and savings.
Checking accounts allow you to easily withdraw your money. When one pays for a transaction with a debit card, the funds are usually taken from the consumer’s checking account.
Savings accounts are a little different.
“Savings accounts place limits on what you can withdraw, but pay you an interest rate on the funds that you keep in the account,” Raizada said. “Over time, you will begin to earn a small amount of interest on these funds.”
“Stocks are a prime example of an easy concept made unnecessarily difficult,” Raizada said. “When you open up the stocks app on your iPhone, you’ll find all sorts of flashing red and green numbers, strange acronyms and volatile graphs. At first glance, it looks like an absolute circus.”
While markets can be circus-like at times, stocks are quite simple. A stock represents an ownership share in a company. When you purchase a stock, you’ve technically bought a minute portion of the company that issued the stock. The terms “stock” and “shares” are often used interchangeably.
A stock exchange is a marketplace in which these stocks are bought, sold and traded. Stock prices float, meaning that they constantly changed based on the interplay of supply and demand. When the demand for a company’s stock is low, few people wish to purchase it, and its share price declines.
Major stock indexes like the Dow Jones Industrial Average and the S&P 500 are aggregations, or combinations, of the prices of multiple companies’ shares. The Dow, for example, captures the share price 30 of America’s largest firms, including companies like Boeing, Apple and Nike.
“It’s important to understand what these indexes are and what they represent,” said Raizada. “While one should never take market’s performance as a surefire sign that the economy is growing or contracting, they’re usually a decent bellwether our country’s overall economic health.”