An extra decade or two of compounded returns may be the best financial gift any parent can give to their kids. This gift can be even more powerful if you encourage your children to open a Roth IRA, which could allow them to never pay tax on the investment gains. Both my children will open Roth IRAs the first year they earn income to take advantage of the tax-free growth. However, parents also need to be careful about giving a young adult access to a large account. Here is how I plan to help my children start building wealth for retirement:
Show them the power of compound interest. I love talking about compound interest, but the concepts don’t always hit home until it’s your own money in the bank. I can make the numbers much more real for them if I can show my kids the history of their own money in the market. I can also use the opportunity to teach them about volatility and how staying the course with an index fund strategy produces a positive outcome over the long term. This will give them more ammo to defend against their emotions when the market takes a nosedive in the future.
Ask them to contribute something. It’s important to me that my kids have skin in the game. This will not only teach them to make choices early, but it will also be easier for the lessons to hit home. Otherwise, they may think this is just someone else’s money and tune out when I’m trying to teach them valuable investment lessons. I plan to teach them about investment basics by showing them their own account as it travels through time.
Stress that every dollar is earmarked for retirement. Withdrawing the money early destroys the benefits of the Roth IRA. The tax-free growth isn’t nearly as powerful if they take the money out before they retire. While I understand they can go back on their word later on this, there would be no deal if they cannot agree to being disciplined right from the start.
Try to delay letting them know the balance. I’m not going to lie to them about their accounts, but that doesn’t mean I need to voluntarily tell them how rich they really are. Any amount of money is going to seem quite large to a kid, so it’ll be easier to mold my kids into more responsible adults the longer I can keep them from knowing their theoretical purchasing power.
Teach them the merits of investing in index funds. You earn better returns when you select affordable funds, such as low cost index funds. I can’t force my children into a specific investment strategy, but I can show them the benefits of index investing with examples of how it has worked for their own money so far. Index investing has the added bonus of working without much effort required to manage the investments. After all, their money has been compounding for years without them even spending an ounce of sweat on the administrative side of things.
Remind myself that it’s their money as soon as it hits the account. I need to be comfortable with my children being able to dictate how and where the money goes. I cannot start a Roth IRA for my children otherwise. The money could be tremendously helpful to them, but it is possible that the privilege could hurt them by making them less motivated to work hard. It’ll be up to me to provide guidance and make sure that wealth is used responsibly.
David Ning is the founder of MoneyNing.com .
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