Kids and Money: Tackling the Various Issues
The benefits of teaching children about money are substantial. By understanding saving, investing, and borrowing, children can develop fiscally responsible habits, enabling them to be better prepared for financing their college education, to avoid debt problems, and to get on the road to a comfortable retirement. Unfortunately, most schools don't teach children the basic financial skills that they'll need throughout their lives, so that responsibility falls on you, their parents.
Although there are different schools of thought regarding teaching children about money, many experts recommend teaching your children the following lessons in this order:
- Money is earned by working, not given freely.
- Money is saved in order to accomplish certain goals.
- A bank is often used to save money.
- You can earn interest by investing.
- Money that is borrowed is repaid with interest.
- In the long-term, compounding magnifies the effects of interest.
The first direct experience many kids have with money is an allowance. Parents should use the allowance to teach kids about the value of money, and of saving it. Experts disagree about whether an allowance should be tied to household chores. Some say doing so sends the message that the child should only do the chores for the money, not out of a sense of responsibility as a family member. One solution is to require your children to perform certain chores, and to pay them for additional duties they perform. This becomes more viable as the children get older. Regardless, make it clear at the outset what types of purchases the allowance can and can't be used for.
Encourage your children to save a part of their allowance for a long-term goal. Younger children will be reluctant to put their money in a bank account miles away, so start them with a piggy bank and only move them to a bank account when they're comfortable with it, probably when they're 8-10 years old. Have them set specific saving goals (for example, a new bike by next spring), and check their progress with them periodically. You might even want to draw a chart showing monthly progress, so they can watch the savings grow toward their goal.
Since children tend to be less patient than adults and might be disappointed by how slowly their money grows in a bank account, you might want to offer a matching system. For example, you could give them a bonus dollar for every dollar they're willing to promise to use toward some long-term goal. The matching bonus should be larger for younger children, because patience takes a long time to learn. You may even want to offer larger matching bonuses for more worthy goals.
The next logical step is a checking account, but you should be careful to monitor their use of it to confirm that it meets your standards. This is also a good time to explain how bill paying works. You might even want to get them involved in some household spending decisions, so they get used to comparing the costs and benefits of various expenditures.
Once your children understand saving, you can begin to teach them about investing. A lot of parents feel that giving a gift of stocks in a well-established company can be a great way to plant the entrepreneurial seed, especially if it's stock in a company that makes kid-oriented products that your child thinks are cool. Actually, minors in the U.S. aren't allowed to own securities, but parents and guardians can set up custodial accounts for their children. You can set up a custodial account through a brokerage or mutual fund. And if the account is online, you can let your children use the account directly, with whatever level of supervision you feel is appropriate. Laws on custodial accounts (UGMAs and UTMAs) vary from state to state . Most require that a custodian hold the account in trust until the child is either 18 or 21, and most enable parents to give gifts of up to $11,000 a year without paying taxes on it. But whether they're old enough to own stocks or not, kids are allowed to participate in stock market simulations, in which they construct and monitor their own portfolio of stocks.
Accounts for children generally take one of two forms. A guardian account is owned by an adult who is responsible for taxes and all other maintenance. Taxes are paid at the rate your earnings are taxed. A custodial account is owned by your child. Taxes are paid according to the rate at which your child's earnings are taxed. You control the custodial account until your child is no longer a dependent. The tax rate will usually be lower for the custodial account, but you must sacrifice a degree of control.
IRAs can also be used to earmark money for children. However, for your child to open an IRA, he must be earning money. You can then control the account until your child turns eighteen. This system applies to both traditional and Roth IRAs. In most cases, the Roth IRA is preferable for children because of the added flexibility regarding withdrawals. Education IRAs are another investment vehicle that can be useful for children. All tax benefits of the Education IRA are applicable only upon withdrawal, and the money must be used for education although not necessarily for the education of the family member that it was originally intended for.
A simpler option is to invest in a mutual fund which focuses on kid-friendly stocks. And of course, even if your children don't have money to invest in the stock market, they can still select and track a simulated portfolio, testing their theories and learning without the risk of loss. In any case, you should warn them about the difficulties of being a successful stock picker, and encourage them to put most of their long-term savings in somewhat safer investments such as an S&P 500 index fund rather than the latest hot stock.
When your children are old enough, it's a great idea to have them take on part-time jobs. This will give them a clear understanding of the value of a dollar. As they save for long-term goals such as a first car or a college education, you can teach them about the effects of compounding. Explain how compounding offers the greatest benefits to those who are willing to plan the furthest in advance.
Whenever your children want something that they can't quite afford, it's a good time to explain how borrowing works. Be sure not to encourage borrowing every time they want something, as delayed gratification is a valuable lesson for them to learn. But you might occasionally decide to use such a situation as an opportunity to show them what it means to get a loan. You can act as the lender, extending them credit, writing out a detailed IOU explaining the repayment terms. Charge a small amount of interest, so they understand that borrowing means paying a fee for the use of the money.
At some point (probably in their late teens), they'll be ready for their first credit card. Before then, make sure they have a clear understanding of the dangers of borrowing and the impact that a high interest rate has on future cash flow. Also be sure they understand that credit is a privilege and not a right, in that if they don't pay back their debts on time then no one will want to lend them money in the future. Also be sure to explain what they can and can't use the credit card for. You should seriously consider having their first card be a secured card or a debit card, to be sure that they remain within your spending limits. When they're ready to move to a standard credit card, be sure they understand that they should pay the balance in full every month, to avoid exorbitant interest charges.
Throughout all these steps, the best way to encourage fiscal responsibility in your children is to exhibit it yourself. For big-ticket purchases, show your kids the process: gather information on the different options, decide what you really need or want, be willing to wait awhile for a better deal, save up for the item, and then get it. Avoid impulse buying. Don't borrow unless you absolutely need to, and will be able to pay it back on time. Put together a monthly budget and stick to it. Have a detailed roadmap for how you'll accomplish your financial goals, and stay on track to accomplish them.