A recent round of back-to-school shopping highlighted my successes and failures in teaching my children financial skills. All parents struggle with how to teach children about taxes, 401(k) plans, saving for the future and other critical financial skills. Discussions on the bogleheads.org forum over the last few years have provided several suggestions from other posters that I have adopted in my own family.
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1. Take Out Taxes
My children are now young teens, but several years ago they began receiving allowance. When they learned they would each receive $10 in allowance every payday, they were thrilled to be "rich." The joy lasted until that first payday arrived and they received only $9 each. Obviously I had made a mistake. Nope, they just learned the impact of taxes. Since they were in the 10% tax bracket, $1 left their paycheck to pay for taxes and they received $9 in their hands. The missing dollar provided an opportunity for a family discussion how taxes pay for services like schools, police, and fire departments that benefit everyone in the community.
2 . Automate Savings
To learn the importance of automating savings, my children were required to automatically have $6 of all future allowances placed directly into their savings accounts to be divided into different buckets - college, car, and "spend it on anything" (parents have the veto power for non-suitable items). As they now approach driving age and college, they are finally beginning to appreciate that setting aside funds for the future rather than spending all their money immediately will mean they can afford transportation and an education. These funds will soon benefit them, and they now voluntarily contribute extra money to these savings accounts because these have become personal goals and are no longer just parental goals. The lesson here is that ownership of the saving goal is key. (For more tips, see 5 Ways To Trick Yourself Into Saving.)
3. Match Savings
The government, employers and parents all struggle with how to encourage savings. One of the posters on bogleheads.org suggested matching savings in the way most employers match funds going into 401(k) or other retirement accounts. It seemed to be worth trying. For simplicity, a dollar-for-dollar match (100% matching) became an option. For every dollar placed into their savings account, mom and dad match 100%.
The children quickly realized that placing their cash into savings meant they had more in total. Even after placing some of that money automatically into their college, car and "spend it on anything" accounts, they had almost the same amount of money available to spend, but much more growing for longer-term goals. (A word of caution - 100% matching of larger birthday and Christmas cash gifts from relatives can get expensive.)
4. Introduce Investing
After several years of saving allowance, Christmas and birthday money, my children finally reached large enough balances in their accounts and it was time to introduce them to the concept of investing, rather than just saving. It isn't easy with children to select a proper asset allocation (split between stocks and bonds) that balances the need and ability to take on risk. Many would argue that children have a very long-term investing timeline, so they should be all in stocks. On the other hand, since they actually have a relatively short timeframe for the car and college money, one could argue they should be in bonds.
Finally, since the real purpose of this investment exercise is education, making sure the swings in the stock market did not cause them a significant loss of funds was important. Watching $800 to $1,000 disappear can be scary for anyone, so we settled on a conservative asset allocation that would allow some funds to remain stable (college and car funds) and some to be invested in equities to potentially grow over many years.
They have watched the value of their assets rise and fall, sometimes drastically, over the last few years, but have never been tempted to pull out of the market. They understand that lower prices represent bargains for them because they are at the beginning of their investing lifecycle. These lessons will pay off when they have much larger sums of money to invest in the future. (Learn some basics on asset allocation in Asset Allocation: The First Step Towards Profit.)
5. Let Them Learn By "Wasting" Money
All young people waste money on stupid purchases. Some young adults borrow money to buy a "hot" car; others charge vacations they cannot afford on their credit cards. These are all expensive lessons to learn at that point in life. To help my children learn to manage money, we made it clear that mom and dad would pay for all needs, but the children would use their own money to pay for any wants. They kept that money in the "spend it on anything" account (again, subject to parental veto if not suitable).
My children bought cheap toys that broke in one use, paid for after-school snacks for all their friends, saved for several months to purchase video games and used their own funds to buy the "brand" of shoes or jeans that would make them popular in school. They regretted many of these purchases. But none of these decisions put them in long-term debt, and they learned from each experience. Now they are much more careful with their money and much less easily swayed by the latest fad.
6. Treat Money Lessons As An Ongoing Experience
With two young teens at home, the lessons for all of us are still ongoing. However, there are signs that they are indeed learning the value of money. One of my children recently wanted a special sports shirt and insisted I take him shopping. As we walked toward the cashier, I reminded him that this was a want, not a need, so he had to pay for it himself. Without any argument he turned right around and returned the shirt to the rack. When asked why his parents should spend their money on something if it wasn't important enough for him to use his own money on it, he thought about it for several minutes and then replied, "it isn't worth spending your money on either." Lesson learned.