It’s not about how much money you have to pass on to your kids – it’s about passing on money-smarts. Teaching your kids sound financial knowledge can help them make smart financial decisions now, and in the future.
Just like with everything you teach them, there are key concepts and topics that create a foundation they can grow from.
Understanding the Basics
Recent research shows that most of our money habits are developed by the age of seven.1 Yes, you heard that right, seven. But there are a lot of ways that parents can influence those habits, both by addressing them directly and by simply including children in day-to-day financial decisions and processes. Learning how to wait while saving to afford something they want; understanding the concept of ‘future;’ dealing with delayed gratification; and avoiding impulsive, irreversible decisions are all solid money management techniques that set everyone up to be successful.
To get started, one topic to talk about is the difference between needs and wants. An effective way to do this is by:
- Simply sitting down with them, grabbing a pen and paper, and having them write down different things they would like to spend money on, and then simply categorizing each item as a need or a want. This exercise can help them visualize the difference between the two and learn to make the distinctions in day-to-day life.
- Once you have a working list of things the child both needs and wants – you can ask them to prioritize the list by how much they want each item and how much it costs – and then develop a savings plan with some very concrete goals and timelines.
Another concept that can be taught early on is opportunity cost. One of the best times to let kids see opportunity cost in action is at a store.
There are a few lessons that can be taught when kids are asking for a toy or piece of candy.
- First, it can be helpful to ask them whether that toy they desperately desire is a need or want.
- After that, explaining that if they get what they want right now, they will have to delay getting something else they want on their list is a prime example of opportunity cost.
The Necessity of Budgeting
Following the basics conversation, one of the first pieces in building a strong financial foundation is establishing a budget. In Debt.com’s annual budgeting survey, 98% of respondents agreed that everyone needs a budget – but only 80% of respondents actually have one. And this is the highest percentage in the three years of the survey – it’s usually closer to 70%.2 The purpose of budgeting is to help reduce overspending, but it doesn’t stop there.
By implementing a “save, spend, give” system, kids are shown different uses of money rather than just spending. Setting up a save, spend, give system can be as simple as labeling three jars or envelopes to act as their piggy banks. Every time they receive money whether it be an allowance or a gift, there’s a specified percentage that goes to each of the three categories.
Once they’re old enough to have bank accounts, this same process can also be followed through the use of automated transfers. Typically, banks are able to open accounts for minors once they have reached the age of thirteen as long as a parent or legal guardian signs as a co-owner of the account.
Teaching kids about how to create a budget and the importance of budgeting will not only give them a head start, but also helps them develop a habit they’ll hopefully have for the rest of their life.
From Budgeting to Saving… And Understanding Interest
To show children the positive side of interest, rewarding them for saving can help incentivize good budgeting habits. One way to do this is by giving them a small “bonus” every time they put money towards their savings account. Another way to educate them about interest is to ask them if they would rather have $1 million or a penny that doubles every day for one month. Chances are, they will select the $1 million. Now you get to show them the power of compound interest. By taking that penny and doubling it every day for thirty days, the ending balance ends up being north of $5 million.3
One way to show the negative side of interest may be for the parent to act as their kid’s lender if they don’t have enough money for something. By charging them a little interest, they can begin to see that it’s more expensive to buy something if they don’t have the money for it rather than waiting until they have enough saved.
Diving Deeper into Credit – Building It and Keeping Score
When it comes to credit, getting an early head start on building a credit score can not only make adult life a little bit easier, but also iterates the importance of being smart with money. Building a credit score while being young is advantageous and having an existing credit score when entering adulthood can show its benefits immediately. Whether they’re buying their first car or applying for an apartment, a good credit score can save time as well as money.
One way to enable kids to start building their credit score is through a secured credit card. This allows them to start using it for purchases but rather than running up balances they can’t pay off, they’re only able to spend what’s on the card. Another option that allows for a little more parental oversight is adding them as an authorized user on a parents’ credit card.
A great way to teach the implications of a credit score is to sign up for a free credit service, such as Credit Karma or one offered by your bank. Pulling up your own credit score and walking kids through the different factors that make up the score will give perspective on how much it matters to keep credit balances low and maintain a good payment history. To go a step further, show them the total cost of buying a home or a car with slightly different interest rates. Since personal finance topics start to become intertwined the further you go, this is another opportunity to touch on interest with them as well as the importance and benefits of having good credit.
Creating Commitment with Investing
There are a few ways to get kids involved with investing. A fun way to encourage them to learn about investing is by letting them play the stock market game. There are many different websites and apps that can be used, but kids are given the ability to select stocks in a hypothetical account and can manage their own portfolio. The SIFMA Foundation has a great version that you can find at https://www.stockmarketgame.org/
A real-world option is to open a Uniform Gifts to Minors Act or Uniform Transfers to Minors Act (UGMA/UTMA) account. These are custodial accounts that are designed for college savings and can be opened in a minor’s name. This allows both kids and parents to save money and invest while still giving parents control over the account until the child reaches majority age. Both types of accounts can be opened at a bank or a brokerage firm.
Teaching kids about money is an important role of a parent. Just like teaching anything, it takes time and patience. But the knowledge and lessons they learn will stick with them throughout their whole life. It can tough to educate about personal finance and if there’s anything we can do to make the conversations and lessons easier, we’re here to help.
- Financial Capability of Children, Young People and their Parents in the UK 2016. The Money Advice Service. March, 2017.
- Debt.com 2020 Budgeting Survey.
- Calculation by Seven Group.
This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here.
The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.
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