Inflation is pretty simple. It’s the rate at which goods and services increase in value, and in turn, at which the dollar drops in value. For example, your Snickers now costs $2 instead of $1.50, which means your dollar buys less candy bar. Put in another way, your dollar has less value.
The US measures inflation using a metric called the Consumer Price Index, or CPI. The CPI takes a basket of goods and services and averages them out to give you a general idea of how prices are changing. When the CPI goes up, that means inflation is happening.
When inflation is up, we feel the strain. Our dollar buys less and is savings are worthless. That is why you need to invest in assets that hedge inflation.
If your savings plan is to simply to put money into your local bank savings account, you’re actually losing money in times of inflation, because inflation decreases the value of your dollar. The interest your savings are earning won’t be keeping up with inflation, so essentially each month your savings account will buy you less.
I can give you a great example of this. When my parents first got married my father bought a $10,000 life insurance policy for my mom. This was a lot of money back then and would have really helped her if something happened to him. The problem is he didn’t read the fine print that the policy did not increase with inflation and when he passed away a few years ago my mother only received $10,000. Luckily, her children are taking care of her, but that is a perfect example of inflation.
Real estate is a great investment that hedges inflation. Not only does the value of the property rise with inflation, but the amount of tenants pay in rent will follow inflation as well. These increases let the owner generate income through an investment property and helps them keep pace with the general rise in prices across the economy. To learn more about how to invest in real estate during a downturn click here for access to my private Facebook group.
Assets put money in your pocket. Think of a rental property, a business, a skill. A Liability is something that takes money out of your pocket (that is why your primary house is a liability) Credit Cards, your home, your car are all liabilities. Explain this in children’s terms using their allowance. Most kids will just buy liabilities. Candy, games, etc. But open their minds a bit. Have them save to buy a rake and then use that rake to rake yards in the neighborhood for a profit. Or buy business cards to pass out where they can pet sit. The rake and the business cards are assets for children because they are vehicles for them to make more money.
With my kids when they were little we would go pick up golf balls from the course and sell it the next day to the golfers for $1 a ball and $5 for the nice golf balls. My kids were easily making $100 a day. Those golf balls were producing a profit for them far greater than their allowance for picking up their room.
Explain why it is so important to have so many assets under your ownership
When they start seeing profitability from one of their assets explain to them they can have another one. Show them the more assets they have the more opportunity they have to make money. This is diversifying your assets. For example, if they buy a rake to rake leaves their profits will be highest in the fall and non-existent in the winter, so they need multiple assets, so they can withstand the highs and lows.
Cash Flow vs Capital Gains
This is a tough one to teach kids, for adults we understand this. We know if you try and flip a house or sell an asset that is it very risky. For one, you have to try and time the market perfectly and second you pay the highest tax rate even if you do so successfully. I believe it is like gambling, you may win one hand, but will eventually lose it all on red. This is a bit over a child’s head. Capital gains, tax, etc. What I don’t think is over their head is cash flow. So for this lesson, have them take their business and create a recurring revenue around it. For example, if they pet-sit for $15 an hour, tell their clients there is a $10 monthly fee to be able to book services at that price. If not, it is $25 an hour. Explain to their customers what you are trying to teach them. If you can show your kids a monthly cash flow that comes in without them having to go and find more business I think that is a great groundwork for the cashflow vs capital gains conversation later on when they are older.
A champion and advocate for entrepreneurs and real estate investors, Ken has spoken worldwide at top industry events. With media appearances on television and radio, Ken also host Entrepreneur Magazine’s Real Estate Radio program, where he helps listeners navigate the financial and legal arenas of real estate.