When it comes to managing money, nothing beats a good education. So why aren’t we doing a better job of teaching our children the basics?
We intuitively know as parents that our kids understand little about the world of money. A recent government study of thousands of U.S. high school students found them sorely lacking on the basics of insurance, budgeting, retirement and investing. Average score on the 40-question quiz: 69%.
That result illustrates how badly our children need a good financial education. Not only is it likely to improve their general performance in school, but learning how money works can also have a profoundly positive impact on their lives down the line.
My own 16-year-old son had some money saved up, so I helped him invest it in exchange-traded funds, mainly emerging markets and S&P 500 funds. Now he tracks what’s happening with his investments on his smartphone.
While it’s true that you really shouldn’t watch your investments every day, it’s good for kids to see the ups and downs of the market so they begin to understand the risks — and the rewards.
You might not be ready to open an investment account for your child, but you can start your children at a young age with a weekly allowance and begin to talk with them about the difference between spending, saving and giving.
The idea is to help them understand how money works by gently nudging them through the experience of deciding what to do with their own money. For most youngsters (and many adults), spending is not the problem. The money just goes! Talking about spending, however, opens an avenue toward the alternative of saving and, in time, the virtues of giving.
For instance, if there’s money left over at the end of the week’s or a month’s allowance, encourage your kids to roll it over into a savings account — then offer to match it. A bonus can be compelling, especially as they become old enough to start to earn from babysitting, pulling weeds or walking the neighborhood dogs.
Saver to investor
As their savings grows, that leads naturally to a conversation about how savers become investors. Investing young is key and a great way to talk about how time is money. Once your kids have a little money set aside, it’s easier to comprehend how compounding works for them (in the case of an investment) or against them (with credit cards).
Here’s an eye-opener sure to impress your teen or even pre-teen: Explain that every dollar they save today is worth $32 by the time they retire.
The reason is compounding, most easily explained using the Rule of 72. It works like this: If you know what rate your money will earn in a year, just divide that number into 72. The result is how long it takes your savings to double.
So, at 7.2%, an investment of $100 turns into $200 in 10 years. Over the following decade, that same $200 effortlessly becomes $400. Then it doubles again to $800 — with no extra weeds pulled and no more dogs walked. Eventually, it telescopes out to 32 times the money!
The biggest advantage young investors have is time. Compounding is a powerful — and profitable — formula they can learn early on and use throughout their lives. Yet children also need to understand the basics everyday finance.
Step by step
Here are a few things we, as parents, can do to jump-start that education when the time is right:
- Pre-teens: Match their savings from an allowance. It’s a great way to show them on a manageable scale how an employer 401(k) works.
- Just started working: Open a Roth IRA for your child. Contributions aren’t tax deductible, but withdrawals are. The only catch is that your youngster has to contribute earned income; allowance money doesn’t count.
- Ready to invest: There are a million books out there on investing, but one in particular, The Elements of Investing, is great for beginners. Written by two Rebalance Investment Committee members, this slim, easy-reading volume introduces concepts like asset allocation, indexing, rebalancing and diversification.
If you start early enough with the basics of earning and saving, it can lead in time to a discussion of sound, thoughtful investing that will benefit them for decades to come.