Parents who teach their children financial literacy have the opportunity to set them up for life.
Conversations about money can lead to successful outcomes because they:
— Place the time value of money in your corner
— Encourage delayed gratification
— Prepare your kids to become better consumers, employees and philanthropists
— Expose them to broader socioeconomic topics
— Set them up for financial well-being to start a business, buy a home, save for retirement and prepare for the needs of a long life
— Give children a head start
— Create a deep relational bond between parent and child that will boost confidence and trust
Financial literacy has not been well taught in many generations. This can create apprehension for some parents about whether they are up to the task.
Yet, working with your child will enable you to share your own experiences, good and bad, which can help create a deeper impression and offer a unique opportunity for bonding. It will also enable parents to do the research needed to enhance their own investment capabilities.
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Time Value of Money
The best part about starting young is that time in the market can be more valuable than timing the market.
Albert Einstein has long been credited with saying, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” Earning money on your money is an excellent way to accumulate wealth.
Parents can teach a child about compound interest by posing a question to them: “In 30 days, you have a choice. I can give you $10 million dollars cash at the end of the month. Or, I can give you a dollar today and it will double in value every day for 30 days and you will receive whatever is the result at the end of 30 days. Which do you prefer?” Most children are going to choose $10 million because it is a larger number than they are used to seeing. However, when you show them that compound interest could allow them to have received $1.07 billion, their eyes will be opened to the powerful effect of compound interest and a long time horizon.
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” -Albert Einstein
Delayed Gratification
Once a child understands that time is a friend to them, they can easily understand why saving one’s money can lead to bigger things.
Parents can teach a child about delayed consumption by giving them a set amount of money, perhaps through a weekly allowance. This conversation can also be repeated after birthday and holiday gift giving has been completed. However, it’s helpful to tell the child that they must divide the money into two piles — an amount that they can spend today and an amount that they can spend in the future.
It is important to set a specific goal for future spending so that children can have a tangible vision in their head about why they are saving. Courtney Hale, founder of youth financial literacy organization Super Money Kids, says that this goal must truly be specific both in amount and the expected future purchase. By creating a goal that is specific and is intended to create greater opportunity for their lives, they are less likely to quit prematurely.
Depending on the dollar amount of the goal and the age of the children, money can first be saved in a traditional piggy bank. But, eventually, it is a good idea for the parent or guardian to help their child create a savings account. By law, a minor cannot open an account on their own, so the parent or guardian would need to establish a custodial account. A custodial account is the child’s property, but it is managed by the adult until the child is at least 18, depending on state law.
Information is available online about the best bank accounts for children, including interest credit, minimums and other details. Custodial accounts can also be invested in stocks, bonds and index funds for potentially higher returns. Custodial accounts are funded with after-tax dollars and the taxation on the earnings will partially take into account the child’s likely lower tax bracket.
Another good habit to instill in children is to count their piggybanks or review their account statements on a regular date each month. This helps a child understand that it is important to keep an eye on one’s investments, as well as having the joy of watching the balance grow over time.
Becoming Better Consumers, Employees and Philanthropists
While it can be easy to simply let a child keep all of their money, teaching them at an early age that there are only 100 cents in every dollar is another key foundational lesson.
Children have the capability to understand a budget at a young age. When they realize that they will become responsible not only for their wants and desires, but also for boring topics like rent, mortgages, car payments, utilities and taxes, their world expands immediately.
Importantly, a child that learns to budget early helps a parent or guardian explain why it might not be “in the budget” to give the child the latest tech gadget.
Parents can teach this concept by taking 100 pennies and putting them on the table. Set aside 10% each for taxes, charity and long-term savings (30 pennies). Since the rule of thumb is that living arrangements should not be more than 25% of one’s income, set aside another 25 pennies to represent a mortgage payment. This will leave 45 pennies. Show them how those 45 pennies must cover utilities, car payments and credit card payments.
At first, children might complain that so many pennies are being taken away from their ability to spend freely. This is where a parent can explain how choices affect one’s financial standing in life. They can talk about selecting a college degree that increases their income without burdening them in debt payments. They can start conversations about why choosing a lower cost of living may be preferable to a job in a high-priced city. They should begin to understand why some people may prefer to buy a used car over a brand-new model. They will be able to see that debt must be weighed carefully between instant gratification and long-term stability.
Most importantly, they can begin to see that financial decisions are not either/or, but have many nuances that can make the difference in the kind of lives they will live.
[See: Best Investing Books for Beginners.]
Learn About Broad Socioeconomic Topics
When a child begins to understand financial topics, they will become exposed to broader socioeconomic topics, such as student loan debt, credit card usage, home ownership and taxation policies. They will even begin to understand the politics surrounding the news of the day on these topics. This is important because they will begin to realize that money affects every decision we make in our lives and tends to go hand-in-hand with our societal preferences.
Children will begin to see the world beyond themselves. Parents may find themselves answering questions about challenging topics, especially in a society that is increasingly at odds over these issues. These questions may be a bit uncomfortable for parents, but they are also an opportunity to have deep discussions that will be part of their legacies.
Prepare Them for the Needs of a Long and Varied Life
Television host and interior designer Bobby Berk says, “It’s your life. Design it well.”
As children grow, the first major money decision for them is how to pay for their education. Parents can open a 529 college savings plan to make investments and may want to ask relatives to direct part of their monetary gifts to these plans. There are no income limits for plan contributions, but each state may have unique specifications to get the most benefit out of this option. Unused funds can be redistributed to other children or saved for future educational endeavors, such as a career change. Or, the recently enacted SECURE Act allows families to pay off other student loans with tax-free distributions. Additionally, if children are contemplating raising a family, these funds can continue to accumulate for a future grandchild’s educational needs. Funds can be distributed for non-educational needs, but they will incur both federal and states taxes, as well as a 10% federal penalty.
“It’s your life. Design it well.” – TV host and interior designer Bobby Berk
But, this is also a wonderful time to talk about applications of financial decisions, not just the investment itself. For example, this could be a good time to discuss other unique opportunities for children to get the best quality education at the lowest possible price. For example, many high schools now offer dual-credit or transfer-degree programs that allow a student to earn a college-level associate degree before they graduate from high school. Students can then enter college as a junior, reducing the number of college years that need to be funded. If a child does not have the financial comprehension to understand how beneficial this can be to their overall financial success, they may resent the extra time and work needed for the program. But, with their newfound knowledge, they may be able to negotiate with the parents to redirect funds otherwise needed for college tuition toward an alternative major purchase, such as a down payment on their first home.
Another opportunity exists for children who have chosen to work during their high school and/or college years. Since they understand that taxes are a part of the economic equation, they can begin exploring investment vehicles that are designed especially to encourage savings due to favorable tax benefits.
Their employer may be able to offer a tax-deferred vehicle, such as a 401(k), where the contributions reduce current taxable income and are allowed to accumulate tax free until retirement age. At retirement, the funds will be taxed at the income tax rates in effect at that time. These funds can be transferred as the child changes employers or moved to an outside qualified account if they are not employed by a firm that offers the benefit. A child may also be able to establish a Roth IRA that will allow after-tax earnings to accumulate for retirement at which time the funds are received tax free. In both options, the money is optimally designed to be used for retirement. Withdrawals prior to retirement may incur a combination of federal taxes, early withdrawal penalties and/or loss of tax-free income status.
As Americans continue to live longer than ever, new trends indicate that our career paths will become more varied than our ancestors. Since the COVID-19 pandemic, one of the major changes has been that more people than ever are going the entrepreneurial route over corporate employment. According to Digital.com, 43% of Americans plan to start a business this year.
Because of higher interest rates, venture capital funding for entrepreneurs is slowing down. As a result, more business owners are starting their businesses by boot-strapping, or raising their own pre-seed and seed funding. At least one in 10 entrepreneurs have invested more than $100,000 of their own money in their businesses, and this number is growing. Investors look for founders who can demonstrate financial-modeling knowledge through balance sheets, cash flow projections and capitalization tables. Parents who are able to teach their children early about money will often set them on a long path toward successful entrepreneurship.
Offer a Head Start
Parents can give their children a big advantage by introducing them to an investment account, where the child can begin to choose individual stocks, bonds, mutual funds, commodities and other investments. Funds that are needed before retirement don’t receive the same tax benefits as those in a 401(k) or Roth IRA. However, they can be used at any time without early withdrawal penalties.
Each kind of investment has unique characteristics that can be positive or negative under different economic conditions. This would be an excellent time for children to consider teaming up with a financial advisor who can help steer their initial investments appropriately. A child may choose ultimately to invest on their own but can avoid making costly early mistakes with the help of a capable and caring financial advisor.
Children can learn about investing in companies that produce goods and services that they themselves know and understand. Doing so allows them to begin correlating corporate results with their own personal experiences. For instance, they may be using Apple products, such as a computer, iPad, iPhone or Apple Watch. So, if they were to purchase Apple stock based upon their positive or negative experiences with their personal product usage, it could help them understand not only why the investment may rise or fall on any given day, but also learn important entrepreneurial concepts such as branding and product positioning.
Money invested for long-term life needs can be used for home ownership, additional income generation and other sources of both wealth and cash flow. A parent investing time in a young child’s financial literacy can affect their ability to successfully accumulate wealth and have a successful, high-quality retirement life.
Create Deep Parent-Child Bonds
Most of the largest family arguments are over money. Most of the greatest family needs are senior living needs.
When a parent educates their child on the art and science of money, they gain the ability to talk about both money and individual needs on a deeper level. As children become more successful, arguments over “caring for Mom” or “who gets what” tend to retreat into the background. It is not the amount of money that makes a difference, but rather the ability to talk about such a private topic that instills needed trust between family members. An investment in your children today can alleviate much of the tension that often surrounds these topics.
Financial literacy is a true gift for upcoming generations. Even if a parent feels uncomfortable with their own level of expertise, it can be an excellent chance to gain knowledge together. Every year that a dollar accumulates interest is not only powerful in terms of its future worth, but it is also invaluable for opportunity it can offer.
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How to Invest for Your Kids and Teach Them About Investing originally appeared on usnews.com
Update 03/16/23: This story was previously published at an earlier date and has been updated with new information.
