“I wish I started investing at a younger age.”Practically everybody
Investing isn’t something we’re taught in school. In fact, finance in general usually isn’t taught in school. I don’t blame the schools, because most teachers don’t feel qualified to teach such a class. There are plenty of other reasons why finances aren’t taught in schools, but we have to face it: as parents, it’s our responsibility to teach our kids about money.
Unfortunately, most parents don’t feel qualified. Most Americans say they could use help with their finances. Even if you include yourself in that category, you can still teach your kids. It’s not hard to teach them investing concepts that will change their life. Concepts you weren’t privy to. Simple concepts.
It just takes a few ideas to make your kids financially unstoppable. This is what we all wish we knew when we were kids.
Teach Saving, Then Investing
Investing isn’t the first step, it’s the finish line. Before you get into stocks, mutual funds, and index funds, your children need to simply understand that some money is for now, and some is for later. That’s where saving comes in. You know the classic “give, save, spend” jars. They actually work, because they teach delayed gratification, and they teach it visually.
When your kids are young, they need to see that big clear jar filling up with dollar bills. They need to get the concept of not spending everything they receive, and the concept of watching that saved money grow over time. Part of everything they ever receive goes to “give” and part to “save.” Later on, you can add investing by adding a “grow” jar.
Slowly work up from savings accounts to conservative investments. Things that you may never consider as an adult, like a Certificate of Deposit (CD). This way kids learn how interest works, which we’ll talk more about in a moment.
If a kid puts $100 into a CD, and then receives $101 however many years later, she’ll start to understand that she earned money by simply not touching her money. You have plenty of time to explain to her how other investments will earn much more. The goal isn’t to make huge gains, it’s to teach the concept of “invest, wait, earn.”
Another option is a conservative mutual fund. You want your kid to invest in something that will move up or down, but not by much. I’ll explain why below.
“Pay Yourself First”
If you only teach your kid one thing about investing, let it be the concept of “pay yourself first.” Because that’s the most important thing they could possibly know about investing.
You’ve likely heard this before. As adults, we often know this idea. We know that if we wait and invest what’s left at the end of the month, there will never be anything left. Yet, if we invest first, we somehow always find a way to do things like pay your bills and eat. It’s funny how that works.
It’s also funny how many adults nod in agreement when I mention this concept, as if they’ve heard it a hundred times, and then go on to explain that they don’t actually practice it, but they know about it. Sound like someone you know?
When your kids start life with the “pay yourself first” mindset, it will be a natural part of their budget. It won’t take discipline; it will just be how it is. They won’ even know that there’s another way out there where people lazily don’t invest because they didn’t do it first, and therefore have no money left. Don’t even let your kids realize that most people do it backwards like that… at least not until your kids are old enough to understand that most people do finances wrong.
Remember that “pay yourself first” is just a concept, and as Christians, we give to God first, but this concept still applies. The first thing we spend our money on, other than giving, should be investing. If your kids use the “pay yourself first” plan, it won’t take much money before they start to see results. Why? Well, because time…
Let Time Work Its Magic
There’s a popular chart in circulation around the internet and in many finance books (and in some of my other articles). It’s a chart of two people who start investing at different times.
One guy starts when he’s 19, and the other when he’s in his mid-late 20s. They each invest the same amount of money every year, except the 19-year-old stops after 8-10 years. The guy in his 20s keeps investing every year for basically forever, and he never catches up, because he started late.
Here’s an example of the story, from Dave Ramsey (this assumes a 12% interest rate):
The point here isn’t that people who start late can’t still do well. It’s also not that a 12% interest rate is unrealistic. And the point definitely isn’t that you should stop investing after 10 years merely because compound interest will work its magic, though, it will. But why would you stop?
So what’s my point? The point is that the younger you start, the better. Compound interest… well… it compounds. Makes sense, right? I though so. Yet, 66% of Americans don’t understand how compound interest works, according to a study from The George Washington School of Business.1
If nothing else, it’s crucial that our kids understand compound interest. It’s important that our kids start investing at a young age, because they can. We didn’t all have that luxury. I didn’t know anything about investing until I was in my early-mid 20s.
If I had even just known enough to start investing in a conservative mutual fund as a teen, I’d be in a completely different spot right now. If I had understood how important compound interest over time is, I’d unquestionably be in a different spot.
What Not to Do
I think it’s funny when articles say things like “do what works for you” and “this isn’t a one-size-fits-all answer; every kid is different.” I’m not going to insult your intelligence. I’m going to assume you’ve read an article before this one, and you already realize that any type of opinion piece or advice applies differently to different people. My only goal here is to tell you what I’ve learned and observed over numerous years of having children, and numerous years of learning about how to teach investing to said children.
It’s common advice to let your kid buy a share of Disney (that seems to be the go-to when talking about kids), or some other company they can relate to. The idea is that they will understand how stocks work. Well, kids are actually capable of understanding how stocks work with a brief explanation, but that’s not the only reason you shouldn’t let your 10-year-old buy stocks.
I suggest more conservative methods when you’re first teaching your kids to invest, and I don’t just say this because there is less of a chance of losing the money, I say this because there’s less of a chance of anything happening – in either direction.
When your kid buys that Disney stock, and the price skyrockets, he’s pretty sure he did that all on his own. He thinks he’s a great investor. He’s going to be the next Peter Lynch. He can do no wrong. And what about the opposite? When Disney tanks, he decides maybe investing isn’t for him. He’s not good at it, and he should just quit while he’s not too far behind.
Either way, the kid learns nothing. If you want to show him how stocks work, simply show him how stocks work. He doesn’t need to have skin in the game to get the lesson. On top of that, most of the time when people buy stocks for their child, their kid isn’t even seeing the transaction go down. I chock this entire idea—buying your kid individual stocks—up to another case of great intentions, and little actual learning value.
It Doesn’t Take Much
If you instill the “pay yourself first” concept in your child’s mind, it really doesn’t take much for them to be successful investors. Unless your kid is planning to devote most of her waking hours to researching investments, index funds are all she needs. Even Warren Buffett suggests, for the average person who isn’t a professional investor, index funds are their best bet. Based on history, I’d say most professional investors would be better off if they’d taken the same advice, and stuck with index funds.
It’s a simple formula:
Your child + pay yourself first + index funds x time = successful investing
It’s easy when you learn this stuff at 11 or 12. That’s why most investing books are written as if you’re behind and trying to catch up, because you didn’t start at 10 or 11.
There are methods that work better than others, and some methods that are proven over and over to not work at all, such as spending 30 minutes a month reviewing some random individual stocks and buying whatever feels right at the time. That last method seems to be one of the most popular, though I doubt anyone would describe it that way.
The fact is, if you teach the index investing method from a young age, your kids will do well financially. There’s plenty of time to get them interested in other methods of investing, while using index funds all the while. Think of index funds as the foundation. Everything else is building up from there.
If you have questions about index funds, I explain them in greater detail in 15 Finance Terms Children Need to Understand (see #10).
Further Book Reading
- Make Your Kid a Money Genius by Beth Kobliner
- Money Monster or Money Master? by Norma LaFonte
- Moneybags: A Guide to Teach Your Kids About Money by Wendy Gillespie
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- Lusardi, A. (2015). Financial Literacy: Do People Understand the ABCs of Finance? Public Understand of Science.