Most adults don’t fully understand investing, so how are we supposed to explain it to a child? My advice is to keep it simple, teach with stories, and practice with real money. The goal is to teach them the foundational principle that their hard earned money can make them more money if they invest it wisely. But, if they choose to borrow money, they will be making money for someone else.
I believe children need to understand debt first. They need to understand that if they borrow money, it will cost them something (note that this is the opposite of investing). This can be a difficult concept to communicate to kids, but we have found that talking openly with our children about our family finances helps.
I’ve used a mortgage schedule similar to this one to show our kids how much we pay in interest and principal. We want them to see how much of our payment goes to reducing the loan and how much goes to the bank as an interest payment. Kids are smart and quickly understand how much more fun it would be to spend the money instead of using it to pay interest.
Teaching your kids about loans and interest can be quite amusing... When our kids learned that we didn't own 100% of our home, they immediately wanted to know which rooms we owned and which ones the bank owned!
What will work even better is giving your children some personal experience with borrowing. Try giving them a loan and charging them interest. So let’s say, for example, that your child gets an allowance and her payday is Friday. But when you take her shopping on Monday, she wants to buy a toy for $5. She doesn’t have the money now, but she will in a few days. Explain that you will lend her the $5, but that she will have to pay you back $6 or $7 dollars for getting the money early. Perhaps she will refuse your offer, in which case you can congratulate her wise decision to wait until she can make her purchase interest free. If your child accepts your offer, it’s a great opportunity to discuss things that are and are not acceptable to carry debt for. But, ultimately, if she will accept your offer, I’d suggest you follow through with the loan and interest charge since experience is often the best teacher.
Another thing we have done to teach our kids about debt is allow them to borrow money with a specific plan for them to earn money to pay us back. It goes something like this: yes, I will lend you this money, but you will have this list of jobs to do that must be completed by x date in order to pay me back. This is meant to be reflective of the work we do to earn money and the due dates of payments when we borrow money in the real world.
There are teachable moments along the way when your child wants to go outside and play, but they are not free to do so yet, because they haven’t completed their extra jobs for the day. Or, perhaps worse, the realization that they are dedicating themselves to all this hard work without any future payoff is a great reality check. Maybe they want to start saving for something else, but they can’t do that either because they have to use the money they’re currently earning to pay you back. In my opinion, this is one of the best ways to teach kids about how the borrower is enslaved to the lender.
Once your children understand debt, it’s time to move on to investing. Just focus on how to use the money they already have to make more money. After we felt comfortable that our kids understood the principles of saving, we established the “Bank of Ellisor.” This bank had extremely generous terms. Basically, if you invested your money in this bank for 3 months, you got double your money back. We found that the reward needed to be high in order to help them understand the benefit. What kid wants to invest $5.00 in order to get $0.25 three months later? But investing $5 and getting $10 back three months later? Now that’s something that most kids would consider!
After they have mastered the basic concepts, I would encourage you to teach them about long-term investing. You can have them develop a list of stocks and help them look up the value. To keep it relevant, try to focus on companies that they actually use products from or at least see in their everyday life. Yahoo Finance, Google, and numerous others have easy ways to build a hypothetical portfolio, so it’s a great way to introduce your children to the stock market. Make it fun by tracking the performance and turn it into a household competition. You might be surprised to find that your kids are better stock pickers than you are!
Here are my son's stock picks from when he was 6. The tech stocks doubled in the first 2 years. Not bad for a novice!
If tracking stocks is not your thing, then just focus on teaching compound interest. The ultimate goal should be to position your kids to leave your home one day with these understandings:
the borrower becomes a slave to the lender, and
the key to building wealth is earning, saving, and then investing.
If you do this, you will have financially responsible children who have the knowledge they need to make wise decisions as they earn more and more money. These are concepts that will serve them well throughout their entire lives. If they keep them in practice, they can live a life of true financial freedom, which is what everybody wants.
I hope this series on Kids & Money has inspired you to make good use of the extra time you have with your children this summer. If you missed the first two posts, you can go back and read Part I HERE and Part II HERE.
Feel free to reach out to me with any questions or comments. I love hearing back from you each week!
P.S. If you don't like my advice, just have your kids read Easy Money by Robin Banks. ;)