Children have the gift of time for building their future.Unfortunately, thousands of young people waste their early opportunity to start building an emergency fund, saving for adulthood, and investing for retirement.Here are 3 examples:
A neighbor who finished the first year of college with a 3-point average (good grades!) decided to move to New York to find a job and live with her sister. This was not surprising when considering that she used to sell stuff door-to-door to earn money. What surprised me was that she asked if we had any advice? “Yes”, I said, “invest in a Roth IRA”. “What’s a Roth IRA?”, she asked. Neither she nor her college-graduate parents knew about IRAs.
Two grandmothers told me on separate occasions that they wished their young adult grandsons would invest in the stock market.
References 1 & 2 describe the problem and correction for delinqent investing.
Education and Investing are the best ways for young people to develop their future. Their success is measured in terms of personal security for a lifetime rather than in millions of dollars. Investing starts with learning how to save for future wants and needs despite many distractions. Family teamwork is an invaluable aid. This Overview is aimed at helping families inspire and train their young people to make investing a lifetime habit.
Journalists and educators agree that children learn about spending, saving, and sharing money very early in life. Whether their money habits become useful or futile depends on the examples and coaching of trusted adults. Financial education starts at home where family traditions of money management set the standard. If there is no family tradition, then start one. Young investors need a team of parents and trusted adults to provide,
Money management is essential to investing and protecting financial assets such as stocks, bonds, and savings. Building good habits can be a family tradition or a new family experience. Either way, children start forming money habits early, before entering school. Many families teach the wise management of money by encouraging their pre-schoolers to store money in jars (chart 1). Any container would work -envelops, cartons, bowls, socks, etc.- but transparent jars are the favorites.
Spending Jar teaches decision-making and accountability. Children love money and never have enough to pay for everything they want. They should learn to spend wisely, track their expenses and accept the consequences of their choices. Learning to spend wisely can help them avoid future financial insecurity due to fluctuating income and overwhelming debt.
Saving Jar teaches investing. Saving leads to investing and the funding of financial goals. Start by helping children save for short term goals, then encourage them to gradually save larger amounts over longer time periods. Introduce them to the stock market by explaining that their favorite businesses sell shares of ownership. Consider helping them buy stock in their favorite company.
Sharing Jar helps build relationships. Expose children to the needs of their community. Community engagement will cultivate relationships and humane values.
Dreams are gateways to an exciting and prosperous life. Teamwork can help turn those dreams into financial plans for earning and protecting money. The earlier your child’s team begins the process, the better the chance of success.
Dreams can become realistic financial goals. Younger children dream of becoming grown-ups. For example, they wonder what adults do for a living and how parents earn incomes. Older children are inspired by classmates, role models, field trips, activities, etc.
Chart 2 shows examples of goal-starters:
teenagers want expensive things like cars and computers; they should save for it!
young adults think about weddings and buying a home; they should invest in it!
children dream of becoming millionaires; they could invest in a retirement account!
– My granddaughter read a story in The American Girl magazine about saving to become a millionaire. She was ‘hooked’. I discussed the article with her and asked her mother (my daughter) if I could provide some seed money to open an investment account. A year or so later, my granddaughter started earning money as a tutor and used her earnings to open a Roth IRA. She enjoys reading her financial statements and watching her investments grow in value. –
Starting a Roth IRA: www.irakids.com
Chart 3 outlines the sources of income for children.
Unpaid chores are work assignments needed to run an efficient household.
Allowance is a regular gift of money that ‘allows’ young children to practice spending, saving, sharing, and budgeting money.
Jobs are types of labor performed by older children to earn money without a work permit. Not only do jobs enhance wealth but they also improve social skills and help children make decisions about future vocations.
Those who chose to turn a job into their own business are called Entrepreneurs. A successful business matches the skills of the child with the type of job; it also requires planning, organization, perserverence, and reinvestment.
Employment for wages in a regulated business requires children to have a work permit issued by the State.
Investments are a good way to save money for future use. Children have a BIG OPPORTUNITY to create wealth by reinvesting stock returns that will multiply the value of their investment. Chart 4 shows the future value of $1 invested in the stock market when all dividends and capital gains are reinvested in stocks. This mechanism of growth is called “compound interest”.
Dividends and capital gains are types of interest called “stock returns”. The colored dots in chart 4 represent values of compounded returns at selected time intervals. One application of a growth curve is the use of time intervals to help plan big projects. For example, childhood goals of saving for college and retirement fit into uniquely different time intervals:
The growth of $1 to $3 in 18 years is a realistic expectation of saving for college.
The growth of $1 to $30-$114 in 50-70 years is a nice investment for retirement.
Young investors need trustworthy adults to help navigate the red tape of opening a banking or investment account (chart 5). Minors (those youth under the age of 18 or 21 years depending on the state where they live) are unable to open the account without the written consent of an adult parent, guardian, or acceptable attorney. Full control of the account reverts to the young person at the age of majority (age 81 or 21 depending on the state).
Big projects require saving thousands of dollars.
Short term projects include saving for a computer, car, vacation, or wedding.
Long term projects include saving for college, a house, or retirement.
Planning a big project requires setting the goal, estimating the deposits of money, overriding the obstacles, and occasionally reviewing the plan. A simple Retirement plan might be the following:
goal, save a million dollars [this may change later]
deposit 10% of earned income [this will change later]
override obstacles with frugal investing (chart 6) and other protections (chart 8)
review the plan when there are substantial changes of income, expenses, or personal life.
Brokerage firms charge fees for professional advice, trading services, accountants, and safekeeping of securities. The fees are inescapable, but they can be minimized by frugal investing (chart 6).
Automatic reinvestment: Ask your broker to automatically reinvest cash payments from stocks and investment funds.
Infrequent trading: Otherwise, frequent trading (especially small amounts of money on a daily or weekly basis) will dilute investment returns.
Low trading fees: Consult online ratings and reviews of brokerage firms to assess their trading fees.
Dollar cost averaging: The best way of compensating for fluctuations of market prices is to make monthly contributions to the investment account which will then purchase varying numbers of investment units (i.e., shares) depending on the market price. Dollar cost averaging requires a dependable source of money (e.g., payroll deduction, bank account) and a receptive account (e.g., direct deposit plan, 401-K, brokerage).
Taxes reduce the profits from investing. Here are several ways of protecting the profits from taxes:
The Kiddie tax defers some of a child’s investment returns from taxes.
Tax-efficient investments reduce the capital gains & dividends taxes (e.g., growth stocks) or state taxes on bond interest (e.g., muni-bonds).
Federal taxes are not charged on the profits from Roth retirement and Education Savings accounts.
Long term investing: stock prices rise and fall frequently during the short term, but in general the price of a stock will gradually rise in the long term. The young investor can expect a rise in stock price over 30-70 years.
Diversified investments: Some stocks fail to earn returns for the investor. Consequently, it’s a good idea to own several different kinds of stocks to protect the total investment.
“College” is a Big Project
“College” is defined as any 2-year, 4-year, or career school after high school graduation. College prep is a family enterprise that prepares the high school student to negotiate their admission to college. Negotiation is the bargaining process that occurs between the student who wants to attend a desirable college and the college who wants to admit desirable students. The student’s ideal financial goal is to balance the cost of college with family savings and scholarships. Financial aid is only used if needed (chart 7).
TIMELINE FOR COLLEGE PREP
Family starts saving for college 15-18 years early with a “529 Plan” or “Coverdell account” owned by the parents. Grandparents can help fund the plan.
Family has early discussions about college and the opportunities offered by a college education.
Student starts seeking scholarships during the freshman year of high school. Start with the school guidance counselor and librarian. The family can help with the research, proof-readings, practice interviews, travel costs, etc.
Student reduces the cost of attending college by earning college credit during high school.
Family applies for financial aid during the senior year of high school.
FAFSA (Free Application for Federal Student Aid) is required by all colleges.
CSS Profile (College Scholarship Service Profile) is required by colleges that award non-federal aid
Student negotiates the terms of college admission.