Three finance lessons for your child

Money skills are not taught in schools. However, they are essential for one’s growth. It is better to start educating kids at younger age.

Depending on their age kids make choices with money – whether to hang out on weekends at the local ice cream parlour, whether to go with brands or look at value. Before they take on their own financial responsibilities the skills of handling money ought to be provided to kids.

Unfortunately money skills are not part of formal school education. Many of us would have picked up some of our own financial lessons the hard way…through mistakes and corrections. That qualifies us to be a personal finance coach that the younger generation can look up to. Here is a guide to imparting essentials money to kids.


Make learning easy

From a young age children can be taught that money has purchasing power and that it needs to be earned. According to a study by a UK based advisory service, by the age of 7 years kids develop several basic concepts about money that will later broadly relate to personal finance. Some of these include the understanding that they need to pay for goods with an equivalent amount of money, the concept of earning and income.

So depending on their age and capacity you can introduce various aspects of finances. Opening a bank account for teenage kids can go a long way in helping them gain confidence and experience with handling money transactions. Many banks offer student account for school and college students. Teens can be taught how to use a debit card, and the “grown up” activities of write a cheque or DD.

Games are a nice way to engage the smaller kids. You would find many board games on money management such as Monopoly, Cashflow etc. and plenty of them are available online too.

Saving money in a piggybank

Three finance lessons for your child

i. Saving comes before spending

Kids may not have paychecks to save from but if they do have some kind of income they can be encouraged to save. Let them begin with whatever amount they can, even if it’s Rs 20 a week. The habit once formed is likely to stay with them, as some day they take on their own financial responsibilities.

You could incentivize them to drive home the virtue of saving by adding a rupee for every X amount of money they save. Another effective way is to make fun deals. Say they wish to have a camera for the next birthday. Agree to buy one for them after they have accumulated a small portion of the amount required for it. Your child would also better appreciate its value since she has earned it, in a sense.

ii. Avoiding the debt trap

One of the foundational keys to financial wellbeing is to learn to live within one’s means. You can talk to them about how debt could hurt one’s financial life and even ruin it, if in excess. Older kids can be educated on how credit card debt, personal loans can become a vicious trap.

Inculcating the savings habit discussed in the point above would go a long way in making them used to creating a corpus from which they use in the future and avoid debts.

iii. Inflation and investing

Although compared to our western counterparts many of us Indians are savers by tradition, only a minority seems to appreciate the importance of long term investing in growth assets, and even fewer people actually practice it. For many adults saving in a bank account is equivalent to investing! Teenage children can be introduced to the concept of inflation, how money loses value over time and the need for accumulated savings to outgrow inflation to help in meeting future goals.

Set a good example to follow

After all is said, one must carefully adhere to the good financial principles they’d like their child to follow. Your kids are likely to resemble you in their financial behaviour and orientation because like they say, children learn more by observing than by hearing.

By the time your child is ready to fly out of your nest he/she will have built solid foundations for his/her personal finance life.

Data Source: Bloomberg and Quantum AMC

Active Vs Passive portfolio strategy

Actively managed funds are those where the fund manager decides which stocks to buy and when to buy or sell them. It also means that the fund manager tactically manages the portfolio. So when he sees upside in a sector, he may move into that or exit it altogether if he is of the opinion it could crash.

Since the aim of active management is to deliver a return superior to the benchmark, an actively managed fund offers the potential for much higher returns than the benchmark, providing the fund manager gets his calls right. If not, the downside could be much higher too.

In the case of passive investing, the fund simply tracks the benchmark. It invests in the identical sectors and stocks in the similar allocations of those of the benchmark.

What is tracking error?

Tracking error is a measurement of how much the return on a portfolio deviates from the return on its benchmark index.

Not all index funds are identical. Some track their benchmarks more closely than others. The amount by which a fund veers from the performance of the index it is trying to match is known as tracking error. For example, if an index gained 3% over a year, while a fund that tracks it gained 2.7%, the tracking error is 0.3% over that period.

The tracking error exists due to trading and management costs. It is all the more heightened when a fund doesn’t hold all of the securities in its benchmark. Then research and trading costs increase the expense ratio, which impacts the tracking error.

The lesser the tracking error, the more accurate the index fund.

active

What makes an index fund different?

In its simplest sense, an index fund is a fund that attempts to replicate the performance of a given index by duplicating its composition. Most index funds work by identifying an already well-known index, then building a fund that either owns every asset in the index or achieves the same end by holding similar securities.

For instance, HDFC Index Nifty tracks the Nifty and the portfolio consists of the 50 stocks that comprise the Nifty. While HDFC Index Sensex tracks the Sensex and its portfolio comprises of the 30 Sensex stocks. On the other hand, HDFC Index Sensex Plus aims at investing 80-90% of the net assets into stocks which comprise the Sensex, while the balance is left to the discretion of the fund manager.

A regular fund on the other hand will have the fund manager researching and picking stocks he believes have great upside. He will not restrict himself to the universe of the benchmark stocks, as in the case of an index fund.

Who is an index fund targeted at?

An index fund is targeted at first-time investors – those who are investing in funds for the first time and have no idea as to how other funds are positioned and how to select one from the hundreds available.

They are also targeted at those investors who are unconcerned with the relative performance of one company over another in terms of its stock price, and with beating the market in general. They are for investors who want to participate in the stock market, but don’t want their investment to dip below market returns. Hence they buy a fund that moves in accordance with the benchmark.

This is also for investors who want a low-cost exposure to the stock market. To use the earlier examples, the expense ratios of HDFC Index Nifty and HDFC Index Sensex are 0.56% and 0.49%, respectively. It goes up to 1.06% in the case of HDFC Index Sensex Plus to account for some amount of active investment. In the case of pure active funds, the expense ratio can go up to 2.50%.

Finally, investing in a fund like the above which will offer exposure to large-cap stocks, can be a good core holding for a portfolio.

5) How does an index fund differ from an ETF?

An exchange traded fund, or ETF, is a type of fund which owns the underlying assets (stocks or gold) and divides ownership of those assets into shares. For example, a Gold ETF will buy actual gold. It is for this reason that it serves as a proxy to investing in gold. Or, for instance, iShares, the world’s largest ETF provider, has an ETF called iShares S&P India Nifty 50 Index Fund, which tracks the S&P CNX Nifty Index.

In the case of an index fund, you can buy the units from the asset management company, or AMC, and sell them back to the AMC, based on the current net asset value, or NAV. In the case of an ETF, the units are listed and traded on the stock exchange. Which means that investors need to have a demat account to buy and sell ETFs. Unlike an index fund where the NAV is declared end of the day, an ETF could experience price changes throughout the day, depending on demand for the product.

While actively-managed funds carry fund manager’s risk—not just on the stock and sector selection, but also the risk of the manager quitting.Passively-managed funds don’t come with such risks. Passively-managed funds, such as index funds and exchange-traded funds (ETFs), invest in all the companies, and in exactly the same proportion, that are there in the benchmark index they track.