Everybody agrees that it’s important to teach your children about money. When it comes to preparing them for the real world, a solid foundation of financial literacy is one of the best things you can do to ensure their success.
But all too often, that education stops after the basics are covered. While the value of a dollar and balancing a checkbook are important lessons for any child, a nuanced understanding of more complex concepts is crucial to a healthy financial future. Nowhere is that more apparent than with investing.
No financial concept is more important – and less explained to children – than investing. It’s the basis for almost all significant financial growth and the best way to build robust passive income. It’s also more effective the earlier you start, giving a massive leg up to young people who were familiarized with investing at a young age.
Here are four simple ways that parents can teach their children about investing and get them started on the path to a hopefully successful, financially responsible adulthood.
Allow Them to Earn Money
If your kids are too young to join the official workforce, allow them to earn money doing chores and tasks around the house. Financial advisor Tom Martin from Clear Path Financial Planning of Wallingford, Conn. said that’s how his children earn their money.
He believes giving a guaranteed source of income, like an allowance, is a bad idea and a poor financial lesson. Earning money by working at home allows them to feel more accomplished.
“Maybe I want to see if they are willing to put in the work, but I believe it not only teaches them how to save and budget their hard earned money, but teaches them good work ethics,” he said.
Other chores can include outdoor tasks such as weeding and planting the garden, organizing the garage, raking leaves, shoveling snow and mowing the lawn. Martin advises that you pay children by the task or by the hour, so they learn that the more they work, the more they earn.
Give Them an Allowance
While some parents believe that giving their children an allowance amounts to giving them money they haven’t worked for, others use it to teach their children how to budget and save.
CFP® Scott Weiss from Weiss Financial Group of Mahopac, New York said that he follows the advice in New York Times writer Ron Lieber’s book, “The Opposite of Spoiled.” Both his six and nine year-old receive regular allowances that they can use to buy what they want.
“I’ve found this approach helped fast track my kid’s understanding of the value of a dollar,” he said.
At first, one of his children spent his allowance immediately, but they quickly learned that they needed to slow down in order to to buy the larger items they really wanted.
Since implementing an allowance, his children have become more resourceful and have learned to stop asking Weiss and his wife for something they want. They know they need to save for it themselves.
Teach Them About Compound Interest
The beauty of putting money away in an interest-bearing account is that the interest will continue to accrue and compound upon itself. This is a powerful visual for young children to see, that if they save money faithfully, their savings will grow.
CPA® John McCarthy of Cincinnati, Ohio said he set up his own “bank” that his children keep their savings in. Every month, he pays them a high interest rate and compounds that interest monthly.
“Not only do the kids get the experience in counting early on, but they quickly see the tangible benefit of saving when they get their interest payout,” he said.
Open Retirement Accounts While They’re Young
The biggest reason many people fail to adequately save for retirement is that they start too late. What better way to give your children a head start than to teach them about contributing to a retirement plan?
Once they’re older and start working summer or after-school jobs, encourage them to open Individual Retirement Accounts (IRAs) and contribute their salaries. They can only add money they’ve earned (not birthday money from Grandma), and the current limit is $5,500 per year. But putting in $1,000 every year can add up quickly if they start while they’re 16.
Among account types, a Roth IRA may be the best option for them, since they will almost certainly be in a lower tax bracket now than when they’re old enough to retire.
“If your child is old enough to babysit, mow the lawn, shovel snow they can claim the income,” Martin said.
They can also contribute to a 529 college savings plan – something that will come in handy if your child pursues higher education.
Teaching your child about investing may seem like teaching them to enjoy their vegetables. It’s going to be a painful process and they might resist at first. But doing so now will enable them to become financially stable adults with a healthy regard for money.