I'm enjoying the fact that as my kids are getting older (the eldest is now 12), I can start to discuss more technical money topics.
Up until now, I have mostly spoken to my daughters about investing in the stock market and that's where they invest some of their money every time they receive any.
Given that most millionaires have become millionaires by investing in real estate, I thought now is the right time to start talking to them about this (even though they can't actually invest in real estate directly until they are 18 at the earliest).
In this blog, I'll share how I've been teaching my daughters about investing, focusing on the stock market and real estate.
Growing a Financial Forest
If you've read my previous blogs or read Grandpa's Fortune Fables, you'll know that I get kids to think of money like seeds. If they plant those seeds (invest), they will grow into trees. Their goal is to grow their own Financial Forest.
Investing in the Stock Market: Blue Trees
As mentioned, my kids invest some of their own money in the stock market. We call the money they have planted (invested) "Blue Trees", hence the name of this website. They love seeing their Blue Tree Forest grow over time.
The beautiful thing about investing in the stock market is that once you have set up an investment account, it is cheap and easy to maintain, and the investment grows relatively fast (between 7% to 10% per year on average over the long term).
In terms of growing a Financial Forest, you can plant your seeds and just watch the Blue Trees grow over time. There is little more to do. Easy!
Don't get me wrong, there will be some storms (stock market crashes) which can damage the trees. However, my kids know, and have already experienced, that after a storm their Blue Trees grow back bigger and stronger, i.e., the stock market recovers.
We can now expand this analogy to consider investing in real estate.
Investing in Real Estate: Purple Trees
We can think of investing in real estate as planting a different type of tree, "Purple Trees".
I reminded my daughters that a Purple Tree is buying an apartment or house (it could also be commercial buildings or land but I wanted to keep it simple). This is a reminder as we've spoken to them about owning our house in the UK and have called it our Purple Tree Forest.
People can either live in their Purple Tree Forest themselves or allow other people to live there. If other people live in the house/apartment, they have to pay rent. The rent paid is equivalent to the Purple Trees producing seeds.
Similar to Blue Trees (stock market), Purple Trees (real estate) are expected to grow but there will be storms which can damage the trees.
I then explained that there are quite a number of differences between Purple Trees and Blue Trees. These include:
Purple Trees are very expensive so you need to have a lot of money to start with
There are lots of fees you need to pay in order to plant Purple Trees (stamp duty, legal costs etc)
Purple Trees take a lot more effort and money to look after (maintenance and managing tenants)
Purple Trees are not expected to grow as quickly as Blue Trees (the stock market has outperformed real estate over the long term, source)
As you'd expect, my eldest daughter then asked:
"Dad, why would someone invest in Purple Trees when Blue Trees seem so much better?"
Why do People Invest in Purple Trees?
I explained that there are three main reasons:
People need somewhere to live so they use their money to buy their home (which is a Purple Tree).
Whilst there are storms (market downturns) that damage Purple Trees, these storms aren't as common as the storms that damage Blue Trees. Therefore, people prefer to invest where there are less storms as it feels safer.
When it comes to investing in real estate, the main reason to do so is Leverage!
Let me expand on the last reason, 'Leverage', as it's super important.
ONLINE COURSE (buy now): A Guide To Raising Your Kids So They Become Wealthy!
Explaining Leverage to kids
What is Leverage?
With Purple Trees, for every seed that you want to plant, it is possible to borrow a lot more seeds and plant them too.
For example, if you have 100 seeds saved, you could borrow another 400 seeds. You just need to pay back the seeds and a few extra in the future. With all these borrowed seeds, your Financial Forest can grow much more quickly.
I put this in the context of buying an apartment that costs $100,000. Instead of saving up the full amount, you can save $20,000 and then borrow the remaining $80,000 to buy the apartment. You just need to pay back the $80,000 plus some extra as it costs to borrow money.
The seed analogy really helped here as they could visualize the borrowed seeds being planted and growing into a forest of Purple Trees. These Purple Trees could then produce seeds (income from rent) which they could use to pay back the seeds they borrowed and still be left with this big forest at the end.
They could now see why so many people like investing in Purple Trees. Especially, as it's not easy/possible to use leverage when growing a Blue Tree forest (investing in the stock market).
Explaining the Downsides of Using Leverage
I wouldn't be doing a good job of teaching my kids about good money management, if I didn't highlight the potential dangers of using leverage when investing in Purple Trees.
Storms can really hurt: If there is a big storm (real estate market crash), then their trees might get damaged and be worth less than the seeds they started with. This is particularly painful as you still need to pay back all the seeds you borrowed. This means the amount they lose could be multiple times the amount they would have lost if they didn't use leverage (borrowings). I mentioned that there was a big storm in 2008 (the Global Financial Crisis) and many people with Purple Trees lost a lot of money.
Read More: Explaining the 2008 Financial Crisis to Kids
Cost of borrowing: The extra seeds that you need to pay back when borrowing seeds can be a lot. The more you borrow, the more extra seeds you need to pay back. I explained that for many years, the amount of extra seeds you had to pay back was relatively low (as mortgage rates were low) but other times can be large (interest rates high). This means that whilst all the Purple Trees are getting bigger, the amount you have to give away goes up a lot so you might not actually be getting wealthier.
Read More: How To Explain Mortgages to Kids
Moral Dilemma: In the past, people used leverage to buy their home. Now more people are using leverage to invest in real estate and become wealthy. As more people are investing in houses/apartments, this has led to the prices going up. This is good for people investing but is making it really challenging for people to buy homes as they are too expensive.
I wouldn't encourage my daugthers to use too much leverage to become wealthy given the potential large risks and the impact it could have on other people trying to buy their homes.
Real Estate: An Investment vs a Home
This blog focuses on using savings to make an investment in real estate rather than buying a home. There is a big difference which I set out in my blog: How to Teach Your Kids that a Home is NOT an Investment (this is one of my most-read blogs)
ONLINE COURSE (buy now): A Guide To Raising Your Kids So They Become Wealthy!
Summary
Is it better to investing in Real Estate or the Stock Market? My view is that ultimately you want to be investing in both.
I'm a big fan of investing in the stock market in a simple manner. That being said, as my kids become adults, I probably will encourage them to invest in real estate (if they can afford to do so) because it allows them to benefit from the use of leverage when they are young adults.
However, I will continue to highlight the potential dangers so they can manage these risks and not borrow too much or get too greedy.
As mentioned at the start of this blog, most millionaires made their money from investing in real estate. This week, try discussing the concept of leverage with your children using the seed analogy. Ask them how they would feel about borrowing seeds to grow more trees and what risks they think might be involved.
I hope you enjoyed this blog - if so, it would be great if you could share it with other families.
Don't forget to subscribe here as I'll be publishing more blogs to help you and your kids learn about new money topics.
Thanks for reading!
Will
P.S., Want your kids to grow up financially healthy and wealthy? Grab them a copy of our book Grandpa's Fortune Fables (Available on Amazon) or sign up for our online course.
