When it comes to teaching kids about money, there is no doubt that it is one of the few skills that can help them live better lives, enjoy greater freedom, exercise more control over how they spend their time, and afford a degree of comfort and security that otherwise may not exist. An adult who was inculcated with the right money management skills in childhood has a better chance at avoiding poverty, escaping the grind of financial pressure, and even ending up one of those secret millionaires like janitor Ronald Read, who left behind an $8,000,000+ estate discovered after executors started digging through the safe deposit box of the near minimum-wage earning worker who had been collecting stocks throughout his entire life as one might baseball cards or decorative plates.
How can you do it? Here are some thoughts on ways you can help your kids, grandchildren, nieces, nephews, godchildren, or any other young person in your life get a grasp on the fiscal side of things.
1. Begin Teaching Kids About Money By Starting with the Most Important Part: The Saving Habit
Several generations ago when Napoleon Hill, the legendary author of Think and Grow Rich, wrote his profiles of America's most successful self-made men, he devoted considerable time to the saving habit; the ability to spend less than you earn under nearly all conditions so you have a surplus. Knowing how to generate that surplus is the single most important foundation of building wealth. That surplus is what you put into your 401(k) plan. That surplus is how you fund your Roth IRA. That surplus is what serves as a down payment on your home or when you make your first real estate investment. That surplus is how you buy shares of stock or purchase bonds. Even if you earn millions of dollars a year, if you don't know how to balance the debits and credits, you could end up broke.
There are different approaches you can take with ingraining the saving habit into kids. The best place to start? Though it might sound cliché, piggy banks are one of the most useful tools for teaching kids about money. In our family, they are acquired prior to birth. My brother, who is about to become a dad, already has his future daughter's piggy banks (there are two — one for coins, one for bills) sitting on her dresser in the nursery. There is something tangible about hearing the clink-clink of coins and the rustle of paper money as it fills the bank, making it grow heavier with weight as wealth is accumulated. It makes it visceral in a way few other things can. Have each kid reserve a fixed percentage of any income that is brought in — perhaps 10%, perhaps 50% — as he or she works toward a larger goal. Make sure that any birthday, Christmas, or other celebratory funds include a portion of saving capital to be put aside. Later, when they get a job, have them reserve a portion in a separate account that you then allow them to spend when they're off at college or starting their adult life.
When you go to the store, teach them how coupons work and have them put the savings in their piggy bank (e.g., if you were to buy a box of something for $5 but can get it for $3 with the coupon, have them turn over the coupon in the checkout lane and then hand them, in cash, at that moment, the $2 saved — nothing else in life will make that connection so quickly). Show them how to comparison shop online. Take them to a car dealership to watch price negotiations. No matter how young they are, children are listening. In a lot of ways beyond ingrained characteristics, they absorb your values, your priorities, your behaviors, and your wisdom (or lack thereof), mimicking what you do as much as what you say.
2. Next, Focus Not on Teaching Kids About Money, But Basic Math. It Sounds Counter-Intuitive But the Research Indicates It's the Best Way.
The Wall Street Journal ran a great piece in October 2017 detailing research showing financial literacy had a lower correlation to financial success than did mastery of basic mathematic concepts. At its core, this makes sense because money is really nothing more than addition, subtraction, multiplication, and division. For example, how many people outside of finance can calculate exponential growth? It's something you take for granted. If someone approached me and said, "I want to know how much money I'd have if I began putting aside $500 a month, at 10%, for 50 years", I don't need to think about the equation, I know it by heart. It's math. Nothing more. Nothing less. I can whip out a calculator and have an answer in short order. The fact there is a dollar sign in front of the math problem doesn't change that, at its core, that is what it is: A math problem.
Every middle schooler in the country should know the formula for the future value of a lump sum and the present value of a lump sum. That alone can mean the difference between a life overlooking the ocean, drinking your coffee as the waves hit the edge of your property or one worrying about making rent each month until you die in old age. It's this inability to calculate what should be basic concepts that cause otherwise smart people to pass on incredible, jaw-dropping returns, such as ESOPs that offer 15% or greater discounts for employees wanting to buy stock in their blue chip employers. To put it more starkly: By the time you factor in everything except taxes, in many cases, you could dump the stock, arbitrage the difference, and effectively earn 80% or 90%+ on your money in six months or less due to the way the programs are put together. These programs are so incredible, I've written on my personal blog about the research done trying to figure out why almost no employees take advantage of them. The best data I've seen shows the typical American leaves between $4,000 and $5,000 a year in free money on the table, all of which could have been grabbed had they possessed basic math skills. It's lunacy but practically nobody is grabbing the funds to which they are entitled.
3. Have the Kids Master Basic Accountancy, Cash Flow, and Financial Accounts
Whether you use a digital spreadsheet or old-fashion green ledger paper, with the saving habit and basic math skills down, require the kid or kids to track every inflow and outflow, along with a running balance. Later, establish a checking and savings account, explaining how they work. Describe how FDIC insurance functions.
4. Teach the Kids About Growing Their Money By Investing It
With all of the basics covered, now it's time to get into the fun part. You want to teach kids how money actually grows. This is going to vary from family to family but here are a few ways you can make the investing process real.
If you develop or acquire real estate, set up the property in a limited liability company and have the kids buy membership units. Physically have them hand over cash and give them a printed stock certificate. Include them in the annual meetings. I know successful adults who watched their parents construct storage rental units and car washes as a kid. I know others who were there when the bulldozers arrived and started moving ground. When the LLC makes a distribution, walk them through how much they received and make a ceremony of handing them the check. The same goes for an operating business. When Wal-Mart was nothing more than a tiny retailer nobody knew existed, Sam Walton divided up the business into 5 shares, giving each of his 4 kids a share and reserving a share for his wife, Alice, and himself. You can do the same thing with a diner or a gas station; a hotel or a garbage truck used to start a trash hauling service.
Give stock as a gift. Explain how the business works, walk through the annual report, 10-K, and proxy with them, and have the dividends either direct deposited into their account or have the check mailed to them so they get to open it; a constant stream of gifts arriving in the post. It might start small but things get interesting when compound interest can work its magic. When my youngest sister was in school, I gave her stock in The Coca-Cola Company through the direct stock purchase plan. My parents then made regular monthly contributions to it. By the time she was in college, spare change here and there had amounted to a pile of ownership in the world's largest beverage company worth somewhere in the low five-figures. In fact, if she stops contributing to it now, and holds what she has, even at average rates of return, it will be impossible for her to have less than $3,600,000 by the end of her natural life expectancy. When she was growing up, we would walk her through the grocery store and point out people buying Coca-Cola, explaining that the money she was sent came from her cut of the sale.
For each of my nieces and nephews, we do the same, only this time, we use a brokerage account structured as a UTMA gift. My seven-year-old niece was recently on a trip to Florida and saw an Exxon Mobil gas station. She lives in a part of the country where there aren't many of them but she knew all about the business, had been receiving dividends from it, had gone through the shareholder materials with my husband and me, even voting her proxy as we explained what each proposal meant. When it came into view, her eyes widened and she erupted with a cry that would make the armies of Mordor weak at the knees, "EXXON MOBIL! I OWN THAT!", pointing excitingly out the window. You have to make it real. They need to see it; to understand that stocks are not electronic blips on a computer screen but a legal equity stake in a real operating enterprise that sells something - a product or service - for cash.
If you're really aggressive, you can find a way to pay the kid for services, giving them taxable, earned income that makes them eligible for a Roth IRA.
5. Teaching Kids About Debt and the Cost of Capital Relative to the Opportunities It Brings Can Save a Lifetime of Frustration
Finally, teach kids about the cost of capital - namely, what debt means in real world consequences. For example, if they want to borrow $50,000 for a college education at an 8% interest rate, make them calculate that the student loans will require them to come up with $4,000 per year, or $333.33 per month, every single month just to cover the interest expense without paying down any of the principal. Is that worth it? It depends entirely upon the additional income he or she will receive from having the degree.
In other words, the college degree is an investment that either makes financial sense or doesn't. While, perhaps, this shouldn't be the case (college is about learning to think, expanding your horizons, establishing critical analysis skills that permit you to self-educate for the remainder of your lifetime), in the current system in which we find ourselves, ignoring this will cause a lot of heartache and suffering turning the borrower into little more than an indentured servant. You should not spend your life worshipping money, there are far more important, more valuable, things that deserve your attention. Do not make a deal with the devil to get a piece of paper from a specific institution if there's no financial reason to do so. Is it fair that others don't have to worry about this either because their family covers the cost or they inherited a trust fund? No, but that's life. Deal with it. Suck it up. You can't make decisions based upon someone else's pocketbook.
Have them calculate the cost of carrying credit card debt. Make them figure out what a $2,000 purchase carried at 25% for years and years ends up costing. Then make them calculate all the other things they could have bought with that extra money; money that now belongs to the shareholders of the banks (tie it back to stock ownership).
Teach them about the different types of mortgages, educating yourself along the way if you're unfamiliar with them. How many families could have avoided losing their home if they'd had a basic grasp of why an adjustable-rate mortgage is different from a fixed-rate mortgage? Many of the rich do it, so should you.
6. Incorporate Charitable Giving Into Any Plan to Teach Kids That Money Isn't Just About Serving Your Own Needs
It's easier to respect money when you see that wasting it could have lead to a better life for someone else. There are many ways to do this but a few that I've seen or used over the years:
- A few weeks before Christmas, hand each child an envelope of cash. Have them shop for gifts to donate to a local orphanage or halfway house, making it personal to them.
- Set up a family charitable gift fund with a financial institution such as Fidelity or Charles Schwab. For the Kennon-Green family, we use low-cost index funds to park past tax-deductible donations until we find something we want to support. During bull markets, we can donate appreciated shares, too, avoiding capital gains tax. Sit down once a quarter and have each child suggest a charity he or she wants to issue a grant to support, giving a presentation as to why it is their number one pick.
- Sign up to donate time to an organization such as Habitat for Humanity to drive home the message that writing a check isn't enough; sometimes, you have to get your hands dirty to make the world a better place. At the very least, it will connect you to the work so you don't take it for granted.
In the end, if these six foundations are in place, most of the other details can be acquired in time. As they enter their teenage years, make sure to teach them some of the most complicated keys to financial responsibility.