According to the National Endowment for Financial Education, approximately 70% of individuals who win the lottery or receive a large prize (e.g., court settlement, insurance claim, etc.) go bankrupt within a few years. This should come as no surprise, as financial literacy is largely inherited – with good ones and bad money habits passed down from generation to generation.
Chances are these lottery winners never received proper financial training from their parents to handle money. It is estimated that half of Americans or 120 million adults do not practice responsible finance.
Are you ready to invest?
One of the most frequently asked questions on the BiggerPockets forums is, “How can I invest in real estate with no money and bad credit?” The answer? They should not. You need to get your situation in order and invest from a position of financial strength.
The lack of financial education
Parents need to teach their children financial literacy because they will not learn it anywhere else. Most schools don’t teach financial literacy. Financial education is not one of the four core subjects, but it should be. It seems that financial literacy is just as important to the education of well-rounded adults as the four core subjects of math, science, English-language arts, and history / social studies.
Financial institutions also don’t focus on teaching children financial literacy. With minimal outside support, children who grew up in households with financially illiterate people face an uphill battle.
Break the cycle
The good news is that the cycle of poor financial literacy can be broken as well as the cycle of poverty – through education. When I think of breaking the cycle of poverty, I think of Hillbilly Elegy: A Memoir of a Family and Culture in Crisis, a 2016 memoir book by JD Vance that turned into a Ron Howard film Was converted in 2020.
In his memoir, Vance tells the inspiring story of his upbringing in the Appalachians and his escape from a family legacy of poverty, family dysfunction, and drug use through hard work and education. Pushed by his tough but loving grandmother, Vance left Middletown, Ohio to attend Ohio State University and Yale Law School.
After graduating from law school, he worked as a director in a venture capital firm, Mithril Capital Management, owned by PayPal co-founder and billionaire Peter Thiel. In 2020, Vance raised $ 93 million for Narya Capital, its own venture fund based in the Midwest. Growing up with no financial literacy, Vance broke his family’s cycle of poverty through education and perseverance.
Focus on producing, not consuming
For far too many Americans, financial disaster is just a paycheck away. According to the Federal Reserve, in 2017, 40% of Americans surveyed didn’t have enough cash to cover a $ 400 emergency. Many of these respondents said they would cover the cost by using a credit card or loan from friends or family. How did these 40% of Americans get here and how can they get out of there?
For me, the first step in financial literacy is understanding money. For far too many Americans, money is just a medium of exchange. If you want something, you hand over money. If you want money, offer your services to an employer for money. If you want more things, you work more hours or take another job. The problem is, a lot of people want to keep adding to their necessities and adjusting their income – and spending whatever they make. Some even spend more than they make by taking on consumer debt.
The problem with the financially illiterate person dealing with money is seeing it through the only lens they know: as a consumer. Financially savvy people, on the other hand, view money through the lens of a producer. For consumers, money is a commodity – only good to buy. For those with the producer mindset, money is a productive commodity that can be used to make money for them while they sleep.
The rooster vs. the hen
I like to use the following example when teaching kids the money:
If you had a choice between a rooster and a hen, which one would you choose? Your chicken will come with a month’s supply of feed, but after that you are responsible for the feed. If you’re like most kids, choose the rooster because it looks and sounds cool. Who wants a simple, old-looking hen that just cackles?
Children who choose the rooster encounter a common problem. They don’t keep track of how much feed they give the rooster and burn the first month’s supply early. The tap owners go into panic mode. If they can’t find a way to find more food, they must give their rooster away to someone who can afford to feed it. The rooster now rules their lives as they struggle to find more money to buy food. You have three options:
- Take on more tasks to make more money.
- Start by begging friends and family members for money.
- Borrow money from a sibling at an exorbitant interest rate.
Neither of the alternatives is pleasant.
The children who choose a hen choose it for a reason: the hen lays eggs that can be sold to the neighbors for money that they can use to buy food. And after tending to feed the chickens, the young owners even have some money left over. What do these kids do with the extra money? You don’t just go out there and spend it. No, they are reinvesting the money to buy more chickens. You can even diversify on the street and buy a dairy cow for her milk. Eventually, the chicken owners can hire other children to look after the chickens and have time to do whatever they want.
There are several important lessons financial illiterates can learn from this object lesson:
- When you let your money work for you, you will ultimately be freed from having to work for money.
- As you spend money on shows, it is going to suck more and more money out of your pocket.
- Take every extra money you make and reinvest that money to get that freedom from a time clock even sooner.
- Sacrificing today makes for a much better tomorrow.
Make money for you
What do you call money that works hard for you – that works around the clock? Passive income. Once you have enough residual income to meet your financial needs, you no longer have to rely on your day job to meet your financial obligations. You are no longer dependent on a paycheck. That’s what people call financial independence. What is lost in this whole discussion is that there is more than one way to speed up the timeline for achieving financial freedom:
- You can fill the gap by increasing passive income streams.
- Cut down on your expenses.
- A combination of both.
What, in my opinion, are the most important habits a person can adapt to break the cycle of bad financial decision making?
- Educate yourself. Look for knowledge and learn about investing and making smart financial decisions.
- Treat money through a producer’s lens, not a consumer’s lens. Let your money work hard for you instead of the other way around.
- Live according to your possibilities. Don’t spend to be seen. Spend to be free. Save what you won’t spend on reinvestment.
So what will you choose – the rooster or the hen? Stop working for your money and instead let your money work for you in the ways listed above. Do this and you will be able to convert your savings into passive income – by thinking like a producer rather than a consumer.
More about passive income at BiggerPockets