When it comes to advice on how to teach your kids about money, it’s hard to sort through the not-so-great stuff to get to the “oh, that’s helpful!” parts.
It’s unfortunate because experts say that it’s important to broach the subject of money with kids at a young age, but studies show that parents are more comfortable discussing bullying, drugs and smoking than family finances or investing.
“There’s no way to expect a child at any age to understand money unless you talk about it,” says Neale Godfrey, author of “Money Doesn’t Grow on Trees: A Parent’s Guide to Raising Financially Responsible Children.”
So what should you talk about? Godfrey walks us through what she thinks are the five most important financial conversations to have with your kid.
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1. People Earn Money at Their Jobs
Teaching children the importance of hard work is part of what Godfrey calls the “no entitlement program.”
“It’s about raising kids who understand money doesn’t grow on trees,” she says. You’ll know your child is ready to learn what it means to have a job when she starts nagging for money to buy things. “Once your kid recognizes that you’re using money to make purchases, usually around 3 years old, it’s time to teach her where that money comes from,” adds Godfrey.
Best Approach: Discuss how you picked your career, and what you do at work–and then ask her what she might like to be when she’s older. Consider also paying your kid extra cash, beyond her allowance, for tasks that she accomplishes related to that career. For example, if she wants to be a veterinarian, put her in charge of walking, bathing and feeding the dog, and pay her slightly extra for the tasks.
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2. You Need to Budget If You Want to Buy Things
A lot of parents forget to explain to their kids what they’re supposed to do with money once it’s earned. “When you’re a child, and you’re given a lump sum of money, if no one teaches you what to do with it, you’ll grow up thinking it’s all meant to be spent,” says Godfrey.
Best Approach: Children as young as three can start receiving an allowance, and with that allowance comes the idea of budgeting and saving. Godfrey suggests using four clear jars (the visual aspect is important for kids), and sitting down on allowance day with the jars to divvy up the money into 10% for charity, 30% for quick cash, 30% for savings to be used in the next couple of years and 30% for long-term savings.
“When you’re at the store, have your kid point out items that she wants,” says Godfrey. “For less expensive things, tell her that she can pay for those out of her “quick cash,” but for more expensive items–like a bike or a video game system–she’ll need to save up for them using her “long-term savings” jar.”
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3. Giving Back Is Just as Important as Saving for Yourself
If your kid has allowance jars, he’ll know that part of his money has to go toward charity. Now you just need to pick the charity–and make it a habit.
Best Approach: Giving back is an important part of life, but the concept may take some getting used for small kids. “The easiest way to help your kid understand why it’s so important is to first involve him in ways that he can see how he’s making a difference, like helping at the food bank or sorting through clothes for the homeless,” says Godfrey. As he gets older, search through Charity Navigator together to find an organization that interests him, and make donating to that organization a regular routine on allowance day or at the end of the month.
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4. Good Financial Responsibility Means Managing Financial Tools Well
Kids who start budgeting with cash from an allowance often find it hard to make the transition to checking and savings accounts, credit cards and the idea of investing. It’s your job to teach your kid how to use these financial vehicles responsibly.
Best Approach: Godfrey suggests these three tactics:
1. Checking and Savings: Set your kid up with a savings account around the age of five. (Learn more about the ins and outs of opening a custodial savings account for your kid.) Even though most banking is done online these days, it’s important to physically take him to the bank, so he can see where his money is going–and that it’s in good hands.
Once he’s opened a checking and savings account, pay your child his allowance in check form, and go to the bank together to deposit it. Then open an online account together, which you can monitor, and explain how online banking works. You can even reserve his savings account for different categories–charity, medium-term savings or long-term savings–so he can get the satisfaction of watching the numbers go up with each deposit.
2. Credit Cards: Once your kid proves that he can manage the basics–he’s held a summer job successfully, saved up a certain amount in his savings account, has never overdrawn his checking account–set him up with a pre-paid credit card, ideally around the time that he’s set to leave for college or take a full-time job. Pre-paid cards are good because they work like regular credit cards, but your child won’t be able to accrue debt, since these cards have a set spending limit.
3. Investing: Godfrey says that you can introduce the concept of investing around the age of 10. “Start by finding stores and companies your kid loves, and purchase small amounts of individual stock for her, so she can watch it grow,” advises Godfrey. “As she gets older, explain the idea of finding companies and products that are recession-proof and why that’s so important when it comes to long-term investing.”
A note from LearnVest Certified Financial Planner (CFP) Brandie Farnam: “Owning a little bit of stock in a company that the child likes can help teach the concept of ownership and volatility, but focusing on the stocks themselves is emphasizing the wrong part of the process. It ignores the most critical aspects of successful investing–choosing an appropriate risk level for your goal, and diversifying your portfolio.
So I’d encourage parents to make sure that their child isn’t left with the impression that successful investing is about picking stocks. Instead, try to introduce the important concept of diversification and not putting all of your eggs into one basket–the goal is to spread your risk across different types of investments.”
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5. Everyone Has to Pay Taxes–Even You
Explain to your child that everyone has taxes taken out of their paychecks to keep things running smoothly in the country. Tell him that the salary he sets up for himself for his job–mowing the lawn, doing household chores–isn’t the same amount that he’ll be getting in his take-home pay.
Best Approach: Starting at age 10, put your kid in a 15% tax bracket and have him deduct that money from his allowance into the family tax jar, suggests Godfrey. “Of course, you’ll need to explain that, in real life, this money goes towards things like keeping our roads clean and safe, but at home, your family can vote on a quarterly basis how to use the tax money,” says Godfrey. “This will help avoid the freak out later when he gets his first paycheck and he’s like, ‘Who’s FICA, and why is he taking money out of my salary?’”