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Raising the piggy bank generation

A major development is happening in the curriculum of Ontario schools, and the timing could not have been too soon. The Ontario Ministry of Education has announced that financial literacy will be required curricula for Grade 4 to 12 students in the entire province by September 2011.

The ministry is now reviewing a report on 13 recommendations, from introducing students to the fundamentals of finance as early as possible, to providing teachers with the proper tools and resources to confidently teach money skills.

To date, financial literacy has only been a brief topic of discussion for many schools across the country, while for others, it is a topic that has yet to be introduced. Although some classrooms have embraced financial literacy, the breadth and depth of their teachings have varied among schools at best.

Financial literacy will be a welcome addition to today's curriculum as it is downright vital to have a proper understanding of how money works, particularly for students. In a lifetime, an average Canadian will bring home between $1 to $3 million in after-tax income. How they manage it–especially in the earlier years–will determine how much of that money goes toward personal security, comfort and enjoyment, and how much of it goes toward unnecessary expenses that add no value to their quality of life. Money is far too scarce for unnecessary expenses.

The fact that money is scarce is no unfortunate predicament. It is a vital part of how a functioning capitalist society, such as Canada's, works. If everyone had an abundance of money, then it would quickly lose its value and become worthless. The reality is that money is in short supply and high demand, which means knowing how to manage it properly is an essential life skill to learn. It is easier to spend money than to find it.

Expect the new financial literacy curriculum to focus on budgeting, savings and responsible use of credit. Proper spending habits and setting money aside for future financial goals will be key tenets of financial literacy for students of all ages. While it is unclear how much time will be dedicated to financial literacy within each grade, the following five subject areas should be familiar to students by the time they graduate from high school:

1. Saving

The cardinal lesson of financial literacy is to set money aside for the future. In simple theory it means spending less than what you earn, or by earning more than you spend. As basic as it may sound, you cannot build wealth without saving money, and if you need to increase the amount you save, you need to either spend less or earn more. The earlier a student can develop the habit of saving money, the more entrenched it becomes, and the easier it is to build wealth.

2. Saving vs. Investing

The next step after saving money is putting it to work–investing the money rather than just saving it. Rather than simply putting money into a piggy bank or savings account that pays little or no interest, students should understand the benefits of investing their savings, allowing the money to grow on its own. Without the benefit of investment income, you would typically need to save three to five times as much to keep up with those who invest their savings properly.

3. Compound Interest

Perhaps the most effective way to encourage saving money and investing it is to understand the powers of compound interest, which means reinvesting interest in order to earn interest on interest. For example, if you invested $100 for one year earning 10 per cent, you would have $110. If you keep the original $100 invested and re-invest the $10 you earned, you would have $121 the following year. It may not seem like much, but in the 30th year you would have $1,745, and by the 50th year you would have $11,739. In contrast, with simple interest after 50 years, you would only have $600.

4. Responsible Use of Debt

The ability to buy now and pay later is more prevalent today than ever before. Consumer lending products such as credit cards, lines of credit, and overdraft have made borrowing a near seamless process. Previous generations had to save money before they could buy something, so it wasn't that easy to get into debt troubles. Today, the ability to borrow is easier, and the same is true about getting into financial trouble. Students must be aware of the implications and expenses of using debt, and why it is so important to manage it properly.

5. Building a Good Credit History

Very few Canadians will ever go through life without having to borrow money. Whether you borrow to fund your education or purchase a home, your credit history is a key component used by lenders to extend a loan. It is your financial resumé describing how you have managed credit and debt in the past. A poor credit history signals to the lender that you are a high-risk borrower. If the lending institution doesn't reject your loan application, it will typically charge you a higher rate of interest to offset the higher lending risk. This can translate into tens of thousands of dollars of extra interest expenses over a lifetime. Paying bills on time and responsible borrowing are essential to building a healthy credit rating.

Avoiding Pitfalls and Personal Biases

What the new financial literacy curriculum requires is something to help teachers become more versed in the subject. Few teachers, if any, have had the fortune of learning financial literacy when they were students. Certainly we've all picked up money skills and experience along the way, and most of us have had our share of successes and have made our fair share of errors to pass along what not to do. But there is a real concern about passing along personal biases about money to students; and despite the countless pieces of good advice a student may receive, a few pieces of incorrect advice can have a profoundly negative effect.

For example, on numerous occasions I've heard people say, "I don't invest in RRSPs because they are risky investments." This would be a detrimental statement to communicate to students for at least three reasons: first, an RRSP is not an investment. Rather, it is a type of account that holds investments; second, there are plenty of investments to choose from at every level of risk; and third, risk is a subjective term that has a different meaning to everyone.

That may seem like an obvious personal bias, but others are far more subtle. For example, there is a phenomenon known as myopic loss aversion, which is the tendency for investors to make short-term changes to investments, even if their investment goals are long term. In other words, if your investment portfolio was built with retirement in mind 20 years from now but you received your portfolio statements every three months, the tendency would be to make adjustments to reflect a three-month time horizon rather than 20 years. More commonly, the outcome leads to lower performance of the investment in the long term.

Another common yet subtle investment trap is known as confirmation bias, the tendency to accept information that supports our personal beliefs while ignoring information to the contrary. Long-held beliefs tend to override empirical evidence that would suggest otherwise. In such cases, investors tend to seek out research that supports their own beliefs and dismiss research that argues against them. Since different investment categories tend to outperform others in a given year, business cycle or decade, parting with long-held beliefs is a critical, albeit difficult step in developing financial literacy.

The list of subtle and not-so-subtle biases is long and extensive, and no one is immune to them. For the new financial literacy curriculum to work, it will be important for teachers to have a sound understanding of the fundamentals of finance to avoid passing along poor habits to students.

—John Waldron
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