Economic Lessons for Kids Beyond Saving and Investing
When parents introduce more advanced concepts like fungibility, purchasing power, and asymmetrical risk, kids develop more analytical skills.
When parents teach their kids about money, they often teach the basics. The first basic concept is working for money. Parents sign up their kids to perform chores around the house and eventually graduate to having them earn money outside the home through babysitting, tutoring, coaching, or manual labor. The next concept parents teach their kids about money is saving it. Whether putting away a percentage of a child's earnings into a piggy bank, an actual bank or storing it underneath their mattress, the financial education imparted begins to inform kids of delayed gratification.
Taxes and Investing
The next two basic-to-intermediate concepts often involve parents having fun with kids by teaching them about taxes and investing. I always enjoy the videos of 10-year-olds who have had their money confiscated by an imaginary and elusive ghost, what parents call the taxman! Kids with a lack of emotional control become unhinged the moment they hear about how taxes took their money away.
When teaching kids about investing, the concept of compounding is less understood and visualized, though kids are often able to understand how investing in companies can make their money work for them. After graduating from a savings account, kids demonstrate more enthusiasm at the thought of picking a company they like—be it for its name, colors, or products—and start to buy shares in that company.
Lessons from Classical Economics
However, I propose another school of thought for teaching kids about money. This school of thought is rooted in classical economics, especially the Chicago School of Economics and the Austrian School of Economics. The first concept to teach kids about money is how money is fungible.
"Fungibility refers to the property of a good or asset whereby individual units are interchangeable and indistinguishable. In other words, one unit of the good or asset can be substituted for another without affecting its overall value or utility."
- Friedman, M. (1953). Essays in Positive Economics. Chicago: University of Chicago Press.)
A layperson's definition of fungible can be thought of as a system of barter. I will trade you my bag of Flaming Hot Cheetos for your 1-liter bottle of iced tea. These are two different items with two different values; however, in a voluntary exchange, these items may carry equal value. Not everyone may have Cheetos to trade, so when you don't have Cheetos, then you have money.Â
As kids become teenagers and eventually working adults, exchanging time for experience is the currency of their lives. This is a valuable lesson for kids because it removes the stigma of profit without disassociating it from hard work. In startup culture, exchanging time for experience is known as sweat equity.
The second intermediate concept that should be taught to kids is the purchasing power of money. Austrian Economics dominates this subject matter, and in the book Economics in One Lesson by Henry Hazlitt, he paints a picture that if we had 2x the amount of money, we would buy 2x the amount of goods and services, right?
If this were true, then the government would print and distribute money for the whole day for the economy to grow and enrich people's bank accounts. But, we know it isn't the case that if you earn 2x the amount of money, you buy 2x more goods and services. Why? Because there are not enough goods and services to accommodate the demand.
When there is low supply and high demand, the price of goods and services increases, which means the purchasing power of your dollars is weakened. You are buying the exact same product for a higher price.
A fun simulation that teaches the purchasing power lesson is having kids pay for their meals. Start by paying kids for work performed in one month; the next month, they will have to purchase every meal from you. One breakfast meal is $1 the first week, and the same exact breakfast is $3 the second week. How will your kids react, and what will they do?Â
The third and final concept kids can learn to advance their financial knowledge is asymmetrical risk. A more basic version of asymmetrical risk is the risk of tradeoffs, which is always best explained by if-then statements. If you save your birthday money today, then you will accumulate enough money to buy a better bike. If you get into a fight with a bigger kid, then you may get more seriously hurt. If you do not wash the dishes now, then you will have more dishes to wash after dinner.
Asymmetrical risk involves calculating a risk with a significantly bigger payoff than the downside risk. And if the payoff is substantially more significant than the investment of time or money, it is worth it.
If my child attends the IMG Tennis Academy for $70K annually, the likelihood of becoming a professional tennis player increases to 70%.
If my child runs every day for the next six months, then the chances of them making the varsity track team rise by 90%.
If your child speaks daily for 30 minutes, then the likelihood of them becoming school president increases 100%…
…If my child speaks for 30 minutes every day and doesn't become school president, then they will be sad, but they still will be a far better communicator.
Decision Making in a Controlled Environment
Teaching children financial concepts early on is paramount for their long-term financial literacy and success and their cognitive decision-making. The foundational concepts of working for money, saving, and understanding taxes and investing lay the groundwork for a solid understanding of personal finance. These concepts instill values such as work ethic, delayed gratification, and the importance of planning for the future. When parents introduce more advanced concepts like fungibility, purchasing power, and asymmetrical risk, kids develop more analytical skills and can test their decision making in a controlled environment.
Furthermore, neglecting to teach children these financial concepts can have detrimental consequences. With a grasp of basic and advanced economic principles, individuals can manage their finances effectively as adults, avoiding bad debt, poor financial decisions, and a lack of preparedness for unexpected expenses or retirement. Therefore, parents and educators need to prioritize financial education to empower the next generation with the knowledge and skills required to navigate the complexities of the modern economy and achieve financial stability and success.
